Finding the right incentives is key to effective DAO management

As the Web3 space grows and more projects make progress on their road maps to decentralization, some of the more difficult management problems begin to emerge. Decentralized governance is often seen as a mysterious subject, but the problems it presents are well known and easy to grasp. Simply achieving decentralization, where a token is fairly distributed among a wide and diverse group of holders representing a range of viewpoints, is a huge challenge in itself.

Previous research from Chainalysis shows that token concentration in some of the largest DAOs means that less than 1% of token holders have 90% of the voting power. Smaller token holders in such a scenario will inevitably become disillusioned with their lack of voting power, as Lido Finance discovered. A token holder is suing the project, claiming that the token concentration in VC firms prevents ordinary investors from having any say in decisions.

However, even once a project has achieved a wide and fair distribution of tokens, there are still many challenges with effective management decision-making. In such a large group, there must be a high enough voter participation to prevent fringe groups from pushing through self-interested proposals. However, a larger group can also lead to the value of a single vote being diluted.

No easy answers

These are difficult challenges to overcome, but failure to implement effective governance can become an existential crisis for a cryptocurrency project. This can lead to the project being subjected to a hostile takeover or a general inability to implement changes needed to keep the business model competitive and relevant in an evolving market.

Unfortunately, there are no copy-paste solutions, as these problems simply do not exist in centralized organizations, where anyone can simply set up a company, start making decisions, and pivot to new models if things don’t work out. Web3 projects must find a way through these challenges in real time, using trial and error. But the first generations of DAOs exposed the core issues at stake, and new ways to address the challenges are now emerging by focusing on incentives that will keep voters engaged.

Uniswap’s recent fee conversion proposal is an example of this. Uniswap has one of the largest user bases in crypto, and its fair token distribution model, where UNI is awarded to past users of the exchange, has been hailed as one of the most fair in the sector. A recent management proposal, if passed, would see UNI holders who hold and delegate their tokens rewarded with a share of the platform’s transaction fees. The Uniswap Foundation explained via a post that: “Decentralized, resilient and engaged governance is essential to the long-term health and success of the protocol.” Uniswap has collected $3.3 billion in fees since it launched, so the promise of a stake has driven interest and engagement in UNI to unprecedented levels.

Creating incentivized communities

Another example is Ambire, developer of the Ambire wallet and AdEx decentralized advertising network. Crypto wallet services are the gateway to Web3, which means that Ambire is already in a favorable position to address a diverse audience of Web3 users. The wallet also makes use of account abstraction, meaning users benefit from a smoother experience with no need for private key management.

Following a fair distribution model similar to that of Uniswap, Ambire users receive an allocation of $WALLET tokens in proportion to the funds they hold. The tokens grant DAO membership status, with voting rights proportional to the $WALLET tokens held.

Since wallets are the most important user-facing component of crypto infrastructure, integration decisions are usually the most contentious. Ambire aims for its wallet to become a full DeFi dashboard, so the project has devised a way for users to get directly involved in the development process.

A final example is MANTRA, the multi-asset compliant DeFi platform, which recently tabled a management proposal to convert its DAO token, $OM, the native token of a new L1 launched by the project, to make. Since the platform will operate under a proof-of-stake consensus, and the mainnet launch will require community participation, MANTRA offers attractive rewards for existing DAO token holders to migrate to the new platform.

Anyone staking $OM tokens from when the proposal is passed until the MANTRA mainnet is launched will be eligible for enhanced staking rewards with a 1.35x multiple. Any undistributed funds from the grant created for this initiative will be returned to a community pool for future allocation to benefit the project. By bringing together its established community with the promise of incentives, MANTRA aims to bring about a substantial change while preserving decentralization.

It is not easy to find the most efficient ways to structure a decentralized organization for optimal management, decision making and engagement. It is likely that the Web3 community will continue to innovate and test the boundaries of what is possible. However, these difficult problems are among the most important facing the industry, and any success in implementing good governance on a large scale will provide a model for future projects.