Decentralized Autonomous Organizations, or DAOs for short, represent one of the most exciting technologies. The DAOstack is not just for financial innovation but also for social technology and potential for human civilization. Many believe that they have the ability to revolutionize the future of organizational structures. But are these just pipe dreams of Cypherpunks and idealists? Or is there something more to these ideas?

Why we need DAOstack

Many large scale corporations don’t act in the best long-term interests of civilization, in some cases even directly opposing it. Corporate lobbying has been corrupting politicians, leading to many situations where traditional democracy fails.

If elected officials take bribes in some form, it defeats the purpose. Corporatists and politicians frequently are looking to achieve advancement of their own career at the cost of society’s long term goals. This happens even with the best of intentions, because to run political campaigns you need funding from somewhere.

For companies wanting to improve their bottom line, they will cut costs anywhere they can. Especially if those costs are externalized outside of the organization.

Case in point – ExxonMobil

Look no further than the ExxonMobil climate change controversy, where Exxon did research on climate change, determined that it was likely real and then proceeded to lobby politicians and fund climate denial organizations. Reports on the documents from the organization said that Exxon actively used climate research in their business planning while simultaneously funding denial groups. Exxon is under investigation for defrauding its investors and the public on the risks of climate change. The externalized cost of this on the economy and society are immeasurable.

This misalignment of incentives is due not entirely to evil, greed, or any other boogeyman or political scapegoat. But it’s often the result of system design and scale-ability. Traditional organizational structures are more susceptible to certain types of corruption. The rules of the game are the problem.

Skin In The Game

Skin in the game is an aphorism in economics and game theory for consequential decisions made by people who pay for the consequences. Problems can arise when people are put into positions where they can make choices on behalf of others without being affected or affected to the same degree. Being proportionally affected by the choices you make is called risk symmetry.

Consider the case of the wealthy executive of an organization who has to find a way to cut costs. He decides that the best way is to cut wages across the organization. So, everyone that’s below him in the organizational structure now makes less money. Not only is the executive’s wages the same, but he will also get a nice bonus for his cost-saving measures while having risked little to himself. All this before it’s clear if lowering the wages was a good idea for the company as a whole.

Nassim Taleb explains Skin in the Game

Nassim Taleb, author of the book Skin In The Game further elaborates on the concept and how it facilitates evolution.

“My argument is that there is a more essential aspect: filtering and the facilitation of evolution. Skin in the game – as a filter – is the central pillar for the organic functioning of systems, whether humans or natural. Unless consequential decisions are taken by people who pay for the consequences, the world would vulnerable to total systemic collapse. And if you wonder why there is a current riot against a certain class of self-congratulatory “experts”, skin in the game will provide a clear answer: the public has viscerally detected that some “educated” but cosmetic experts have no skin in the game and will never learn from their mistakes, whether individually or, more dangerously, collectively.”

How DAOs change the rules

DAOs can change the rules of the game so that the decision makers of organizations have more skin in it. There is ongoing experimentation with various designs for these types of organizations. The particular innovation blockchain brings to the table here is that it allows us to have trustless mechanisms like token staking, reputation, and fractal governance to incentivize good decision makers and filter out the bad ones in a meritocratic way.

DAOs promise to do to for organization structure what blockchain did for money. Create open autonomous organizations outside the control of central authorities or dictators who have little skin in the game or personal risk.

Are DAOs Plutocratic?

Maybe it would be foolish to relinquish control to DAOs given their decentralized and viral nature. One big fear is that they will lean towards plutocracy, or ruled by the wealthiest, because these protocols often use various forms of staking or coin voting.

To describe staking oversimplistically, each coin equals one vote on some decision and usually there is some kind of penalty or reward for your decisions depending on if they were good or bad for the system. Therefore the richer you are, the more influence you have over a decision. But each good decision you made to grow richer also benefited the overall system. Perhaps they could be worse than what we have now.

There are many fears people have about current and future blockchain governance systems. Especially those that involve staking schemes. Here I am using the terms “staking” and “governance” very loosely to refer to consensus algorithms, formal on-chain governance, and any decision making systems that run on a blockchain such as a DAO.

Some are worried that purely using staking is bad because the people with the most amount of money have the most power. This potentially leads to a plutocratic situation where the rich rule the majority. This fear is very reasonable since the rich minority often have different goals than the poorer majority.

However, there are important distinctions to be made between the de-facto plutocracies we see in some societies and plutocratic governance enforced by crypto-law (the blockchain or a smart contract).

Plutocratic societies

Let’s consider a company that has to spend millions every year to not break environmental regulations. They decide to lobby government officials to repeal regulations so they don’t have to spend as much disposing of their waste. It goes without saying that the cost of lobbying is lower than the cost of continuing to follow regulations, otherwise they wouldn’t be doing it. So it must be a profitable strategy for these companies.

Asymmetry – Here is the problem, the individuals running these companies have a lot to gain from doing this whereas the majority of the public does not. The public is faced with even more pollution, which they will eventually have to pay for in one way or another. The company polluting also spends and risks relatively little to lobby, so this becomes an asymmetrical trade-off for them. Simply, lobbying is more profitable.

– Here is the problem, the individuals running these companies have a lot to gain from doing this whereas the majority of the public does not. The public is faced with even more pollution, which they will eventually have to pay for in one way or another. The company polluting also spends and risks relatively little to lobby, so this becomes an asymmetrical trade-off for them. Simply, lobbying is more profitable. Opaqueness – In many countries, lobbying isn’t the most transparent process. Often it’s not even documented. The lobbying from plutocrats is often done in secret. So we don’t always know if a politician is genuine or if he’s pushing some plutocrat’s agenda for personal gain. Over the past two decades, lobbying groups have spent $2 billion lobbying against various environmental policies.

Plutocrats are able to hack society for their own gain by attacking the central points of failure often in secret, which are usually the people writing the laws. This type of attack on the system is low cost and low risk.

Plutocratic blockchain governance

Plutocratic blockchain governance, such as Ethereum’s upcoming Proof-of-Stake consensus algorithm, differs significantly. There are rules to make things fair. But there is also a bit of a false equivalence when comparing blockchain governance to an actual government anyway.

A blockchain is more analogous to a corporation than a government. And generally in a company, the people who wield the most power are also the wealthiest. Another distinction is that any blockchain or DAO is, by definition, on the free market and is an opt-in system. It’s much easier to change your investments or cryptocurrency than to swap out your government for a completely different one.

Symmetry

This is an important difference. Staking systems usually involve putting your money where your mouth is and taking on some risk. With Proof-of-Stake, a validator places a bet with its staked Ether on which block is authentic and should be added to the blockchain.

If they are dishonest and validate invalid blocks, they lose some of their staked Ether. If the validator has a large amount of Ether staked and is a “plutocrat”, it risks an equal proportion as a small validator would. This is very different than a plutocratic company lobbying the government as the larger the company, the more they benefit from economies of scale and the lower amount of proportional risk they would have from spending money on lobbying. The richer they are, the lower the risk.

The risk for plutocrats is asymmetrical compared to their poorer counterparts. But this is not the same for staking and blockchain governance, where your absolute risk is always proportional to the size of your stake; there is no economy of scale to give an unfair advantage. Relatively speaking, you are just as exposed and have just as much skin in the game.

Transparency

Given that transactions are all on an immutable public ledger, it makes staking a much more transparent plutocratic system than what we see in governments. Everyone’s chips are on the table and anyone can see who’s voting for what, although vote buying is still possible.

The alternatives are worse

If you are still unconvinced of Proof-of-Stake systems, consider alternatives like Proof-of-Work. Mining equipment benefits from economy of scale, bringing to the top minors having a disproportionate amount of power over the system. And mining pools have just made the problem worse. Proof-of-Work leads to centralization and plutocracy more so than Proof-of-Stake.

Also, miners don’t have as much incentive to increase the value of the coin they are mining. Usually, they sell most of their mining rewards on the open market right away. Their assets (mining equipment) depreciate overtime regardless of how much they benefit the system. With staking, the assets can appreciate with time if you continually act in the best interests of the system as a whole. They have more incentive to make the system better.

Economic incentives

Critics of Proof-of-Stake often completely miss the massive economic incentive that validators have. If the plutocrats in a staking-based system decided to attack the system by voting for upgrades that benefit themselves disproportionately or at the cost of the majority, analogous to a company lobbying governments for changes in the law, the majority can decide to:

A) Fork the blockchain or DAO removing the plutocrats from it entirely, or

B) Exchange their tokens/coins for one of the thousands of other competing projects, causing massive downward price pressure and significantly devaluing the plutocrats’ assets.

Greed-busting design

The very design of this system works so that even with greedy plutocrats, it still functions fairly. A greedy plutocrat isn’t going to want to devalue their assets or destabilize the very system that their wealth depends on. With DAOs or staking validators, the people that own the most tokens are most affected by the changes in prices.

The plutocrats in blockchain systems have the most exposure and skin in the game and therefore the loudest voice. If they make bad decisions for the system as a whole, they will become poorer and filtered out. With time, their power in the DAO or blockchain will diminish.

So the big difference is that in blockchain systems, due to tokenization making most users of the system stakeholders, there is more of an alignment of incentives between a “plutocrat” and everyone else using that system. This is different than plutocracy in a country where incentives between politicians, corporations, and the public can all be entirely different.

What is a DAO?

A Decentralized Autonomous Organization is a new open organization structure controlled by share(token) holders who make decisions on behalf of an organization. The “open” nature of it refers to the fact that the code is opensource and participation in decisions are open to anyone in the world with internet access and capital to participate in the system. Nearly two-thirds of the planet now have cellphones, so the barrier for entry is quite low.

It doesn’t have a centralized control system and coordination between the individuals in the system happens through a process in biology known as stigmergy or spontaneous order.

The decision-making process is usually written in stone and dictated using smart contracts on a blockchain. Unless, that is, shareholders vote to change the rules and update the code of the DAO. It is similar to how some companies who issue stocks also allow shareholders to vote on things like policy changes or boards members. However, unlike traditional companies, a DAO typically endows its users with far more involvement in the decision making processes.

DAOs and scaling

A DAO can scale so that every managerial decision could be made by the shareholders. This is also one of the issues with traditional top-down organizations. As they become larger, they become increasingly complex and the need for more complex decision making.

If you aren’t familiar with DAOs, you might be wondering how it could be possible that an organization could actually function without centralized governance. If anyone anywhere in the world can make decisions for these smart companies, how do they not just turn into chaos? How does everyone agree with what decision is best, if any?

Just because someone has a bit of capital to place votes doesn’t mean they are the best decision makers. The exact answer to this depends on which DAO we are talking about, because there are a few different structures. But there are several things most of them have in common. The first being shareholders.

Aligning incentives

DAOs can create alignment of incentives between people of different ethnicity, countries, politics, and any other arbitrary categorization we humans can give each other.

They do this by making people stakeholders in the system. If the DAO is successful in its goals, it should lead to an increase in the price of the token, much like a stock. This increase in price can come from higher dividends, burning supply, or increased usage of the platform if it involves using the token in some way.

Skin in the game

Since no rational person is going to want to devalue their assets, they should want the value to increase and therefore have the same incentives as everyone else in the system. They have skin in the game.

Some people are doubtful that this is feasible. They believe that organizations need strict, centralized, and top-down, hierarchies with bosses dictating what happens. However, this is an underestimation of our natural tendencies to self organize when we have an alignment of incentives.

In nature, self-organizing systems are surprisingly common and they emerge through natural processes like evolution. There are far more examples of highly organized structures or systems in nature than there are created by humans. We can easily observe this by virtue of the fact that every strand of DNA, cell, and organism is a complex system.

Order and Emergence

Ordered systems arise naturally from disorder. Emergence happens when a collective of small parts exhibits properties that individual parts do not. There are many examples of emergence in nature.

Some examples are things like crystals and snowflakes naturally ordering their molecular structure to create all sorts of wonderful patterns. Every living thing qualifies as an emergent system. Living systems are emergent. Over time, populations of organisms usually become more complex and ordered to exploit environmental niches. This happens without anyone thinking or designing the organism, just a little random mutation, and natural selection suffices.

The Game of Life

The great scientist John von Neumann was very interested in space colonization. Originally, he thought about sending machines to Mars that could prepare the planet for humans. Some level of terraforming or preparation would be necessary as it isn’t logistically possible to send all the supplies needed for an indefinite space colony along with the passengers. But there is a problem with that as well because you also need to send a fleet of supplies with your machines, coming back to the original problem.

Replication

So the machines that went to terraform mars needed to be able to replicate themselves to increase their productivity and replace broken down machines. But there is a problem with that, too, as creating such a machine typically requires a more complex machine. And to build that machine, an even more complex machine, so on and so for. Von Neumann uncovered an interesting problem in science that wasn’t just about space exploration.

Von Neumann invented complicated cellular automaton simulations in an effort to prove that it was possible for the machine to self replicates without needing an infinite amount of parent machines. He knew that he could because our DNA essentially is such a machine.

Cellular Automata

Cellular automata are simple simulations that were initially for use on simple grids. The simulation was actually designed on a Go board before it was programmed on a computer. In the grids, you have cells or Go pieces, or in our case blocks. Depending on some rule set defined by the game any individual square would have a new cell created or destroy an existing cell removing it from the board.

The mathematician John Conway would build upon Von Neumanns ideas by creating an even simpler automaton simulation. The Game of Life is the name of the simulation.

The Game of Life

We can render this game with our blocks to find all sorts of interesting patterns. The first example above is a random starting point which eventually stops as no new moves become possible. Over the years online communities around this game have gotten more popular and people have discovered all sorts of interesting patterns. Here is a stable infinitely repeating pattern called a Blinker.

As it turns out, the Game of Life is a universal machine and could do any computation hypothetically possible. It can even create stable patterns which can create replicators which is proof that Von Neumann was correct. Here is another pattern that continually produces child cells which themselves go on infinitely.

Rules to the Game of Life

There are just four, simple rules in the Game of Life. It is a demonstration of the power of emergent phenomenon. Simple rules can create ordered and complex systems even without intelligence designing them. To quote the DAOstack whitepaper; a DAO is a self-organizing entity, and at large better resembles an organism rather than an organization.

DAOstack

DAOstack is an Ethereum-based platform built with smart contracts to facilitate the self-organization of DAOs. In other words, it acts as an operating system for DAOs. It is designed to solve several of the problems we have seen with some DAOs.

DAO topology

There are two main ways to think about and design a DAO. The differences between the designs are similar to the difference between centralized and decentralized systems.

Assembly

This is more of a centralized system, like a smart contract, which interacts with each DAO participant directly. The issue with this is that it has limitations with the scalability of decision processing power and constrains the system as a whole.

Fractal Federal-governance

Fractal Federal-governance is a more organic system that branches off into many sub-organizations like a tree. These sub-organizations or agents can themselves have sub-sub-organizations and so on. It is a fractal structure. These organizations can also share and connect other organizations creating entire networks of organizations.

Open Organizations

The whitepaper of the DAOstack details some of the problems with our current economic system. Competition between corporate entities for customers is partly what causes innovation. Much like living organisms, these corporations evolve and optimize to fill niches in their markets.

The economic game inherently optimizes systems or organizations locally. Locally, not just in the spatial sense, but also in the temporal sense of seeking short term over longer-term benefits to the whole. It is called a non-cooperative Nash equilibrium in game theory.

This is when you have multiple agents in a system. Each has settled on strategies that benefit themselves to some extent. However, there could be other strategies where all the agents could actually benefit more. But in this case, there is no incentive for any agents to risk changing their strategy, given that everyone else’s strategy would also have to change. And so the status quo remains. Large scale coordination is more difficult than ever.

Game theory vs profits

The DAOstack whitepaper asks us to consider what happens with software companies and how they are naturally against benefiting consumers or the public due to game theory. A company that wants to survive as a long as possible will actually keep as many secrets as possible as these secrets can give it an edge in the market.

For-profit companies have an incentive to not allow their code to be opensource or they would be helping their competitors. As a consumer or person in the public, that’s exactly what we want to happen because innovation can happen faster that way. Although if several companies decided to share their secrets with each other they could all mutually benefit themselves and their consumers.

Collective Capitalism

After World War II, Japan experienced what economists would call the “Japanese economic miracle”. From around 1945 to the 90s Japan experienced unprecedented economic growth due to the adoption of slightly more Americanized capitalism.

However, instead of just copying the United States, they developed their own system, Collective Capitalism. The Zaibatsu were a network of business conglomerates in Japan up until the Second World War. They were family-controlled monopolies of industry. They were superseded by the Keiretsu, when Japan started to embrace American style capitalism more.

What are the Keiretsu?

The Keiretsu are groups of companies who have interlocking relationships. Each company owns a portion of each other’s company shares so there is partial collective ownership within the group.

This actually makes the companies stronger as it protects them from market volatility. It also makes hostile takeovers less likely. The companies in the group also share information with each other, unlike most companies today. This system still fosters healthy competition within their economy but not complete domination or destruction of other companies. They all share some common skin in the game.

A different kind of competition

An organization in a Keiretsu group might want to beat competitors. But they wouldn’t want to destroy or bankrupt them as some of their capital mingles with these companies. This change in the economic game made companies go from pure competition to a more cooperative model that benefited the entire Japanese economy. Allowing shared resources is key for large scale open collaboration.

This is the same goal of creating a DAO. Create incentives that lead to more cooperation between the different components of our economic system. DAOstack can help replace corporate structures not because it’s nicer, but because these open models are more effective if they can be incentivized properly.

Solving blockchain governance

With DAOs, there are several problems that have come up that DAOstack is trying to solve, including smoothing over the issues with plutocratic governance.

Reputation Systems

Instead of just staking tokens to vote, implementing a non-transferable reputation system means that the power any individual has is based on how “good” they’ve acted in the past. If they are good decision makers, their reputation is increased and decreases if they were bad. Blockchains are perfect for reputation systems given their immutable nature. Reputation systems can help to solve most of the problems associated with token-based governance and plutocracy.

Quiet ending

Aragon is another platform for DAOs. However they recently demonstrated that finalization attacks are very real for decentralized platforms. In a recent contentious vote, a large token holder swayed it right before the end, much to the upset of the community. A finalization attack is when a vote happens and in the very last moment, someone with a lot of capital uses it to sway the vote. By this time, it may be too late for more people to come in and put the vote back in their favor.

DAOstack fights this kind of attack with a quiet ending. Simply, if the majority vote on a proposal changes, the end-date will add an extra day. So until the majority vote stays the same for at least 24 hours voting continues. This prevents finalization attacks, no last-minute swings of the vote.

Relative majority

With so many proposals that could be up for voting in the DAO it quickly loses scalability as human attention is a scarce resource. Having a system where the majority has to vote “yes” would lead to an organization that isn’t very efficient as there isn’t enough time for everyone to evaluate everything.

To solve this, DAOstack inserts a middle layer between a proposal and the actual voting. A user can choose to bet on the passing of a particular proposal with the GEN token. The proposals with the highest bets move to the top of the list. If people vote correctly, they get a reward. These boosted proposals only require a relative majority, instead of an absolute one, to pass.

Design Principles

DAOstack is a general purpose operating system for people to design whatever type of organization they need. With this goal comes several design principles to enable endless designs.

Generality

Part of the DAOstack is the Arc library. By building a general purpose library of elements for DAO designers to draw upon, it will allow them to come up with many designs for different design protocols.

Modularity

Modularity is a very common design principle in many fields. Building a system out of reusable smaller blocks or elements makes it much easier to manage security and change design on the fly. It isn’t necessary to reinvent the wheel every time you deploy a DAO, which is good because that is not an efficient way to build things. Modular blocks don’t need deployment directly to the blockchain.

Interoperability

A DAOstack entities can interact with other DAOs and can even act as an agent within another DAO as part of its fractal structure. The ability for DAOs to interact with each other is pretty important if you consider traditional companies also interact with each other to make contracts and all sorts of agreements between them. The blockchain enforces these agreements rather than laws.

Openness

Opensource is at the heart of most blockchain projects and DAOs. DAOstack is completely opensource from top to bottom. Like the WordPress and Android frameworks, it is inviting for developers to make their own apps and create an ecosystem of applications.

Conclusions

DAOstack helps to break down decision making into the smallest possible pieces and reintroduces skin in the game for all the parties involved in the process. The innovative design could lead to the reorganization of society with more efficient organizations whose incentives align more closely with the public at large.