Ever wondered how a DAO (decentralized autonomous organization) is governed? Or why do some DAOs operate differently than others? Perhaps you’ve been wondering about the very concept of governance itself and questioning the way we manage and make decisions. It’s difficult to make broad observations due to the large number of DAOs in existence and the variety of ways in which their governance models operate. However, amid this diversity, some components emerge consistently. The objective of this blog is to provide you with a better understanding of the fundamental elements that constitute DAO governance. By the end, you'll be equipped to identify its components and develop better-informed opinions about DAO governance going forward.
Need a refresher on DAOs? Read What is a DAO? and Types of DAOs.
A DAO’s governance model
DAO governance exists in two parts: the on-chain part and the off-chain part. These parts are usually closely aligned, and observing how they interact with one another can provide valuable insights into a DAO’s governance dynamics. These interactions can reveal where true decision-power lies and how decentralized the DAO really is.
On-chain governance
On-chain governance refers to the decision-making and voting processes that are recorded on the blockchain and, in some cases, are automated by smart contracts. Organizational processes in on-chain governance are transparent and open for anyone to scrutinize. This is contrary to more traditional forms of governance, which often operate behind closed doors with limited visibility in their processes.
On-chain governance is widely regarded as the “formal” part of a DAO's governance, as the intrinsic nature of a blockchain ensures that any action or record executed on it becomes immutable and irrevocable. The decision-making processes that occur on-chain are facilitated by the DAO's governance token, empowering token holders to solidify their positions into a permanent vote on the blockchain. In order to cast votes, DAO members have to sign a transaction with their private keys, validating their ownership of the associated governance tokens.
A DAO often comes into existence through the issuance of its governance token. Typically, a governance token's main purpose is to facilitate fair and transparent governance by allowing DAO members to cast on-chain votes. Thus, the governance token represents decision-making power within the DAO. In absolute terms, token holders have decision power in the DAO and can co-decide over matters relating to treasury management, grant proposals, and governance rewards, amongst others. It is the ultimate goal of most DAOs to distribute all decision power to its community. In reality, however, when a DAO launches, the founders often still hold the majority of the tokens and, therefore, most of the on-chain decision-making power.
Challenges to on-chain governance
Most existing DAOs are yet to fully automate all the potential governance processes through smart contracts. Often, the execution of proposals, the distribution of funds from the DAO’s treasury, or the distribution of governance rewards still rely on human intervention rather than being automated by smart contracts. This can be due to smart contract risks or legal and regulatory compliance. To protect against this, wallets that hold DAO reserves are often multi-signature and require manual action to be used. A further complexity is a general disconnect between blockchain and traditional finance services, which often requires off-chain execution. For example, a DAO may manage funds to donate to charities, but not all charities accept crypto.
Another challenge faced in on-chain governance is that a heavy concentration of a governance token in the hands of just a few actors can lead to a loss of integrity in the DAO’s voting processes and governance. DAOs also sometimes struggle with low participation in governance. If DAO members are not rewarded for their participation or have to pay high blockchain transaction fees to cast votes, this can discourage them from participating in governance. A potential solution to explore is allowing delegation of voting stake.
Delegation happens when a DAO member delegates the voting rights associated with their governance tokens to another DAO member, usually known as a steward. A delegation system is shown to have the ability to accrue community opinion pretty well while contributing to increased voting participation. However, there are some challenges to delegation as well. For example, delegation doesn’t necessarily solve the issue of voting centralization. Voting stake usually still ends up in the hands of just a few influential community members, like the core contributors or founders. Another potential downside to delegation is that it allows for the politicization of a DAO’s governance, meaning that stewards can offer services in exchange for delegated voting stakes.
Off-chain governance
Off-chain governance refers to processes that are not recorded on the blockchain or automated by smart contracts. In most DAOs, the off-chain part of governance consists of the community processes that lead up to formal voting rounds. On-chain governance is most successful when there is a community that actively participates by discussing ideas and relaying constructive feedback. These community discussions and early proposal drafting often happen on an official forum or a designated platform. Community processes are an essential part of governance as they enable the community to have input into the actual governance processes of the DAO.
It is important that off-chain processes are fair and transparent; all relevant data should be made available to DAO members at all times. The obstacle often lies not in transparency itself but rather in DAO members being able to find, understand, and make decisions based on the information available. If these challenges are not properly addressed by the founders or the DAO’s core team, DAO members may become discontent and begin proposing alterations to the DAO’s governance processes.
How governance works on Algorand
Layer-1 blockchains essentially operate or aim to operate as DAOs, with the goal of ultimately handing over all governance control to their communities. For example, in the case of Algorand, it is the Foundation’s long-term goal to hand over all governance processes to the community. There is a continuous collaboration between the Algorand Foundation and the community to improve governance processes.
Algorand Governance is the initial implementation of Algorand blockchain governance. The program allows Algo holders to vote on measures proposed by the Foundation relating to the future of Algorand, such as governance reward allocations and other strategic decisions. Votes are cast on-chain and discussions are held on the Algorand forum. In Algorand Governance, Algo is the governance token. A Governor must commit Algo for a 3-month Governance Period in order to participate; the committed Algo remains in their wallet and must not be moved during the period. If the committed Algo leaves the wallet during the Governance Period, the Governor becomes ineligible to participate in governance. Voting by Governors is recorded on-chain. Learn more about the Algorand Governance program.
Algorand’s xGov program aims to create an expert layer of governors whose first mission is to decide on funding allocations for grant applicants that align with the mission of growing the Algorand ecosystem. The on-chain component enables voting through smart contracts and data to be recorded on-chain. The off-chain component encompasses the proposal submissions and discussions that take place in a transparent environment on Algorand’s GitHub repository, where proposals can be submitted in a standardized format for xGovs to review. Learn more about how xGov works.
How off-chain governance influences on-chain governance
On-chain and off-chain governance go hand-in-hand: proposal discussions take place off-chain and publicly, while token commitment and voting processes take place on-chain. While token commitment often equates to voting power, there have been occasions where influential community members without many tokens committed to the DAO can hold great influence on the future of the DAO and affect its on-chain state. Remember that, especially in the early stages of a DAO’s life, a lot of the influence remains in the hands of the founders, or core contributors, who usually wield both on-chain and off-chain influence.
What was The DAO Hack and what can we learn from it?
The DAO Hack is a significant example of how off-chain influence can affect on-chain governance. The DAO, launched in 2016 on Ethereum, was designed to be a self-governing investment fund and raised over 12.7M ETH (around $150M USD at the time) through a token sale. The DAO was one of the earliest significant projects built on Ethereum.
The hack occurred due to a weakness in the DAO's code, letting the attacker take advantage and withdraw 3.6M ETH (around $50M USD at the time) from the DAO's funds. The hack divided the Ethereum community, and part of the community decided to hard fork the Ethereum blockchain, essentially rolling back certain malicious transactions and undoing the hack. Some community members expressed concern as they believed that making certain transactions undone would affect the blockchain’s integrity going forward. Ultimately, this event resulted in the Ethereum blockchain splitting up into two versions (known as forking): one where the hack happened, now known as Ethereum Classic, and one where the transactions of the hack were reversed, now known as Ethereum.
The reason it was possible to effectively undo the hack was because of the strong community influence of the people who believed that this was the right decision. Once the rollback was complete, the majority of the Ethereum community moved to the altered chain, which became the Ethereum blockchain from that point on. This is a demonstration of how community power was able to fork and rollback transactions to appease the demands of the community without the involvement of on-chain governance.
The rollback of transactions was done for the good of the community and to restore those who lost funds. However, being able to alter transactions on a blockchain goes against its immutable, or tamper-proof nature. Immutability allows us to trust a blockchain and is what many projects rely upon to avoid manipulation, replacement, or falsification of data on the network. Good or bad, we must live with the history of blockchains. Good intentions should not justify tampering with immutability, one of the basic principles of blockchain. True believers in immutability stayed with Ethereum Classic, while those who wanted their funds back went on to support Ethereum. Although this kind of rollback has never happened since, there isn’t any guarantee that it won’t.
Conclusion
It’s clear that both on-chain and off-chain governance are indispensable parts of a DAO, with both working together to deliver fairness and transparency in decision-making processes. It is important to understand and assess the weight of each governance dynamic when participating in a DAO, as well as how and to what extent on-chain and off-chain governance interact. Naturally, this is just the beginning, but it should enable you to form wiser judgments and more refined opinions on DAO governance in the future.
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