Abstract
Corporations and other forms of business organizations can be supplemented with blockchain-based agency constructs. Blockchain-based decentralized autonomous organizations (DAOs) expand the definition of the firm. On-chain DAO governance enables dynamic regulatory features that facilitate unprecedented decentralized regulatory solutions.
Key Words: Corporate Governance, Decentralized Autonomous Organization, Blockchain, Distributed Ledger Technology, Regulation, Protocols, Optimization, Efficiency, Governance, Dynamic Regulation, Principal-Agent, Emerging Technology, Agency Cost, Monitoring, Feedback Effects
JEL Categories: K20, K23, K32, L43, L5, O31, O32
TABLE OF CONTENTS
II. Business Organization Revisited. 7
1. Distinguishing Features of Decentralized Systems. 7
3. The Theory of the Firm Revisited. 10
III. Governance Shortcomings in DAOs. 11
1. Centralized Design Elements in the Original 2016 DAO.. 12
2. Lack of Proper Incentivization. 15
4. Lacking On-Chain Voting Mechanism.. 18
6. Decentralized Infrastructure Requirements. 21
IV. Dynamic Governance in Decentralized Systems. 22
1. Shortcomings of Centralized Governance in Decentralized Systems. 23
2. Benefits of Dynamic Decentralized Governance. 27
V. Optimizing DAO Governance. 29
2. Level of Decentralization. 32
4. On-Chain DAO Governance. 34
5. Reputation-Based Governance. 38
VI. Reforming Corporate Governance. 40
I. Introduction
Corporate governance is characterized by agency constructs. The agency relationship in modern finance and corporate governance is characterized by attempts to optimize incentives between principals and agents, control costs, minimize information asymmetries, control adverse selection and moral hazard, optimize risk preferences between principals and agents, and engage in monitoring. The Corporate form remains the most popular form of a governance mechanism, despite the unresolved substantive agency problems associated with the division of ownership (shareholders) and control (agent),[1] and the incomplete and suboptimal rules that govern such conflicts.
Shareholder value maximization has emerged as the dominant corporate governance solution for the agency problems.[2] To reduce the risk of managerial misbehavior and the associated agency problems,[3] alignment of the interests of the stakeholders within those of the investor-shareholders has become the dominant implementation of the shareholder primacy doctrine.[4] The doctrine suggests that by aligning the interests and incentives of the various actors with those of the investor-shareholders all of the stakeholders in a firm and the public benefit.[5] Following this logic, increasing shareholder control over other actors within the firm has become the primary goal of corporate governance rules.[6] The correct corporate governance is seen as naturally resulting in shareholder value.[7]
The existing corporate governance attempts for inevitable agency problems fall short of accomplishing the needed governance quality and stability. In an effort to curtail the inevitable instability that is a by-product of the pervasive agency problem in the corporate governance system,[8] governments have responded to corporate governance scandals by adopting a number of regulatory changes. Such changes include substantively increased disclosure requirements.[9] Shareholder activism reform by itself has been unable to sufficiently improve the corporate governance system.[10] Upgrading the U.S. proxy system has been another government priority.[11] Changes in executive compensation has been another approach to address the instability of the existing corporate governance system.[12] Government-sponsored organizational experimentation that enables new business models and new organizational structures is desirable and valuable and may be one of the few ways to facilitate the much needed corporate governance reform.[13]
Despite decades of governance experiments and extensive rule revisions, the existing scope of agency problems suggest that the core underlying agency problems cannot fully be resolved within the existing theoretical and legal infrastructure.
Blockchain-based technology has started to offer alternatives to the existing corporate governance solutions. Blockchain technology can facilitate the removal of agents as intermediaries in corporate governance through code, peer-to-peer connectivity, crowds, and collaboration. Blockchain-based guarantees embedded in blockchain code can help ensure that no participant in business transactions and agency relationships can circumvent the set of governance rules. Blockchain guarantees include contract execution between principal and agent only if and when all contract parameters were fulfilled by both parties and verified in a consensus algorithm. Hence, in the blockchain infrastructure, a lower level of oversight and monitoring of agents changes the cost structure of the principal-agent relationship.
Smart contracts enabled by blockchain technology allow for the comprehensive, near error-free, and zero transaction/agency cost coordination of agency relationships. Smart contracts and smart property are blockchain-enabled computer protocols that facilitate, verify, monitor, and enforce the negotiation and performance of a contract between principal and agent. Agency relationships in smart contracts run exactly as coded without any possibility of opportunistic behavior of the agent. All contractual terms are public and fully transparent. Accordingly, a company’s finances, for instance, are visible on the blockchain to anyone, not just to the company’s accounting department. Smart agency contracts run on a custom-built blockchain, that enables principals and agents to store registries of debts or promises, create entire markets, among many other aspects that have not yet been considered.
Blockchain-cased legal constructs, known as decentralized autonomous organizations (DAOs), have started to challenge the core belief that governance necessitates agency. The first DAO, launched in May 2016, in the founders’ attempt to set up a corporate-type organization without using a conventional corporate structure, had a governance structure that was entirely built on software, code, and smart contracts that ran on the public decentralized blockchain platform Ethereum.[14] Because it was pure computer code it had no physical address, no jurisdiction that could claim jurisdiction/control over it, and it was not an organization with a traditional corporate hierarchy. The DAO did not use a traditional corporate structure that necessitated formal authority and empowerment flowing top-down from investors/shareholders through a board of directors to management and eventually staff. Indeed, it had no directors, managers or employees. In essence, all the core control mechanisms typically employed by principals in agency relationships were entirely removed in the DAO.
For purposes of this article, the DAO is a group of anonymized individuals who decide to follow a certain protocol. For instance, the Uber DAO can be seen as Uber the company with all its constituents except without the company, e.g., the entity, itself and its hierarchical governance structures. If Uber were a DAO, the Uber drivers as a group with their respective non-fungible token holdings would become Uber, e.g., a fully decentralized company without hierarchies. The control and power over the Uber DAO would be in the hands of the DAO Uber token holders. Yet, the staking mechanisms for non-fungible tokens in emerging DAO protocols make the voting structure different than any previous attempts at creating liquid democracies.
DAOs are by no means mainstream and are subject to a significant emerging development process. Because the blockchain industry is still in its infancy and core decentralized infrastructure elements will remain lacking for the foreseeable future, DAOs are less likely to disrupt existing corporate structures and the associated governance solutions in the foreseeable future. However, DAOs have the potential to create significant decentralized equivalents of corporate structures. Such development is contingent on workable governance solutions for DAOs. Without DAO governance, their evolution is even less certain. The blockchain industry has started to recognize the need for DAO infrastructure and governance solutions. Yet, such governance solutions are still largely lacking, even in the developmental phases.
Blockchain-based corporate governance solutions in DAOs require evolutionary blockchain governance protocols. Existing blockchain governance still mainly consist of forking a given chain. Even attempts to create socially optimal chain forking rules cannot suffice. Blockchain-based coded guarantees will evolve and require protocol upgrades for that changing environment. Without evolutionary governance upgrades the cost reduction for the agency relationship cannot be maintained.
II. Business Organization Revisited
Blockchain-based corporate governance only limitedly works in traditional corporate forms. While several US states, including the state of Delaware, have started to evaluate the use of blockchain-based technology for their proxy systems and for the transfer of stock ownership, among other benefits, the traditional centralized forms of limited liability entities can only partially benefit from the decentralized governance offered by blockchain technology. Blockchain-based corporate governance offers dynamic regulatory features that are partially incompatible with the rule-based traditional legal environment that traditional limited liability entities are required to comply with.
1. Distinguishing Features of Decentralized Systems
Existing decentralized systems display several core commonalities that affect commerce and society. Decentralized systems do not have a central intelligence or leadership system based on traditional hierarchies. Instead, the intelligence is spread throughout the system. Information and knowledge naturally filter in at the edges of the system, closer to where the action is and where most real-time information is created. Decentralized systems can also very easily mutate and change because the information flow is optimized through dynamic feedback effects. As a result, such systems become more attack resistant on multiple levels. In turn, the ability to mutate quickly allows the decentralized systems to grow incredibly quickly.
DAOs can be more efficient than hierarchical organizations and their governance. In a hierarchical organization power is organized in a hierarchical tree structure by necessity. Governance in a hierarchical organization follows the tree structure and supplements the power structure further with agency constructs. By contrast, in a DAO, ideally each member is given autonomous power. The power distribution in DAOs enables greater flexibility and enhanced options for efficiency using the decentralized power structure of interacting domains of expertise. DAOs can be more productive in comparison with hierarchical organizations because the information allocation and feedback effects allow them to distribute the optimal amount of power to the optimal talent at the optimal point in time. The successful implementation of such dynamic power organization requires a decentralized governance structure that motivates DAO token holders to collaborate productively, by fairly rewarding development, work, and the policing of any diminishments.[15]
2. Original 2016 DAO
The original 2016 DAO had many original features that distinguished it from traditional forms of business organization. During the DAO crowdfunding campaign in May 2016, investors could become DAO constituents by purchasing DAO Tokens.[16] The DAO raised more than $168 million from approximately 10,000 “investors” and was considered the largest crowdfunding campaign in its days. The original 2016 DAO, in the founders’ attempt to set up a corporate-type organization without using a conventional corporate structure. The founders’ central idea was that the wisdom of the crowd would lead to smarter and more game-changing investment decisions.[17] The original 2016 DAO had to operate as a kind of venture capital fund managed directly by the token holders.[18] The DAO governance structure was built on software, code and smart contracts that ran on the public decentralized blockchain platform Ethereum.[19] The original 2016 DAO did not have a physical address as it was merely computer code. And it was not an organization with a traditional hierarchy as we know it from traditional corporate structures where authority and empowerment flow downwards from investors/shareholders through a board of directors to management and eventually staff.[20] Indeed, it had no directors, managers or employees. Because a series of smart contracts granted original 2016 DAO token holders voting rights, the blockchain-based smart contracts imitated the role of articles of association or bylaws. Because the DAO code was open source, the token holders would not only vote on “investment proposals”, but also on any change made to the code.[21] Accepted proposals would also be backed by a software code, defining the relationship (in terms of rights, obligations and performance metrics) between the DAO and the funded proposals.
The hack of the original 2016 DAO called the evolution of DAOs as governance vehicles into question. Fundamental flaws in the original 2016 DAO code enabled hackers to transfer one third of the total funds to a subsidiary account that could not be controlled by either the hacker or the original 2016 DAO members and founders.[22] The hack in combination with additional technological limitations terminated the original 2016 DAO initiative.
In order for future generations of DAOs to operate successfully and facilitate governance solutions, the outstanding legal issues need to be addressed. While legal solutions are slowly emerging around the world, it is still unclear whether DAOs would be subject to taxation, what legal regime could govern the issuance of DAO tokens, and if minority DAO token holders can be protected. It is also still unclear if coded smart contracts that coordinate DAO member behavior are legally binding in the existing legal infrastructure.
3. The Theory of the Firm Revisited
The various interpretations of the theory of the firm suggest that firms exist to reduce transaction cost and as a response to the high cost of using markets.[23] Coase suggests the existence of the firm can be explained by the incentives to internalize transactions in order to free workers/collaborators from the need for external regulation.[24] A well-defined task can easily be put out to the market, where a contractor is paid a fixed sum for doing it. The firm is needed when simple contracts of this kind will not suffice. Instead, an employee agrees to follow varied and changing instructions, up to agreed limits, for a fixed salary. Others define the existence of a firm as the added efficiency of a centralized production-monitoring agency.[25]
Inexpensive open-source smart contracts eliminate a major motivation for creating a firm under Ronald Coase’s transaction cost theory.[26] Coase posits the existence of the firm derives from the incentive to internalize transactions in order to free workers/collaborators from the need for external regulation, such as costly contracts for minor engagements (e.g., coworkers sharing office supplies).[27] Smart contracts enable trustworthy transactions of any size with minimal transactions cost and high levels of transaction security. Barzel’s motivation for the existence of a firm, the added efficiency of a centralized production-monitoring agency,[28] is also largely irrelevant with efficient smart contracting as the smart contract performs the production-monitoring function and largely removes agents.
DAOs challenge the various versions of the theory of the firm, stretch the definition of a firm, and question the need for firms. Existing experimentation with DAOs designs already violate fundamental assumptions about firms, such as the hierarchical organizational structure, the separation of firm members from market members, the cultural or technical homogeneity of members, and many other natural definitions for a firm.
Decentralized transaction cost economics call into question the theory of the firm. If the high costs of using markets, that legitimize the existence of the firms, can be lowered ad infinitum, it becomes questionable what the role of the firm can be. Peer-to-peer transactions in DAOs, facilitated by trust through decentralized consensus protocols and other emerging decentralized technology, can significantly lower transaction costs. Monitoring costs and the cost of agent supervision are largely superfluous in effective DAO designs. Overall, emerging DAO designs can be expected to continue to remove transactions cost. DAOs evolving design makes them a more efficient business organization vehicle, especially comparison with traditional firms.
Economy of scale advantages of centralized firms are challenged by the evolving efficient DAO designs. Decentralized organizations can be organized effectively to achieve greater economies of scale and greater efficiency than traditional centralized firms. Existing DAO designs only give an early glimpse of what may be accomplished by future generations of DAOs. Future DAO efficiency can be significantly increased through parameter manipulations to DAO protocol development, security, stability, recruitment and retention of members and outside business. With such parameter upgrades, DAOs enable an eternal, reviewable record of all members’ actions that can facilitate a decentralized organization and achieve greater efficiency than traditional firms.
III. Governance Shortcomings in DAOs
Like any business organization governance design throughout history, the evolving governance designs of DAOs is subject to significant shortcomings. DAOs lack the centralized authority used throughout history to organize society, guide individual and organizational behavior, and enforce rules agreed upon by constituents. From a centralized perspective, such lack of organizational authority results in suboptimal governance outcomes for DAOs. Yet, evolving DAO governance designs can offset lacking centralized organizational authority with more efficient decentralized organization.
DAOs require governance mechanisms when inevitable gaps arise in the incomplete smart contracts of the firm. Corporate law’s core role revolves around the supply of majoritarian default rules that fill the gaps of parties’ necessarily incomplete contracts.[29] Corporate governance solutions in the existing legal infrastructure and emerging coded governance solutions have a core common denominator, they are both incomplete contracts. As such, neither can anticipate all problems and eventualities that may arise in the respective entities. Decentralized code-based systems are a nexus of necessarily incomplete smart contracts. Unlike existing corporate governance systems, however, the decentralized nexus of incomplete smart contracts does not have a supply of majoritarian default rules that could fill incomplete code-based smart contracts. The default rules provided by corporate law are largely incompatible because they are based on natural language, among other incompatibility factors. Accordingly, blockchain-based entities have a governance problem like all governance systems that are based on incomplete contracts.
1. Centralized Design Elements in the Original 2016 DAO
The failure of the original 2016 DAO highlights the need for sustainable decentralized governance solutions. The core governance failure illustrated by the 2016 DAO is its failure to create dynamic governance protocol upgrades in real-time through dynamic feedback loops. When the flaws in the original 2016 DAO code materialized, the DAO members were unable to evolutionarily vote for a protocol governance upgrade. Their voting structure was set up to vote on investment proposals, not on governance design. Rather, the platform that hosted the 2016 DAO, had to vote on it, which lead to a hardfork of the Ethereum blockchain. Because of its systemic centralized infrastructure, the original 2016 DAO lacked a dynamic governance mechanism that should have allowed its token holders to vote for a change of the flawed code as its flaws materialized.
The original 2016 DAO was subject to several, then necessary, elements of centralization that undermined its ability to create sustainable decentralized governance solutions. The points of centralization in the original 2016 included the use of centralized decision makers, the voting structure, the payment structure, the lack of staking, among several others.
The voting design in the original 2016 DAO introduced points of centralization and corruption. The tokens of the original 2016 DAO gave token holders ownership rights, voting rights, and property rights. [30] These features are comparable to stock in traditional corporations. Just as in the traditional voting stock of a corporation, the original 2016 DAO token allowed its holders to vote on DAO investment proposals. Token holders with more tokens held more voting power than token holders with fewer tokens. Voting proposals in the original 2016 DAO did not involve staking of any non-fungible tokens towards a vote outcome. Nor had those voting proposals a randomization element. All voting in the original 2016 DAO revolved around centralized voting power. As such, its voting design introduced opportunities to corrupt the DAO and its governance structure.
The governance structure of the original 2016 DAO relied on centralized leadership in the form of “curators.”[31] The 2016 original DAO did not have an autonomous decentralized validation pool for contractor proposals.[32] The curators created and controlled the whitelist of those preselected contractors that were authorized to receive ether from the DAO. [33] Because the smart contract on its own could not distinguish real from fake proposals, the curators had approval power and vote prioritization power over contractor proposals before the proposals were put up to a DAO community vote. DAO token holders who had been selected as contractors through a DAO member vote needed the curator’s verification that the smart contract submitted by the token holder matched the public smart contract on the Ethereum blockchain and that the contractor’s identity matched.[34] The curator, thus, were the core point of centralization in the original 2016 DAO design. Curators would have become the control bottleneck of the original 2016 DAO as they would have had control not over the contractor selection itself, the DAO voted on that, but over the addition of project proposals via smart contracts to the Ethereum blockchain.[35]
The payment structure for smart contract work proposals in the original 2016 DAO introduced a point of centralization. Any tokenholder in the original 2016 DAO was eligible to submit a proposal via smart contract for a DAO vote to become a contractor for the tokenholder community. Yet, the requirement to pay an ether deposit that the tokenholder would forfeit if the proposal failed to achieve the quorum requirement introduced a point of attack and centralization. Fungible cryptocurrencies, such as ether, are by their very nature a corruptive element. Decision makers can be influenced by the power that derives from fungible currency. Power can grow with the size of fungible cryptocurrency holdings. Decentralized decision making necessitates non-fungible payouts metrics combined with an indirect fungible payout structure.
Similarly, the payment structure for curators and contractors of the original 2016 DAO created points of attack on the overall governance structure of the original 2016 DAO. Any projects that were approved by the original DAO token member community would have required the contractor or curator to complete the approved task in exchange for ether from the DAO. Direct payments to the curator or contractor in a fungible cryptocurrency create points of attack and corruption for the governance structure. If curators’ and contractors’ payment come from a fungible currency source without a direct or indirect penalty for underperformance, such as lower token scores, DAO contractors and workers may be corrupted by external sources. A non-fungible form of payment with a penalty for underperformance would make those corruptive elements less likely.
2. Lack of Proper Incentivization
Existing DAO governance design structures failed to take into account the historical precedent on governance. Humanity has been debating governance designs since the inception of human organization.[36] Common core denominators of existing problems in governance design include the corruptive effects of existing governance designs with fungible assets as well as identity of actors in governance designs. These factors contributed to the resulting inability to govern institutions effectively.
The lack of proper incentivization is a core common denominator for all existing blockchain governance structures and especially on-chain governance structures. The participants in any institution need to be incentivized to improve their own utility while at the same time benefiting the entirety of the institution for the long run. Without that duality of incentivization, rational and opportunistic internal and external constituents will attempt to game the governance design.
Throughout history, when fungible assets are used as the dominant incentive design in the governance of institutions with identifiable actors, rational and opportunistic internal constituents and external participants have attempted to corrupt the system. If the governance and incentive alignment design via fungible assets allows for the optimization of personal utility, people will continue to try to game the governance design to maximize their personal utility at the expense of the common good of the institution and its members.
Identity of actors in governance designs contributes to corruptive elements. Throughout history, governance designs were created by identifiable members of institutions for their fellow members. Regulators and regulatees are usually able to identify each other individually. In these identifiable circumstances for institutional governance design, people have failed throughout history to organize effectively. Corruption is possible if actors can be identified. Every instantiation of institutional governance design involving identifiable humans was afflicted by corruption sooner or later.
3. Lack of Default Rules
Default rules provide flexibility and cheap legal solutions for businesses. U.S. corporate law provides relatively few mandatory rules.[37] Rather, business association law provides default rules to fill gaps in contractual associations.[38] Such default rules create a nexus of contracts that are available if and when needed. Contracting parties can tailor the default rules. Parties do not have to anticipate all eventualities that may arise in their relationship because the default rules provide a nexus of contractual provisions that are available if and when eventualities materialize. This creates legal certainty and the associated economic benefits.
Blockchain-based smart contracting calls into question the application of existing default rules. For business associations organized via smart contracts on the blockchain, aka DAOs, existing jurisdictional points of legal intervention are less clearly established. [39] Default rules afforded by the existing legal system are less likely to provide the established nexus of default contracts for blockchain-based transactions. However, the architects, designers, and coders of a given smart contract ecosystem can affirmatively opt into the existing legal order through code. If and how such opting-in would be legally enforceable in the existing legal order or otherwise is less clear. The existing legal infrastructure still relies heavily on natural language which is antithetical to smart contracting.
The DAO created a type of business organization that exists separate and apart from the existing legal order. DAOs are able to create a decentralized nexus of smart contracts that exist on separate nodes around the world with very limited points of centralization. Well-designed DAOs are in the unique position to create very sophisticated, autonomously, and evolutionarily morphing rules.[40] These DAO rules go beyond any sets of traditionally conceived business association default rules. Well-designed DAOs can create oracles that allow the blockchain to interact with unvalidated data sources.[41] They can provide internal and external governance and interaction with other DAOs, external blockchains, and centralized entities. External governance includes the ability for other non-native DAOs in a given blockchain to opt into the rules and templates for rules provided by a given native DAO that established over time the then optimal set of rules by way of precedent.[42] Because of the decentralized, autonomous, and evolutionary nature of the emerging DAOs, entity organization cannot be traced to any particular individual. In other words, it is very difficult to imagine any particular individual actor that the existing law could single out for jurisdictional reach or liability.
Default rules in the form of fiduciary duties are less relevant in DAOs. Fiduciary duties are a major default rule in the existing corporate governance regime. Fiduciary duties are typically engineered to counteract the corporate governance problems associated with the separation of ownership and control, and the associated agency and moral hazard problems. In the DAO structure such fiduciary duties are less relevant. The autonomous decentralized nature of DAOs makes fiduciary concepts superfluous. The disciplining effect of fiduciary duties on management’s conduct is less needed because centralized management is minimal in DAOs. Moreover, because of the value-to-effort focus of work flows in the DAO structure, supervision of management and imposition of legal duties on management is less redundant because there are fewer or no supervisors. Rather, token holders optimize the DAO together according to their best value propositions in accordance with their unique skillsets, backgrounds, and training.
4. Lacking On-Chain Voting Mechanism
Existing decentralized protocols lack an effective on-chain voting mechanism. A one-token-one-vote voting mechanism in existing decentralized protocols with on-chain governance resembles a plutocracy. Token holders in a given DAO with a significant share of the total supply of tokens have more power than the rest of the DAO members. This is a common phenomenon among decentralized protocols at the end of 2019. For instance, on and around September 12, 2017, 4.11% of the bitcoin addresses controlled 96.53% of the total bitcoin supply.[43]
Suboptimal voting outcomes associated with one-token-one-vote voting mechanisms in existing decentralized protocols can largely be traced back to the immaturity of the existing decentralized protocols. For instance, the low voter participation in existing decentralized protocols[44] underscores the lacking incentive alignment of the respective DAO voters and users. Coin owners of a given network have vested interests in the existing pricing structure of their respective network. The user, if different form the coin owners, of that network typically would like the prices to depreciate.
The immaturity of existing decentralized protocols often also makes it possible to bribe coin owners to vote against their best interest as coin owners if the bribe is sufficiently attractive. For instance, delegated proof of stake protocols such as EOS, Lisk, and Ark are reported to have experienced instances of bribery. Because certain nodes in delegated proof of stake protocols have significant power to validate blocks they are elected by stakeholder votes. That power leads to corruption. Block validation nodes in delegated proof of stake protocols are incentivized to bribe voters to be elected as delegates in exchange for some of the newly inflated tokens.
5. Socially Optimal Forks
Forking requirements in existing decentralized systems are different from other corporate governance settings. Hard forks are unique in governance settings in the sense that only a subset of the population, here the blockchain community associated with a given chain, is subject to the protocol change. The typical mandatory corporate governance rule change affects the entire population either via acts of Congress or agency rule changes.
In the current blockchain governance environment, existing blockchains generally need to calibrate forks for protocol upgrades.[45] Forks result in previously uniform nodes that, after the fork, run a different protocol with different data than the newer version. A soft fork is a backward compatible protocol upgrade. The soft fork creates a new more restrictive protocol rule, e.g. block size limit was 1 MB and is changed by the soft fork to 500 KB. Because it is more restrictive and not more expansive it is backward compatible with the previous protocol rule. By contrast, the hard fork creates a more expansive ruleset and is therefore not backward compatible. For instance, the increase of the block size limit from 1MB per block to 2 MB per block would not be backward compatible because the previous protocol limited the block size to 1 MB. While sometimes forks are merely used to test a process or upgrade,[46] forking is more often used to implement a fundamental protocol change, or to create a new digital asset characteristics.
The necessity of chain forking for protocol upgrades in the existing blockchain infrastructure is associated with significant negative effects. The bifurcation of nodes can lead to significant problems, confusion, errors, economic loss, and bugs. For example, in the case of the bitcoin protocol, changes in defining protocol parameters such as the difficulty of the cryptographic puzzle, the block size, limits to additional information that can be added, among other elements, can result in some blocks being accepted by the new protocol but rejected by older versions of the protocol. A result can be the loss of funds. It is theoretically possible that the two and subsequent chains could grow in parallel indefinitely. The economic loss associated with such parallel existence can be quite significant. The result of a hard fork can also be the reemergence of the double spend problem. Because wallets, merchants, and users running the previous code deem the new code invalid and thus cannot detect the spending on the new code, cryptocurrencies spent in a new block could be spent again on an old block.[47]
Contention is another unique risk of a hard fork that can result in social and political turmoil and the need for blockchain reorganization. If after a hard fork, the respective community cannot agree on which chain is the true chain, e.g. the chain that provides the most likely survivable protocol, it may result in two blockchains that compete in perpetuity. This was the case with the fork that created Bitcoin Cash.[48] The only viable solution is for one branch of a chain to be abandoned in favor of the other branch. However, that can result in some miners losing out because the transactions they may have mined would be re-allocated. It is difficult to switch all nodes to the newer version of the protocol at the same time because decentralized systems are typically too widely spread for cohesion.
The emergence of decentralized evolutionary protocol upgrades can help ensure that future DAOs will be less affected by the negative effects of forks. While the forking necessity in the current system requirements can be socially optimal,[49] the long-term social and economic loss of a fork could be avoided if decentralized systems should one day be governed by autonomous evolutionary governance protocols.[50]
6. Decentralized Infrastructure Requirements
DAO governance is subject to multiple layers of underdeveloped decentralized infrastructure requirements. Most of these infrastructure requirements still necessitate instantiation. First and foremost, it is important to recognize the timing limitations for DAO governance. Blockchain technology is a foundational technology whose transformational impact takes decades rather than years to take hold and reform legacy systems.
Most complex systems and structures that will be reformed by decentralized infrastructure technology are interdependent. Reform and development of one area of decentralized infrastructure technology alone cannot be successful. The existence of multiple additional support structures is needed. Even if the decentralized infrastructure elements are being developed in any of the major areas of use cases for blockchain technology, complex discussions around structural and cultural changes in legacy systems are needed before the technology can be applied.
The evolution of blockchain technology in corporate governance requires parallel evolution in both centralized governance structures and in a decentralized governance environment. The former requires the authorities and ultimately Congress to come to a consensus on how and when to implement such technology for the governance use case. For the latter, a truly decentralized public blockchain that is scalable and fully secure is needed to accomplish decentralized infrastructure evolution. Without it, core issues that have afflicted centralized governance solutions, such as information asymmetries between principal and agent, censorship, opportunism of agents, breaches of fiduciary duties, liability rules for principals and agents, fraud or third-party interference, and overall system corruption may persist. In decentralized systems, reform of the agency relationships is possible if and when a truly decentralized public blockchain emerges that is scalable and fully secure.
As decentralized agency relationships become more complex, a backstop for human behavior in agency relationships becomes necessary. The notion that agency relationships in smart contracts run exactly as coded without any possibility of opportunistic behavior of the agent is less likely to uphold in complex agency relationships. Similarly, without a decentralized human backstop to code, the immutability of the blockchain and its cryptographic security systems may not be able to create truly transactional guarantees and trust between principals and agents in the integrity of their contractual relationship.
IV. Dynamic Governance in Decentralized Systems
Dynamic governance systems are becoming an evolutionary necessity. Historically, the institutional infrastructure for rulemaking was geared towards the creation of rules for governing a relatively stable society with relatively stable economic and market environments. Throughout history, the technological evolution typically coincided with legal innovations. Therefore, dynamic elements in rules were less topical at the inception of institutional arrangements for corporate governance. Since the early days of societal and market evolution, society and markets have evolved rapidly and are becoming increasingly more complex. The growing number of rule enactments, revisions, and revocations in the centralized legal environment suggest that existing rules and institutional structures for rulemaking are becoming less capable of addressing the rapid pace of change. The technological acceleration in combination with the emerging decentralization of commerce and society may add another layer of complexity that necessitates new and reformed dynamic legal approaches for corporate governance in decentralized structures.
1. Shortcomings of Centralized Governance in Decentralized Systems
The existing regulatory infrastructure created suboptimal regulatory outcomes for centralized institutions.[51] Regulatory challenges in centralized institutions were largely the result of facts-based, ex-post, trial-and-error-rulemaking with stable and presumptively optimal rules in the existing regulatory framework.[52] Another factor that contributed to the increasing regulatory challenges was and continues to be the suboptimal timing of regulation.[53] Because facts-based, ex-post, trial-and-error-rulemaking cannot anticipate regulatory issues created by disruptive innovation, existing rulemakers in centralized systems may not at all or much too late realize what new regulatory demands apply to innovation and associated regulatory issues. Rulemakers’ near exclusive reliance on stable and presumptively optimal rules,[54] created to attain permanent solutions for perceived regulatory issues,[55] ignores the ever-changing environment for rules that are exacerbated by disruptive innovation.[56]
The existing challenges for the regulatory infrastructure are going to be exacerbated by the emergence of ever-increasing decentralization of business and society.[57] Centralized governance via stable and presumptively optimal rules in an environment of decentralized smart contracting and DAOs further exacerbates the shortcomings of stable and presumptively optimal rules in centralized structures. Facts-based, ex-post, trial-and-error-rulemaking with stable and presumptively optimal rules in the existing regulatory framework is incompatible with the needs of decentralized systems. Decentralized systems do not have a central intelligence or leadership system based on traditional hierarchies. Instead, the intelligence in decentralized systems is spread throughout the system. Because information and knowledge naturally filter in at the edges of the decentralized system, facts-based, ex-post, trial-and-error-rulemaking with stable and presumptively optimal rules in the existing regulatory framework cannot encapsulate in a timely fashion the regulatory needs of the system. Decentralized systems can also very easily mutate and change because the information flow is optimized through dynamic feedback effects. This is antithetical to the static rule-based system of the existing regulatory infrastructure.
The timing of rulemaking in an environment of decentralized smart contracts and DAOs is going to be a primary problem for regulators. Formal rulemaking in the existing regulatory infrastructure is almost always too time-consuming for a centralized marketplace. [58] Decentralized systems morph much quicker than centralized systems and thus exacerbate the timing inadequacies of the existing regulatory infrastructure. The speed of smart contracting and the associated DAO revisions will make regulations pertaining to morphing and evolving decentralized systems obsolete before static centralized regulations are finalized.
The lack of natural language further exacerbates the timing issue. Even if existing courts could exercise jurisdiction over decentralized parties, the code-based legal arrangements would need to be translated into natural language which may often not be possible and would create significant cost and timing restrictions. Interpretation of non-natural language in smart contract disputes also creates major hurdles for the regulators and courts. Coded contractual intent may be unclear and natural language intent can often not be used for interpretation. The cost of “translation” of coded contractual intent has the potential to become overwhelming for the existing centralized legal infrastructure.
Centralized agency power is rather difficult to exercise over decentralized systems because the system is decentralized, autonomous, and secured by a consensus algorithm. Attempts by the government to exert power over the system by influencing any number of individuals within its jurisdiction, would require complete control of fifty one percent of the anonymous global users before it could change any part of the code in the decentralized system. The security of decentralized systems guarantees that no outside power will have the ability to control the non-state actor attempted to take that extreme action. Because of the transparent nature of decentralized systems, users would instantly know about the takeover attempt. Such an event would lead to a loss of confidence and cause ultimately the failure of the entire structure. Because decentralized systems are autonomous, even if a government did find some of the anonymous individuals whose work maintains the ledger, it would be difficult to argue personal responsibility for any wrongdoing. Miners are running a universal algorithm on computers connected to a global network.
The inability to exercise existing notions of jurisdiction over decentralized systems creates friction between decentralized systems and the existing legal infrastructure. Traditional jurisdictional means have limited applicability in the context of blockchain technology. Traditional jurisdictional principles cannot directly apply to blockchain technology because the blockchain is a mere collection of agreed-upon calculations by decentralized computer systems. The blockchain is merely an idea reached by the consensus of computation; it is pure information, contained only in the mathematical rules of its inception and the sum of the computation. The blockchain is entirely maintained and owned by a distributed group of anonymous users located around the planet. The nodes hold imperfect partial copies of the blockchain; no particular node holds the entire blockchain. Hence, the concept of jurisdictional presence is difficult to apply to the blockchain.
Decentralization of business and society may inaugurate unprecedented change in society with significant uncertainty and unknown future contingencies. The existing regulatory infrastructure with stable and presumptively optimal rules is largely incapable of addressing these increases in unknown future contingencies associated with disruptive decentralization. Given the pace of emerging decentralization,[59] future contingencies in rulemaking are likely to substantially increase, making the dynamic anticipation of future contingencies more important for rulemaking.
2. Benefits of Dynamic Decentralized Governance
Supplementing the regulatory infrastructure with dynamic decentralized elements can help address suboptimal regulatory outcomes[60] for decentralized systems. Decentralized rulemaking via code is subject to suboptimal stable regulatory outcomes, just like centralized governance. In light of the growth trajectory for smart contracting, rulemaking via code can be seen, on the one hand, as an attempt to cope with an ever-increasing complex market and legal environment that necessitates technological solutions. On the other hand, coded solutions are subject to natural flaws (bugs) and cannot evolutionarily change protocols. As such, coded solutions for an exponentially changing environment are also a stable and presumptively optimal attempt at creating new solutions and benefit from dynamic elements to overcome those shortcomings.
Because the conditions and the corresponding requirements for optimal and stable hardcoded rules are constantly evolving, making different sets of hardcoded rules optimal over time,[61] dynamic elements in the coding and rulemaking process can help increase the availability of relevant information for rulemaking and improve system design.[62] Dynamic regulation as conceptualized in theory is intended to create anticipatory regulatory responses.[63] The same may apply in the context of coded system designs where smart contract templates that are affirmed by a DAO as optimal can be used anticipatorily by other DAOs who may encounter similar necessities in the future.
In decentralized systems, feedback effects can occur much more frequently and in many more settings compared with centralized systems.[64] The timeliness and quality of information is the focus of dynamic governance rules[65] in dynamic decentralized frameworks. The increased availability of relevant, decentralized, and timely information for governance rules in a dynamic decentralized framework enables unprecedented feedback effects. Because the information is on the edge of the decentralized system and is transferred peer-to-peer directly, information reaches subroutines and subsystems much more directly and timely. Accordingly, feedback effects in a dynamic decentralized governance framework can enhance the availability of institution-specific decentralized information dramatically, especially compared to centralized systems.[66] Because the improved information is on the edge of the decentralized system and is transferred peer-to-peer directly, feedback effects can instantiate in subroutines and subsystems much more directly and timely. Rather than acquiring the necessary information ex-post after rules have emerged as suboptimal, feedback effects help increase the availability of relevant information for governance rules ex-ante and anticipate necessary revisions before rules emerge as suboptimal.[67]
The combination of feedback processes, enhanced information for rulemaking, and institution-specific ex-ante experimentation facilitates the anticipation of future contingencies for decentralized governance. Adapting rules to such identified future contingencies becomes the focal point for rulemaking in a dynamic decentralized framework.[68] Finally, anticipatory dynamic coded regulation can help minimize costly and suboptimal ex-post trial-and-error experimentation with stable and presumptively optimal rules in decentralized systems.
V. Optimizing DAO Governance
Innovation, the complexities of financial markets, and ever-changing circumstances of smart contracting require decentralized institutional arrangements and a rulemaking process that continuously adjusts to these challenges. The complexities of today’s increasingly decentralized society,[69] its coded solutions to remedy the complexities, costs, etc., and markets benefit from dynamic coded institutional arrangements and processes for coded rulemaking.
Future DAO designs have the capacity to substantially upgrade institutional governance. Unlike existing institutional governance designs, future DAO designs and any derivations thereof will likely be community based. DAO Governance is determined by the respective DAO members in any given DAO. Such DAO member generated upgrades are based on feedback effects pertaining to previous version of DAO designs. Hence, future DAO designs will likely vary substantially. The ability to reform DAO governance design, and with it corporate governance, is impacted by the design parameters of the given DAO.
The success of DAO governance designs is determined by several core factors. First and foremost, the level of decentralization in the DAO governance design is determinative for its future resilience and attack resistance. Incentive alignment of DAO constituents is a core function of successful decentralization and has a significant impact on the success of the governance design. Dynamic feedback effects in the DAO governance design also impact its ability to evolutionarily provide solutions as the circumstances of the DAO change. The structure and extent of on-chain DAO governance is also an important evolving design factor. Finally, decentralized autonomous and anonymous reputation verification systems offer much needed governance design input parameters that so far could not been provided otherwise.
1. Dynamic DAO Governance
Decentralized dynamic DAO governance can serve as regulatory supplements enabling rulemakers’ adaptation to regulatory contingencies if and when they arise. Decentralization exacerbates the existing inability of centralized rulemaking structures to address the shortcomings in the rulemaking process for stable and presumptively optimal rules. Feedback effects in DAOs provide relevant, timely, decentralized, and institution-specific information ex-ante. By increasing the availability of information ex-ante, dynamic regulatory tools help lower unforeseen contingencies in the rulemaking process pertaining to innovation. Improved information for rulemaking also helps to maintain certainty in the rulemaking process.
DAO governance epitomizes dynamic regulation. DAOs integrate feedback effects in governance design because the information in the system is fully transparent and constantly updated. Centralized regulatory agencies can examine trends in smart contracts in a given industry by examining the publicly available information. Similarly, regulates can code warning triggers in their governance design to comply with external regulatory requirements. Mandated governance rules can be coded directly in smart contracts if and when trends justify regulatory code to be included.
DAO governance must be dynamic to avoid corruptive influences. Stable and presumptively optimal static constitutional rules for DAO governance typically enable gaming and arbitrage opportunities. In any open and democratic system, naturally opportunistic rational parties will attempt to circumvent and game the sets of applicable complex static rules to increase their share of power and profit within the system. To enable sufficient protection of DAO members while at the same time allowing for DAO enhancements, the static sets of rules of smart contracts in such a system will need to be rather complex. With static complex sets of DAO rules comes inevitable corruptive opportunistic gaming and arbitrage behavior. To avoid these negative effects of static complex DAO rules, effective DAO governance designs should be focused on dynamic elements. Dynamic elements here include DAO members’ ability to re-evaluate existing precedent in the system.
Unlike the existing corporate governance framework, the technological infrastructure underpinning DAOs enables autonomous and evolutionary incomplete smart contract upgrades. With dynamic DAO governance mechanisms, DAO token holders can vote for a change of any outdated or flawed code as the flaws materialize or in anticipation of future contingencies. In that sense, DAOs can generate majoritarian rules ex-post without the need for ex-ante majoritarian rules that function as default rules.[70] Ex-post code-based majoritarian rules are superior to ex-ante majoritarian rules because they are based on more accurate real-time information from the edge and decentralized feedback effects. Ex-post code-based majoritarian rules are not subject to the same information asymmetries as stable and presumptively optimal ex-ante rules. As such, DAOs enable a code-based governance infrastructure that can create dynamic governance protocol upgrades in real-time through dynamic feedback loops.
Dynamic and evolutionary reputation-based DAO governance is possible via a decentralized on-chain precedent system.[71] A decentralized on-chain precedent system enables feedback effects between DAO members, the public record of work/posts on the blockchain, and the public users. The decentralized precedent system makes the continuous upgrading of real-time data possible.[72] As a post/template on the blockchain gets increasingly referenced by the DAO members and other users, it increases in non-fungible reputation weight and associated fungible salaries. Conversely, if a post/template on the blockchain dissipates over time, a new post/template emerges naturally. If the new post/template gets more often referenced by the DAO members and other users, it becomes over time the new prevailing precedent. The old precedent dissipates over time with non-use.[73]
2. Level of Decentralization
The level of decentralization may be a proxy for optimized DAO design parameters. The more decentralized a given DAO design, the more likely it is to affect its precedence and adoption. The level of decentralization and the associated attack resistance and incorruptibility of DAO governance designs are among the core factors that influence DAO design adoption, its precedence, and longevity. However, not all future DAO designs will comply with the ideal typical DAO parameters. Ideal typical DAO design ideal typical DAO design parameters will naturally filter out at the edges. In other words, because the optimal DAO design parameters change constantly, if and when formerly ideal typical designs fail, new and optimized designs will replace them.
The level of decentralization in DAO designs increases with the following instantiations in DAO governance: a) anonymity of DAO members, e.g. DAO members cannot be personally identified other than by their respective merit in the DAO structure;[74] b) merit identifiers, e.g. DAO members merit, knowledge, and influence is measured through their respective DAO non-fungible token ownership;[75] c) non-fungibility of tokens; e.g. merit of a DAO member is expressed by an non-fungible reputation token that cannot be bought or sold;[76] d) full transparency, e.g. all DAO decisions are fully transparently accessible by the public and the DAO members themselves;[77] e) indirect economic incentives, e.g. DAO members are getting paid with fungible tokens in proportion to their non-fungible tokens;[78] f) decisions in the DAO are made with a voting design that revolves around staking of non-fungible tokens;[79] and g) fungible salary tokens are designed as stable cryptocurrencies and maintain their value at around $1US.[80] Several other factors influence the level of decentralization of DAO designs that are beyond the scope of this article.
3. Incentive Alignment
Incentive alignment is at the core of centralized and decentralized governance designs. The failures of incentive alignment in centralized governance structures are well documented.[81] Unlike centralized governance incentive design, decentralized incentive alignment in the DAO can be organized in an incorruptible way with non-fungible digital assets. Because of the technological infrastructure of decentralized systems, it is possible that decentralized incentive design can create solutions that could not so far be accomplished in centralized governance structures. Collective action problems associated with lacking incentive alignment in existing agency-based governance designs can be overcome by efficiently designed DAO governance.
Optimized DAO governance design needs to incentivize DAO members with indirect economic gain. This is possible with a combination of token designs. In a bifurcated DAO design with two disparate types of tokens, DAO members would only indirectly gain economically if: 1. Non-fungible tokens give them voting rights in the DAO and are used as a merit score in the respective DAO, 2. Fungible tokens allow DAO members to earn a fungible salary tokens in proportion to their non-fungible tokens. DAO members would increase their non-fungible tokens by making valuable contributions to the DAO. They would get paid in fungible tokens in proportion to their respective non-fungible token score in a given DAO. The indirect economic effects remove corruptive elements and make the governance design more attack resistant and stable in the long run.[82]
Community-driven audits in DAO governance improve incentive alignment. Centralized systems rarely provide for and administer community-driven audits. Community-driven audits go against the agency and monitoring principles embedded in the centralized governance. External monitoring and validation are key in centralized governance systems because the incentive design in centralized structures does not enable incorruptible internal controls. By contrast, community audits are at the core of DAO governance that is equipped with an effective incentive design. The decentralized nature of DAOs enhances efficiency of coordination because the users of the system, e.g. DAO members, typically know best how to assess other users / DAO members. The decentralized DAO structure enables unprecedented information symmetry in the governance design because governance information, e.g. DAO group decision making metrics and DAO governance protocol needs, is at the edge of the decentralized system and is exchanged and evaluated directly between DAO members in a continuous and iterative stream of information that provides dynamic feedback effects.
DAO governance designs enable a much more equal distribution of power. Language, religion, race, physical presence, group identifiers, culture, etc., influence centralized power distribution. Similarly, commonly used identifiers in centralized governance such as social media profiles and credit scores, among others, are essential for access to the central system and to resources. Such relatively superficial identifiers play less of a role in DAO voting designs. The more equal distribution of power in the DAO governance design allows the inclusion of constituents who otherwise have no agency in centralized systems.
4. On-Chain DAO Governance
Since its inception, the blockchain community has debated the preferable modus operandi for protocol changes.[83] Most cryptocurrencies would not exist if Bitcoin and Ethereum had incentives for future protocol development and governance built into the core protocol.[84] The community has considered different attempts and proposals for more fully democratized blockchain governance. Those proposals included Ethereum Improvement Proposals, [85] Bitcoin Improvement Proposals, [86] Ethereum General Assembly,[87] mailing lists,[88] and suggestion pages on GitHub trees.[89]
On-chain governance is a necessity for most public blockchains. Because all existing blockchains need to calibrate soft forks for protocol upgrades, most public blockchain communities that value decentralization have considered on-chain governance for their protocol.[90] Certain protocols have expanded their on-chain governance considerations. These include, but are not limited to: Tendermint,[91] PolkaDot,[92] DAOstack,[93]Tezos,[94] Dash,[95] Bitshares, Lisk, MemoryCoin, Aragon,[96] Cardano,[97] Maker,[98] and NuShares.[99]
Arguments against on-chain governance are bountiful. Arguably, an off-chain governance system that finds an equilibrium between several competing factors could be a better alternative for protocol governance than an on-chain governance mechanism.[100] In an off-chain governance model, miners provide checks and balances on power over protocol changes. On-chain governance arguably removes such checks and balances. An on-chain governance model also arguably would take the participation of governance away from miners and subsequently users. Because an on-chain governance enables automatic protocol upgrades and is not dependent on manual interference by miners, miners are no longer required to make a conscious choice to participate in their chosen chain.[101]
Emerging more mature voting ecosystems enable on-chain protocol governance with an incentive design that more optimally balances risk and rewards of voting. Alternative voting methods include quadratic voting,[102] futarchy,[103] liquid democracy,[104] and reputation-based voting as an instantiation of non-fungible voting.[105] These voting alternatives can ameliorate the traditional voting power corruption of one-token-one-vote.
On-chain governance models can further be optimized with reputation-based staking as voting mechanisms.[106] Reputation-based voting revolves around voting by way of staking a non-fungible asset, aka staking non-fungible reputation tokens in a given DAO, towards a certain outcome. The corruptive elements of fungible assets/tokens are removed because third parties are less likely able to take over a non-fungible assets, such as reputation, that is organically grown and maintained through actual expertise in a given DAO subject matter. Even if third parties should be able to take over or purchase non-fungible reputation, they are less likely able to maintain the reputation score and the associated revenue stream of fungible assets over time.
5. Reputation-Based Governance
Reputation can take on an unprecedented role in decentralized governance mechanisms. Reputation-based governance can optimize actors’ incentive design in the decentralized governance infrastructure. Reputation can generally be defined as a predictor for actors’ future behavior given the history of actors’ actions. Reputation is central for proper incentivization in the existing centralized infrastructure for business and government. Because of the advances in emerging decentralized technology, reputation can take on an unprecedented role in future decentralized governance mechanisms.
Reputation-based metrics were ineffective in centralized governance systems. Before the emergence of blockchain technology, reputation could not be stored autonomously, anonymously, and transparently. Accordingly, reputation was not a reliable predictor of actors’ future actions in centralized governance systems. Existing reputation governance designs, such as the web of trust[107] and even more primitive designs such as simple reputation triangulation metrics,[108] suffered from countless inadequacies, including sybil attacks[109] and tyranny of the majority.[110] These shortcomings undermined the meaning and value of digital reputation in centralized internet platform-based businesses. What made things worse, these past centralized attempts at reputation verification were unable to meet the demands of constantly changing protocol needs.[111] They were based on stable and presumptively optimal rules which are vulnerable to gaming.
Reputation has key advantages over existing decentralized voting mechanisms. Reputation has two key advantages over existing decentralized one-token-one-vote voting mechanisms: 1) it is non-fungible which avoids corruptive elements,[112] and 2) it optimally aligns incentives for DAO members individually and at the same time for the totality of the DAO as an institution. [113] Because reputation is non-fungible and ideally anonymous, it is much harder for DAO members and external participants to try to game the system to improve their own utility exclusively while hurting the common good of the DAO.
Reputation as a valuation metric allows DAO members to improve their own utility while at the same time improving the whole institution over the long term. If reputation is used as a metric for indirect economic benefits, e.g. a salary in fungible tokens that is paid in proportion of the non-fungible reputation token score, DAO reputation token holders are incentivized to increase their own reputation/utility by engaging in valuable conduct for the DAO. The more the aggregated individual reputation of all DAO members increases the more the overall institution’s value increases and the more the institution creates value enhancing outcomes for its members.
Reputation-staking as a basis for DAO governance improves incentive alignment. Reputation-staking as a basis for DAO governance enables the correlation between individual and institutional value enhancement. DAO members rationally stake their own reputation tokens based on the outcomes they believe will increase their overall reputation/utility. If they did not they would irrationally surrender a future income stream in fungible tokens. Through reputation-staking, the DAO members are incentivized to provide long-term positive contributions because the DAO member reputation is transparent and reviewable by the DAO and the public in a slow and stable review process that reaches far into the future. Valuable individual behavior/work that leads to individualized reputation staking and individual reputation enhancement also enhances the DAO as an institution because the individual and institutional value enhancement are correlated.[114]
Reputation-based DAO governance design changes the dynamic of a zero-sum game to a positive-sum game. Existing DAO governance designs were mostly zero-sum games. Existing DAO governance designs used mostly fungible rewards and incentive designs where DAO members pursued as large of a portion of the rewards as possible for themselves. By contrast, the reputation-based DAO creates a positive-sum game because DAO members have incentives to create lasting non-fungible value for the institution by developing a long-term non-fungible record of productive cooperation that in effect improves the DAO. Moreover, individual DAO member reputation can change dynamically if DAO member actions depreciate in value. The DAO member reputation should be inflationary in the DAO design. As such, non-use, e.g. non-staking or non-voting, would lead to value depreciation, which incentivizes action and thus value enhancement.
VI. Reforming Corporate Governance
Future optimized DAO designs may accomplish significant upgrades for DAO governance that can help reform traditional notions of corporate governance. The remarks below are based on ideal-typical DAO governance design parameters. Not all future DAO designs will follow these ideal-typical parameters.
DAO token holders are largely free from existing corporate hierarchies and their restricting effects. People who work for a DAO are subject to a different kind of agency relationship and not subject to a centralized supervisor or CEO who received legitimacy through centralized validation. Instead, DAO workers work in a dynamic set of working relationships that continuously and dynamically self-organize around projects and outcomes, not corporate hierarchies.
The intrinsic motivation of DAO members changes incentive structure and governance outcomes compared with traditional hierarchical organizations. Most hierarchical organizations rely predominantly on extrinsic incentive structures, through wages etc. By contrast, the core common denominator for all DAO token members is the unifying desire to optimize the DAO structure and the DAO reputation token value. If a member-identified optimization has the potential to make the DAO more meaningful, useful, or valuable to the token holder members, the DAO token holders will desire to perform such optimization tasks as it is in their very interest to do so to help increase the value of their DAO reputation tokens.
Performance assessment in the DAO governance structure is based on DAO value optimization. Existing centralized and decentralized governance designs often rely on hierarchical or political processes and external monitoring and validation. By contrast, DAO workers’ performance is assessed in an anonymized proposal voting scheme which is the predominant basis for assessment and payment. If DAO members perform well, they will get remunerated regardless of politics, background, or education. Validation and monitoring can be internal to the DAO. The predominant factor that counts for purposes of assessment of DAO worker performance is the work’s impact on DAO value optimization.
Non-performance penalties in the DAO structure are free from biases. If DAO community members do not deliver on a proposal that was voted in by the DAO token holder community they lose credibility in the DAO token holder community and may be perceived as lacking an ability to add value. In fact, non-performance on proposal comes with significant reputational penalties. Non-performers in the DAO structure will be less likely to have future opportunities to earn tokens because the other token holders are unlikely to approve non-performer proposals. Crucially, non-performance reputational penalties are entirely free from racial or cultural biases and associated implications as the token holders are unlikely to even know each other. Rather, they all work towards a common goal of optimizing the DAO and the token value.
The DAO governance design benefits all constituents. DAO governance designs emphasize token holders’ incentives to add value to the DAO community. That benefits all constituents. Because projects that cannot add value take token holders’ time away from more productive endeavors, token holders become focused on managing their time and efforts. Unlike in traditional hierarchical organization where face-time and unproductive meetings are the norm, the self-governing DAO token optimizer avoids any such corporate hierarchy inefficiencies and frees herself from top-down inefficiencies and negative outcomes.[115]
Politics in the DAO structure have a different nature compared with traditional hierarchical corporate structures. In a traditional corporate hierarchy, position in the hierarchy and associated authority determine effort. In other word, the supervisor in the hierarchical structure can determine where, what, and when workers have to perform, resulting in suboptimal outcomes, attendance of unproductive and useless meetings, among many other negative effects. By contrast, in the decentralized DAO environment, influence is determined by the value a given token holder contributed to a project’s success.
The value-to-effort focus of work flows in the DAO structure has the potential to reform agency relationships in governance. The value-focused performance in the DAO structure helps optimize work flows and creates sustainable solutions for DAO token holders. The supervisor in the traditional hierarchical corporate structure can determine where, what, and when workers have to perform, which often results in attendance of unproductive meetings, facetime, support for suboptimal outcomes to please supervisors, among many other suboptimal outcomes. By contrast, in the decentralized environment of DAOs, influence and outcomes are not created by hierarchy but rather determined by the value a token holder’s contributions to a project’s success. Moreover, if a token holder adds substantial value to the DAO, other DAO token holders will want to add their skills in the same context which focuses the token holders’ efforts on the highest possible value proposition.
VII. Conclusion
For the first time in history, blockchain technology gives actors and institutions the environment to collaborate on neutral territory. Every member’s contributions to an institution can be recorded in a fully transparent way. These unprecedented technological features enable corporations and other forms of business organizations to be supplemented with blockchain-based agency constructs. As such, DAOs expand the definition of the firm, question the need for firms, and call into question the various versions of the theory of the firm. DAOs have started to challenge the dominant governance structures facilitated by legacy agency constructs. Future ideal-typical DAO governance designs will be filtered out at the edges of the system and will be subject to ongoing dynamic iterative change and upgrading. The technological infrastructure for DAOs enables these emerging features.
* © 2020 Wulf A. Kaal. Professor, University of Saint Thomas School of Law, Minneapolis.
[1] Mark J. Roe, The Inevitable Instability of American Corporate Governance, in Restoring Trust in American Business 9 (American Academy of Arts and Sciences eds., 2004, MIT Press 2005). (“The core fissure in American corporate governance is the separation of ownership from control — distant and diffuse stockholders, with concentrated management — a separation that creates both great efficiencies and recurring breakdowns.”).
[2] According to the dominant view, the goal of a firm should be to increase the financial interests of the investors and by doing so the firm can maximize opportunities to be successful. Stephen M. Bainbridge, Director v. Shareholder Primacy in the Convergence Debate, 16 Transnat’l Law. 45 (2002), available at https://scholarlycommons.pacific.edu/globe/vol16/iss1/5; Mike Marin, The Crisis of Shareholder Primacy, University of Cambridge: Research at Cambridge (Mar. 19, 2012), http://www.cam.ac.uk/research/discussion/the-crisis-of-shareholder-primacy; H. Jeff Smith, The Shareholders vs. Stakeholders Debate, 44 MITSloan Mgmt Rev. no. 4, July 2003, at 85, http://sloanreview.mit.edu/article/the-shareholders-vs-stakeholders-debate/; Lynn A. Stout, The Shareholder Value Myth, (Cornell Law Faculty Publications, Paper №771, 2013), http://scholarship.law.cornell.edu/cgi/viewcontent.cgi?article=2311&context=facpub.
[3] Alessio M. Pacces, Rethinking Corporate Governance: The Law and Economics of Control Powers (2013).
[4] N. Craig Smith & David Ronnergard, Shareholder Primacy, Corporate Social Responsibility, and the Role of Business Schools, 134 J. Bus. Ethics 463 (2016).
[5] Stout, supra note 2 (Discussing residual claimants arguments and potential benefits to society through the company); see also Smith, supra note 2.
[6] Justin Fox & Jay W. Lorsch, What Good Are Shareholders, Harv. Bus. Rev. Jul.-Aug. 2012, at 48, https://hbr.org/2012/07/what-good-are-shareholders.
[7] Id.; Margaret M. Blair, Shareholder Value, Corporate Governance, and Corporate Performance: A Post- Enron Reassessment of the Conventional Wisdom, in Corporate Governance and Capital Flows in a Global Economy 74, 53–82 (P.K. Cornelius & B. Kogut eds., Oxford University Press 2003).
[8]Roe, The Inevitable Instability of American Corporate Governance, supra note 1.
[9] Benjamin E. Hermalin & Michael S. Weisbach, Transparency and Corporate Governance (Nat’l Bureau of Econ. Research, Working Paper No. w12875, 2007), https://ssrn.com/abstract=958628.
[10] Stephen M. Bainbridge, Shareholder Activism and Institutional Investors (UCLA Sch. of Law Pub. Law-Econ. Research, Working Paper №05–20, 2005), https://ssrn.com/abstract=796227; Jonathan M. Karpoff, The Impact of Shareholder Activism on Target Companies: A Survey of Empirical Findings (2001), https://ssrn.com/abstract=885365 (“[T]he disagreement among researchers is more apparent than real. Most evidence indicates that shareholder activism can prompt small changes in target firms’ governance structures, but has negligible impacts on share values and earnings.”); Roberta Romano, Less Is More: Making Shareholder Activism A Valued Mechanism Of Corporate Governance (Yale Law & Econ., Research Paper №241; Yale ICF, Working Paper №00–10; Yale SOM, Working Paper No. ICF- 00- 10, 2000), https://ssrn.com/abstract=218650 (“The finance literature presents an apparent paradox: Notwithstanding commentators’ generally positive assessment of the development of such shareholder activism, the empirical studies suggest that it has an insignificant effect on targeted firms’ performance. Very few find evidence of a positive impact, and some even find a significant negative stock price effect from activism.”); John C. Coffee Jr., Liquidity Versus Control: The Institutional Investor as Corporate Monitor, 91 Colum. L. Rev. 1277 (1991).
[11] The existing U.S. proxy system lacks transparency; has few accountability mechanisms; is complex and costly; tolerates record-keeping inaccuracies partially because it provides no audit trail; and produces voting results that cannot be verified. John C. Wilcox, Shareholder Nominations of Corporate Directors: Unintended Consequences and the Case for Reform of the u.S. Proxy System, in Shareholder Access to the Corporate Ballot (Lucian Bebchuck, ed., 2004); Henry T. C. Hu & Bernard S. Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S. Calif. L. Rev. 811, 811 (2006); David Yermack, Shareholder Voting and Corporate Governance, 2 Ann. Rev. Fin. Econ. 103 (2010).
[12] Lucian A. Bebchuk & Jesse M. Fried, Executive Compensation as an Agency Problem, 17 J. Econ. Persp. 71 (2003); Lucian A. Bebchuk et al., The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000–2008, 27 Yale J. on Reg. 257 (2010).
[13] Bengt R. Holmström & Steven N. Kaplan, The State of U.S. Corporate Governance: What’s Right and What’s Wrong? (ECGI — Fin., Working Paper №23/2003, 2003), https://ssrn.com/abstract=441100.
[14] Christoph Jentzsch, Decentralized Autonomous Organization to Automate Governance 2 (unpublished manuscript) (on file at https://download.slock.it/public/DAO/WhitePaper.pdf).
[15] Craig Calcaterra, On-Chain Governance of Decentralized Autonomous Organizations: Blockchain Organization Using Semada (May 24, 2018) (unpublished manuscript) (on file at https://ssrn.com/abstract=3188374).
[16] Carla L. Reyes, Nizan Geslevich Packin, & Ben Edwards, Distributed Governance, 59 Wm. & Mary L. Rev. Online (2018), https://scholarship.law.wm.edu/wmlronline/vol59/iss1/1/.
[17] Id.
[18] Reyes et al., supra note 16.
[19] Jentzsch, supra note 14.
[20] Id.
[21] Id.
[22] Ethereum press releases. www.ethereum.org (last visited [___]).
[23] Ronald Coase, The Nature of the Firm (1937). http://www3.nccu.edu.tw/~jsfeng/CPEC11.pdf
[24] Id.
[25] Yoram Barzel, Economic Analysis of Property Rights (1997).
[26] Coase, supra note 23.
[27] Id.
[28] Barzel, supra note 25.
[29] Dan Fischel & Frank Easterbrook, The Economic Structure of Corporate Law (1991).
[30] Jentzsch, supra note 19 at 2.
[31] Id.
[32] The DAO founders attempted to turn this lack of decentralization and core attack risk into a virtue by boasting that the existing curators consisted of an “all-star group…of twelve of the brightest minds the Ethereum ecosystem has to offer.”
[33]Id.
[34] The DAO originators attempted to suspend this point of centralization in the DAO design by introducing a debate period for the DAO community of at least two weeks after a contractor was approved by a curator for the whitelist. During the debate period, the DAO community was able to debate and vote on the proposal. See id. Like so many other voting solutions of decentralized platforms that proliferated in the aftermath of the original 2016 DAO, the original DAO would also have been subject to voting participation issues. Staking and inflationary token scoring, e.g. non-participation lowers proportional token score, could have created incentives for vote participation.
[35] The DAO white paper itself observed the limitation of decentralization in its design as limiting the DAO to one curator would give that individual “considerable power.” Id.
[36] Institutional design and governance are a primary subject of study in law, ethics, economics, political science, computer science, philosophy, sociology, social psychology, cybernetics, control theory, among others. Entire school of though, such as new institutional economics evolved because of the insufficiency of governance solutions. See Popper, inra note 52.
[37] Frank H. Easterbrook & Daniel R. Fischel, The Corporate Contract, 89 Colum. L. Rev. 1416, 1417 (1989).
[38] Larry E. Ribstein, Why Corporations, 1 Berkeley Bus. L. J. 183, 187–88 (2004).
[39] Wulf Kaal & Craig Calcaterra, Crypto Transaction Dispute Resolution, 72 The Business Lawyer 109 (2017–2018).
[40] Calcaterra, supra note 15.
[41] Craig Calcaterra et al., Blockchain Infrastructure for Measuring Domain Specific Reputation in Autonomous Decentralized and Anonymous Systems (U of St. Thomas (Minnesota) Legal Studies Research Paper №18–11), https://ssrn.com/abstract=3125822. (“An oracle for a blockchain is a system that allows smart contracts to access real-world (i.e., off-chain) data. Since the blockchain is an autonomous system with no centralized authority dictating decisions, there is a need for a trusted 3rd party to reputably state the results of real-world events. For instance, when blockchain users wish to exchange a smart contract which mimics a stock option, they need agreement on the value of the stock at the expiration date, which generally requires a trusted 3rd party. For the success of the crypto economy, the 3rd party should remain decentralized and anonymous. The platform gives such 3rd parties an opportunity to establish verified and valuable reputation.”)
[42] Calcaterra, supra note 15.
[43]How Much.net, https://howmuch.net/articles/bitcoin-wealth-distribution (last visited Aug. 19, 2019).
[44] The original 2016 DAO had less than five percent of voter turnout. See Jentsch, supra note 33. Even delegated proof of stake protocols, such as Lisk and Ark where voting plays a crucial part of the protocol rarely experience voter turnout above fifty percent of total. www.lisk.com; www.ark.com
[45] Ethereum foundation tutorial on how to program a basic governance structure with voting at https://www.ethereum.org/dao (last visited Feb. 11, 2018).
[46] (“An example of a hard fork that implemented a new feature is Monero. Monero underwent a planned hard fork in January 2017, to introduced Ring Confidential Transactions (RCT). RCT improved security as well as privacy for Monero users”). Monero, https://www.getmonero.org/ (Last visited Aug. 19, 2019).
[47] The double-spend risk that plagues hard forks does not apply to soft forks because users and merchants running old nodes will read both new and old version blocks.
[48] BitcoinCash, www.bitcoincash.com (last visited Aug. 19, 2019).
[49] Cathy Barrera & Stephanie Hurder, Blockchain Upgrade as a Coordination Game (October 17, 2018), https://ssrn.com/abstract=3192208.
[50] Calcaterra, supra note 15.
[51] Wulf A. Kaal, Evolution of Law: Dynamic Regulation in a New Institutional Economics Framework, in Festschrift zu Ehren von Christian Kirchner 1211 (Wulf A. Kaal, Matthias Schmidt & Andreas Schwartz eds., 2014) [hereinafter Evolution of Law]; Wulf A. Kaal, Dynamic Regulation of the Financial Services Industry, 48 Wake Forest L. Rev. 791 (2013); Wulf A. Kaal, Dampening Financial Regulatory Cycles via Dynamic Regulation — A Comment on Professor McDonnell, 65 Fla L. Rev. F. 32 (2013); Wulf A. Kaal, Dynamic Regulation via Governmental Contracts, in Liber Amicorum Peter Nobel (2015); Wulf A. Kaal, Dynamic Regulation for Innovation, in Perspectives in Law, Business and Innovation (Mark Fenwick, Wulf A. Kaal, Toshiyuki Kono & Erik P.M. Vermeulen eds., 2016); Wulf A. Kaal, Dynamic Regulation to Curtail Excessive Corporate Risk-Taking: A Response to Professor Schwarcz, 65 ELJ Online 2061 (2016); Wulf A. Kaal & Timothy A. Lacine, The Effect of Deferred and Non-Prosecution Agreements on Corporate Governance: Evidence from 1993–2013, 70 Bus. Law. 61 (2014)
[52] Karl R. Popper, The Poverty of Historicism (Routledge & Kegan Paul, 1957); Christian Kirchner, Evolution of Law: Interplay Between Private and Public Rule-Making A New Institutional Economics-Analysis, 4 Erasmus L. Rev. 161 (2012).
[53] Wulf A. Kaal & Erik P.M. Vermeulen, How to Regulate Disruptive Innovation — From Facts to Data, 57 Jurimetrics 169 (2017).
[54] See Evolution of Law, supra note 51, at 1212 (“[T]he institutional infrastructure for rulemaking was geared towards the creation of rules for governing a relatively stable society with less upward mobility and relatively stable economic and market environments.”); Kaal, Dynamic Regulation of the Financial Services Industry, supra note 51; Kaal, Dynamic Regulation via Government Contracts, supra note 51; Kaal & Lacine, supra note 51.
[55] Evolution of Law, supra note 51, at 1218.
[56] Kaal, Dynamic Regulation for Innovation, supra note 51.
[57] Wulf A. Kaal, Decentralization: Past, Present, and Future (2019) (unpublished manuscript) (on file at https://ssrn.com/abstract=3411897); Wulf A. Kaal, Decentralization: A Primer on the New Economy (2019) (unpublished manuscript) (on file at https://ssrn.com/abstract=3406323).
[58] Evolution of Law, supra note 51, at 1218; Kaal, Dynamic Regulation for Innovation, supra note 51; Cass R. Sunstein, Is the Clean Air Act Unconstitutional?, 98 Mich. L. Rev. 303, 371 (1999); Thomas O. McGarity, Some Thoughts on “Deossifying” the Rulemaking Process, 41 Duke L.J. 1385, 1386 (1992); Jo Ann S. Barefoot, Disrupting FinTech Law, 18 Fintech L. Rep. 10 (2015).
[59] Kaal, Decentralization: Past, Present, and Future, supra note 57; Kaal, Decentralization: A Primer on the New Economy, surpa note 57.
[60] Kaal, Dynamic Regulation of the Financial Services Industry, supra note 51; Evolution of Law, supra note 51.
[61] Kaal, Dynamic Regulation of the Financial Services Industry, supra note 51.
[62] Id.
[63] Kaal, Dynamic Regulation of the Financial Services Industry, supra note 51.
[64] See infra Part V.1. on feedback effects in DAOs.
[65] Kaal, Dynamic Regulation of the Financial Services Industry, supra note 51.; Evolution of Law, supra note 51.
[66] Kaal, Dynamic Regulation of the Financial Services Industry, supra note 51.; Evolution of Law, supra note 51.
[67] Kaal, Dynamic Regulation of the Financial Services Industry, supra note 51, at 160; Evolution of Law, supra note 51.
[68] Id.
[69] Kaal, Decentralization: Past, Present, and Future, supra note 57.
[70] Contra see supra Part II.
[71] Calcaterra, supra note 15. The design here is possible because of the Weighted DAG in Calcaterra’s design.
[72] Id. As Calcaterra shows, the relative weight of a contribution posted on the blockchain can increase if such contribution is referenced or used by other DAO members or protocols. This particular precedent setting feature enables a precedent system within a decentralized autonomous system.
[73] Id.
[74] Calcaterra et al., supra note 41.
[75] Id.
[76] Id.
[77] Id.
[78] Id.
[79] Id.
[80] Craig Calcaterra et al., Stable Cryptocurrencies, Wash. U. J. of L. & Pol’y (forthcoming May 2019).
[81] See supra Part III 1.-3.
[82] Craig Calcaterra & Wulf A. Kaal, Secure Proof of Stake Protocol, (U of St. Thomas (Minnesota) Legal Studies Research Paper №18–10, 2019), https://ssrn.com/abstract=3125827.
[83] E.g., see this discussion: Buck Perley, Crypto-Governance and the Dangers of Faction, Medium (Oct. 27, 2017), https://medium.com/@BuckPerley/crypto-governance-f1318affbbe0; Fred Ehrsam, Blockchain Governance: Programming Our Future, Medium (Nov. 27, 2017), https://medium.com/@FEhrsam/blockchain-governance-programming-our-future-c3bfe30f2d74; Vlad Zamfir, Against On-chain Governance, Medium (Dec. 1, 2017), https://medium.com/@Vlad_Zamfir/against-on-chain-governance-a4ceacd040ca; Vitalik Buterin, Notes on Blockchain Governance, Vitalik.ca (Dec. 17, 2017), https://vitalik.ca/general/2017/12/17/voting.html.
[84] Naval Ravikant (@Naval), Twitter (Apr. 13, 2018, 9:55 PM), https://twitter.com/naval/status/985018594252742656.
[85] Adam Reese, Ethereum Dev Yoichi Hirai Steps Away From Role As EIP Editor, Raises Questions About Process, ETHNews: Ecosystem (Feb. 15, 2018), https://www.ethnews.com/ethereum-dev-yoichi-hirai-steps-away-from-role-as-eip-editor-raises-questions-ab. For a good argument from the former EIP editor that the EIP system is dangerous, who has since retired based on his serious concerns.
[86] Wikipedia: Bitcoin Improvement Proposals, https://en.bitcoin.it/wiki/Bitcoin_Improvement_Proposals (Last visited Aug. 19, 2019).
[87] Gavofyork, Yellow Paper Committee, GitHub (Apr. 10, 2016), https://github.com/gavofyork/curly-engine.
[88] Lists.ozlabs.org, https://lists.ozlabs.org/pipermail/bitcoin-dev-moderation/ (last visited Aug. 19, 2019).
[89] E.g., Aragon’s Governance Page: Aragon, Governance, GitHub (Sept. 22, 2017), https://github.com/aragon/governance.
[90] The Ethereum foundation has a tutorial for how to program a basic governance structure with voting at Ethereum, https://www.ethereum.org/dao (last visited Feb. 11, 2018).
[91] Ethan Buchman, Tendermint: Byzantine Fault Tolerance in the Age of Blockchains (June 2016) (unpublished A.A.S. thesis, University of Guelph), https://atrium.lib.uoguelph.ca/xmlui/bitstream/handle/10214/9769/Buchman_Ethan_201606_MAsc.pdf?sequence=7&isAllowed=y.
[92] Rachel Rose O’Leary, Polkadot’s Plan for Governing a Blockchain of Blockchains, CoinDesk (Mar. 22, 2018, 1:10 UTC), https://www.coindesk.com/polkadots-radical-plan-governing-blockchain-blockchains/ (“the internal token of the Polkadot network, allows its holders to vote directly on a piece of code, which will then automatically upgrade across the network.”).
[93] DAOstack, An Operating System for Collective Intelligence, (White Paper V1.1, April 22, 2018), https://daostack.io/wp/DAOstack-White-Paper-en.pdf.
[94] (tezos, Tezos-Papers, GitHub (Oct. 25, 2016), https://github.com/tezos/tezos-papers.
[95]Joel Valenzuela, Dash Surges to Record High, Claims $0.5 Mln Monthly Development Budget, CoinTelegraph (Mar. 13, 2017), https://cointelegraph.com/news/dash-surges-to-record-high-claims-05-mln-monthly-development-budget. Decentralized Governance by Blockchain includes a system where “masternodes” have voting power and control of a development budget that takes 10% of the mined profit, which they claim amounted to more than $500,00 US per month in March 2017. However, masternodes can have incentives that are not always aligned with other users so that such on-chain governance may skew the development of the platform in unhealthy ways.
[96] Luis Cuende & Jorge Izquierdo, Aragon Network: A Decentralized Infrastructure for Value Exchange, (White Paper Version 1.1.1, April 2017), https://www.chainwhy.com/upload/default/20180705/49f3850f2702ec6be0f57780b22feab2.pdf.
[97] Cardano, https://www.cardano.org/en/academic-papers/ (last visited Aug. 19, 2019).
[98] MakerDAO, https://makerdao.com/ (last visited Aug. 19, 2019).
[99] NuBits, https://nubits.com/nushares (last visited Aug. 19, 2019).
[100] Buterin, Notes on Blockchain Governance, see supra note 83. Vitalik Buterin argues. Factors to be considered for an off-chain governance system include: consensus among development team, initial roadmap, coin holder voting, user voting with some kind of Sybil resistant polling system, and established norms.
[101] In off-chain governance models node operators have to update their client manually for a protocol upgrade to align with the new chain.
[102] Steven Lalley & Eric Glen Weyl, Quadratic Voting: How Mechanism Design Can Radicalize Democracy, (December 24, 2017), https://ssrn.com/abstract=2003531.
[103] Robin Hanson, Futarchy: Vote Values, But Bet Beliefs, Mason.gmu.edu, http://mason.gmu.edu/~rhanson/futarchy.html (last visited Aug. 19, 2019).
[104] Wikipedia: Delegative Democracy, https://en.wikipedia.org/wiki/Delegative_democracy (last visited Aug. 19, 2019).
[105] Calcaterra & Kaal, supra note 82; Calcaterra, supra note 15.
[106] Id.; Calcaterra et al., supra note 41; Calcaterra, supra note 15.
[107] Wikipedia: Web of Trust, https://en.wikipedia.org/wiki/Web_of_trust (Last visited Aug. 19, 2019).
[108] Ebay, Uber and many other company use these reputation metrics. See e.g. ebay.com, uber.com
[109] Binance Academy, Sybil Attacks Explained, Binance Academy (Dec. 8, 2019), https://www.binance.vision/security/sybil-attacks-explained; Wikipedia: Sybil Attack, https://en.wikipedia.org/wiki/Sybil_attack (last visited Aug. 19, 2019).
[110] Lin Chen, et al., Tyranny of the Majority: On the (Im)possibility of Correctness of Smart Contracts, 16 IEEE Security & Privacy 30 (2018), https://ieeexplore.ieee.org/stamp/stamp.jsp?tp=&arnumber=8425620.
[111] See supra note 51 (effects of stable and presumptively optimal rules).
[112] Calcaterra and Kaal, supra note 82.
[113] Calcaterra et al, supra note 41.
[114] Take for instance, a DAO member who stakes that a given smart contract template is optimal for XYZ outcome/application. Once the template is affirmed by the DAO members as optimal at that point in time, it becomes a valuable precedent for the DAO members and external DAOs. Hence, the staking of an individual and the ex-ante work that leads to staking increases sustainable value for all DAO members. The DAO members and other DAOs will rationally increasingly use the precedent until a better precedent emerges. That precedent thus increases the individual DAO member’s reputation and the DAO overall.
[115] The DAO work proposal and value optimization structure allows the avoidance of bad projects, bad colleagues, and unproductive meetings. The dominant incentive across all DAO constituents is value enhancement. Of course, “value” can have differing meaning, depending on the DAO. If value can be added, the tasks will be performed, if the assessment of the proposal suggests that the value proposition is in doubt token holders will try to spend their time and skills on more productive and value-adding tasks. Importantly, because the DAO structure functions without supervisors, DAO token holders who decide they cannot add value on a given task can move to more productive endeavors that better utilize their skills without any penalties that would exist in the traditional hierarchical corporate structure.
