DAOs in Practice: When Community Governance Meets Reality

Introduction

Imagine businesses where all of the people involved in a particular organization can make decisions together regarding markets they want to enter, salaries, the features they want to create, etc.; therefore having numerous voices being heard by all stakeholders before making decisions about the direction of that business. Unlike traditional structures where one CEO has control, there is no one "CEO" who calls the shots from a throne. Instead, the community reads all potential ideas then ultimately votes for the one they want to proceed with as a way to agree on the direction of the business.

Today, we see this promise of radical Democracy within the technology of DAOs decentralized autonomous organizations that manage billions of dollars through cryptocurrency protocols. While DAOs allow large groups of people to make decisions through democracy, spreading power does not always lead to better decision making and often creates new challenges.

What Are DAOs and How Do They Work?

DAOs represent a new type of organization that enables members to vote through online platforms, using blockchain technology to reach decisions as a group, rather than being managed by one centralized authority or business.

All decisions and regulations within a DAO are based on community agreements captured in computer code called "smart contracts", which act as automated, self-executing processes that enforce the rules and agreements of the community, according to the voting results.

Members of the DAO can monitor all voting activity and decisions and have complete transparency in tracking the action taken, funding options and vote tallying.

This is unlike the way traditional businesses operate, where most decisions are made by employees or executives behind closed doors. In a DAO, individuals holding the DAO's tokens (rather than an executive) have the right to propose decisions, suggest future actions, and vote on matters related to the direction and governing structure of the DAO.

Uniswap's DAO has managed to create a very large decentralized exchange, and they voted in 2024 to create a legal structure for the DAO that would allow for contracts with other entities while maintaining the DAO's decentralized governance. This vote was approved with over 80% of the participating token holders voting in favor of this legal structure and not in some corporate boardroom, but rather through an on-chain voting mechanism.

In addition to Uniswap's DAO, MakerDAO is currently taking these steps to manage the DAI stablecoin. Token holders make financial decisions and policies as a group by voting on which assets may be used as collateral, the interest that borrowers pay, the amount of DAI to be minted, etc. In December of 2024, the token holders voted to raise the stability fees for DAI from 9–12% to 12–16%, creating a substantial increase in the cost of borrowing DAI. These votes create legally binding contracts, which can be automatically enforced by smart contracts.

The Power Shift That Wasn't

DAOs should allow for more democratic decision-making than those being made by just a few individuals. Yet, many people who hold large amounts of tokens or "whales" tend to dominate the voting process. According to Chainalysis' data, approximately 1% of the holders of 10 of the most significant DAOs control around 90% of the voting rights. In addition, it has not realized a greater degree of democracy or decentralization; rather it has resulted in a form of centralization by a very narrow group of voices.

While there is a distributed approach to voting authority, the statistics are less than encouraging. According to industry reports, only 15% to 25% of people are actively involved within the various DAOs. Even the largest protocols, such as Maker and Uniswap (UNI), find it difficult to engage more than 10% of the token holders when it comes to voting on their essential business proposals. In 2024, when Arbitrum's governance token dropped 71% in value, participation decreased by 50%. When the value of the tokens drops, there is less and less incentive for holders to participate in the voting.

Therefore, in reality, decisions are being made largely by a very small group of DAO community members who are capable of taking the time to show up and vote. The principle of community-driven governance will devolve into a governance system governed by only those who actively pay attention to it.

Real Decisions, Real Problems

In 2024, Uniswap is facing a chance while also experiencing tough times by voting to finance Unichain's network and the Uniav4 protocol with a combined $165 million. The community also discussed establishing a presence on BNB Chain but eventually voted yes to the project with differing opinions. These two efforts represent major funding for strategic growth efforts into new blockchain platforms. There was no single individual (such as a CEO) to champion either growth opportunity; all community members participated in those discussions and voted using the company's forum.

MakerDAO's example illustrates how granular governance is set up at a token-holder level. In 2024, token holders made changes to the stability fees; they raised fees when there were too few DAI tokens in circulation and lowered them when demand was high. For example, fees rose 3% in March and fell 3% in December. These changes are ongoing and are completely driven by the community, not determined by the board each year.

However, hands-on governance has its own challenges. For example, if every decision made creates an opportunity to vote on the parameter changes, it leads to voter fatigue among casual participants. Technical issues overwhelm some voters, resulting in very few votes (as low as 10%) being cast for critical governance decisions.

Solving Voter Apathy

Minimal participation in a DAO undermines the premise of community governance.

Most token holders are inundated with information that makes it nearly impossible for them to comprehend the many complex protocol amendments along with their respective financial risks, thereby making voting time-consuming with no assurance of the outcome for smaller owners. Why must an owner spend numerous hours researching a proposal when his 100 tokens would be insignificant when compared against the whale who's holding millions?

DAOs are exploring solutions to resolve the issues of lack of participation. One such method is quadratic voting, which increases the amount of tokens required for multiple ballots, thus limiting the power of whales to sway the outcome. For example, if a token holder were to cast their first vote, it would cost them one token; the second vote would cost them four tokens and so on. This method is easy to do mentally but for many people, it is difficult to conceptualize the translation from tokens to voting power.

Several DAOs are compensating members for participating in governance activities. For example, Uniswap distributes monthly stipends to delegates that continue to serve actively. In early 2024, MakerDAO disbursed over 100,000 DAI to their top delegates for their efforts in promoting governance. This allows for a more professional program, as opposed to having an overloaded volunteer system. The initial results of these paid programs are varied. For example, Uniswap has often attained quorum as a result of lengthy debates; however, some critics have contended that the professionals are only motivated by compensation and not by the desire to steward their protocols.

The Uncomfortable Questions

As DAOs continue to evolve, there are increasingly challenging issues being raised. Are DAOs replacing the old world of Corporations and replacing them with Plutocratic systems? In other words, does wealth determine power? Will Token Voting inevitably develop into a modified version of Capitalism where the wealthiest Holders will have the greatest say regarding the processes of their organization on the Blockchain, while the other token Holders will remain disenfranchised from participating?

There is also the matter of the legal ambiguity associated with DAOs. Most DAOs remain in a state of regulatory gray area; however, with Uniswap paving the way by utilizing Wyoming's DUNA model, current legislation does not allow for a business plan to exist without a central leader. If a DAO is sued, what will happen? Who will the lawsuit be delivered to? Who will be held liable? In traditional companies, there are established legal frameworks; for DAOs, the legal frameworks are still being defined.

Many people question the efficiency of how DAOs are currently operating; is community governance really an improvement over traditional company management? For traditional businesses, the process is quite simple: a CEO makes the decision and the company's associates carry it out. For DAOs, there are many steps that must occur before anything can happen, such as community proposals, the discussion period, a voting period and a delay period before votes can be brought to action. By the time a DAO decides how to respond to an urgent market condition, the market's position might already change.

What Happens Next

Decentralized Autonomous Organizations (DAOs) are testing new power-sharing systems vs traditional methods. For example, in some DAOs, members vote by using a panel of experts on routine technical issues and members vote on larger issues.

Some DAOs are experimenting with the use of AI to track members' preferences and vote, which may increase member participation through automation.

Currently, whether these efforts will enhance, or impede, the movement towards decentralised networks is under debate. An inherent challenge of a DAO is that member-driven decision-making relies on a large number of active members, which may create paralysis when needed to make a decision. DAOs successful in this regard may lead to new collective structures; whereas failure to succeed may clarify functional governance systems will need an element of hierarchy.

Conclusion: Transparency Isn't Democracy

The DAOs demonstrate that a community can manage billion-dollar protocols that are very complex without needing a corporate structure. The holders of tokens make binding decisions on technical upgrades, the financial direction of the protocol, and the strategic direction of the protocol (to some extent). And the system works!

What is different in this infrastructure compared to past systems is that working infrastructure does not necessarily guarantee that power is truly distributed to the owner group. The community governance is a very theoretical concept; however, based on 1% of holders controlling 90% of the votes, approximately 20% participation in the vote, and the ability for whales to influence the outcomes of the vote, the community is transitioning from a system of opaque/decentralized power to a system of transparent/distributed power; however, the current state of the system indicates that while the community is capable of making decisions, the actual decision-making power within the community is not truly decentralized.

This can be seen by the fact that even though every vote is auditable, the ability to influence the decision outcomes is still concentrated in the hands of very few individuals (whales). Nevertheless, this still may be considered progress. Transparency helps to hold individuals responsible for their actions. Since open processes are transparent to all, this gives new community members an opportunity to gain influence over the decisions being made; however, having visibility to the decision-making process does not mean that the community has equal access to the power to make those decisions.

Therefore, while the community can make decisions, the question that needs to be answered is whether granting the community membership decision-making rights has resulted in the development of new hierarchies, or actual decentralization, of authority. Although there are ongoing efforts to establish fair practice associated with retaining the transparency of prior decision-making processes using blockchains, there is no guarantee that the processes will be fair.