Arbitrum Governance Fracas Reopens the Question: Why DAOs?

What does crypto want decentralized autonomous organizations to be? I remember a conversation a few years ago over some cold ones with a former CoinDesker waxing poetic about the possibility of DAOs. While many people are willing to be quite reductionist when describing DAOs, with the “Discords with bank accounts” soundbite, there is also real hope that these technology-driven social organizations can grow into entities that rival traditional LLCs and public institutions .

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This “third way” of thinking about the power, capabilities, and politics of DAOs shows smart contracts as a way to automate away human decision-making. Ground rules for the group are predetermined and set in code, ultimately allowing token holders to make better governance decisions when those decisions are discretionary. DAOs, in this sense, both enhance and minimize human activities. Multisig wallets eliminate single power brokers, blockchains make democratic processes transparent and token distributions give everyone who has a stake a say.

However, the recent governance failures at Arbitrum, one of the most widely used Ethereum layer 2 blockchains, reveal how far DAOs have to go. If these systems are ever able to scale to replace or supplement centralized company or government activities, the industry needs to figure out what they are actually good for. This is not to suggest that every DAO needs to follow a predetermined plot. (In fact, like any decent “general technology,” much of the trouble with DAOs comes from being a messy categorization meant to describe many different and often unrelated types of institutions.) But participants should know what to expect when they sign on.

Arbitrum’s DAO was presented as a way to “decentralize” control of the protocol’s development away from Offchain Labs, the company that launched Arbitrum, and bring users and the “community” into the fold. Tokens were airdropped, a reward to early adopters of the system, seemingly with great promise. Unfortunately, the project took about 18 months to build goodwill and a consistent user base, then damaged its credibility in five minutes, according to critics on the project’s Discord.

The DAO is a shining example of “decentralization theater”, more of a fig leaf for the newly created, Cayman Islands-registered Arbitrum Foundation, who will continue to lead protocol development. About 750 million ARB (then worth about $1 billion) had been earmarked to pay off debt related to Arbitrum’s start-up expenses, with much of the remaining tokens to be disbursed as the foundation saw fit, The Defiant reported.

That in itself is not a problem. Many crypto projects have allocated tokens and given “community development” powers/responsibilities to foundations. The Arbitrum Foundation would receive 7% of the token supply, compared to builders of competing Ethereum layer 2 Optimism, which was allocated 5% of the OP token supply to the foundation, or the Solana Foundation, which received more than 12% of all SOL tokens .

It is not worth revising exactly what happened, especially considering that the foundation is to be reformed. But the problems started because power brokers from Arbitrum decided before votes were cast to fund the organization. Described as a “leaderless cooperative”, the DAO was essentially reduced to a rubber stamp. This shows that it is often human actors behind autonomous smart contracts who get to decide exactly what decentralization looks like.

As founding member Patrick McCorry wrote on the DAO’s board forum: “The Foundation treated this as a ratification of its original setup, not an initial request from the DAO Treasury, and has actually begun using these tokens in the DAO’s interest, including converting some funds to stablecoins for operational purposes.”

There are legitimate questions about whether a tier 2 needs a token to function, as well as whether technology should be built via direct democracies, fake or otherwise.

This is a lesson crypto learned with perhaps the most famous DAO experiment to date: ConstitutionDAO, which failed in its goal of obtaining a historical copy of the US Constitution. That project was marred by issues — including who would bid on the auction and how the capital would be refunded to crowdfunders — that still seem to plague crypto governance. Abstract away the technology that is meant to abstract away human decision-making, and often you find only a few key decision-makers.

There is a silver lining in that the Arbitrum community has thoroughly rejected the original plan and is now demanding transparency. People looked at the record and found that 50 million ARB tokens were moved to Binance, presumably for sale, and 40 million were loaned out to crypto market maker Wintermute. It is not so much that the ARB is a “useless steering sign”, as many have claimed, but that the steering was flawed from the start. Perhaps that is inevitable with any system that gives power relative to wealth, giving some users more power than others to dictate how the system works.

Crypto today needs competent decision makers to oversee the development of new technologies. DAOs can be powerful tools for increasing participation. There are many examples of working organizations that are run collectively and state up front that they are really just Discords with a brand. But before they “decentralize,” project managers need to ask whether a DAO is necessary in the first place, and exactly what their DAO should be.