DAOs and the Centralisation of Voting Power

Decentralised Autonomous Organisations (DAOs) provide a novel way of governing, using smart contracts that automate voting in a trustless and transparent way. However, in many DAOs the voting power is overly concentrated to a few members. In this post, we examine the reasons and consequences of concentration, together with the governance trade-offs that DAOs face.

Introduction

Decentralised Autonomous Organisations (DAOs) are entities which are not controlled by a central governing body but by its members, who hold governance tokens. Instead of appointing a CEO and a Board of Directors, the members of a DAO make proposals that are then voted by anyone who holds the tokens. The process of nominating and voting is transparent as it is written in code, using smart contracts. Governance tokens are usually issued and sold at the start of the project or airdropped. They are used not only to govern the organisation but also to bootstrap the creation of a network and fund the development of the project. 

DAOs are one of most successful use cases of Distributed Ledger Technology (DLT). They control DeFi projects, such as Uniswap and MakerDAO, virtual worlds such as Decentraland, social clubs and NFT creators such as Bored Ape Yacht Club, and they provide grants, such as Gitcoin. In terms of assets under management and number, DeFi DAOs are by far the biggest, as shown in Figure 1.

Figure 1: Total assets held and number of DAOs by Web 3.0 category 

Source: “Dissecting the DAO: Web3 Ownership is Surprisingly Concentrated”, Chainalysis, 2022.¹

Centralisation of Voting Power

Although DAOs are designed to be decentralised and not controlled by anyone, in practice there is significant concentration of voting power among a few members. Figure 2 shows that, across a number of DAOs, a very small proportion of members hold more than 90% of all governance tokens. 

Figure 2: share of users holding 90% of all Governance tokens by DAO 

Source: “Dissecting the DAO: Web3 Ownership is Surprisingly Concentrated”, Chainalysis, 2022.¹

Moreover, although every token holder can vote on a proposal, not everyone can create one. For these 10 DAOs that Chainalysis studied, members need to hold between 0.1% and 1% of the token supply to create a proposal, and between 1% and 4% in order to pass it and present it for voting. This makes concentration an even more significant problem. As Figure 3 shows, less than 0.10% of members can create a proposal.

Figure 3: Share and number of holders that can create a proposal

 

Source: “Dissecting the DAO: Web3 Ownership is Surprisingly Concentrated”, Chainalysis, 2022.¹

If voting power is overly concentrated, the legitimacy of the DAO and its decisions may be questioned. In June 2022, the DAO that controlled the Solana based Solend, a lending protocol, voted to take control of one of the biggest debtor accounts of Solend. The purpose was to liquidate their position, worth $20 million of Solana, with over-the-counter operations. The justification was that, if the account holder could not meet the margin requirements as Solana’s price was dropping, the whole $20 million would be automatically dumped in the market, hurting both Solana and Solend. The proposal passed easily with 1 million “yes” votes and only 30,000 “no” votes. However, the 1 million “yes” votes originated from a single account. This created a huge backlash, not only because someone’s account was being confiscated, but also because the decision was made by essentially one person. In the end, the decision was reversed.

The DAO Tension Triangle

The thresholds for creating and passing a proposal highlight a basic trade-off for a typical DAO. On the one hand, allowing any user to create a proposal would greatly increase the number of proposals while lowering their average quality. Voting on all these proposals would distract the core members of the network from further developing the project. On the other hand, concentrating the proposal power to the hands of a few may alienate most users who may slowly drift away and choose not to participate in the organisation. 

More generally, the trade-offs in a DAO are three-dimensional, as shown by the DAO Tension Triangle in Figure 4.² On one dimension, as a DAO becomes more centralised, its members may become less loyal and stop participating in its governance. A very decentralised DAO will inspire loyalty among its members, as it gives them a voice in governing, however the quality of the proposals may decline and governance will suffer, as explained above. Finally, a ledger allows a participant to control their own information and hence they are not locked into a platform, unlikely when it is centralised. However, this makes it easier to exit the platform, effectively reducing the loyalty of its members. This detrimental effect of the exit opportunities on loyalty can be partly addressed if the users think that the price of their governance tokens will appreciate, then they are willing to stay within the network. 

Figure 4: The DAO tension triangle

 

Source: “DAO: A Decentralized Governance Layer for the Internet of Value”, George Samman and David Freuden, 2022.

The Limits of Decentralisation

DAOs encompass the ideal of direct democracy, where governance is conducted by discussing all issues in an open forum and by allowing anyone to make a proposal that can be voted in or out. It was technically impossible to conduct such a form of governance for large groups of people, in a transparent and trustless manner, until the advent of Distributed Ledger Technology. However, even though concentrating voting power to a few is certainly detrimental for a DAO, there are still limits to how decentralised the governance can be. An organisation must make several decisions every day, but the time and attention are limited for token holders who are not working for the DAO full time. This means that, unavoidably, a big part of a DAO’s decisions will be taken by a small group of core contributors, who tend to hold most of the tokens. Even if all members had unlimited time, the impossibility theorem of Arrow teaches us that for complex decisions, which involve three or more alternatives, there are not really any good electoral systems that can represent their preferences in a satisfactory way.³ In other words, direct democracy is not an effective form of governance. This means that there are limits on how decentralised the governance of a DAO can be, which cannot be overcome by technology alone. More importantly, as DAOs grow, they cannot escape the fact that, to be governed effectively, they need an organisational structure with roles and responsibilities for their core members.

Conclusion

Distributed Ledger Technology has provided the members of a DAO the ability to quickly vote on any issue, making governance more direct. This is a big improvement when compared to a traditional public company, where shareholders are consulted only once a year. However, direct democracy is not an effective form of governance and the fact that DAOs are structureless is one of the reasons why the core members have the incentive to hold the vast majority of the tokens, in order to control the creation and voting of proposals. Eventually, DAOs will need to adopt some form of corporate structure, which will then decrease the need for excessive concentration of voting power. 

Footnotes

¹ The report can be accessed at https://blog.chainalysis.com/reports/web3-daos-2022/.

² For more details, see “DAO: A Decentralized Governance Layer for the Internet of Value”, George Samman and David Freuden, 2022.

³ For more details on Arrow’s impossibility theorem, see https://plato.stanford.edu/entries/arrows-theorem/. 

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