DeFi, Analysis

5 Ways to Fix DeFi Tokens

Most DeFi tokens are useless. Here's how to fix them.
David Hoffman David Hoffman Aug 1, 20226 min read
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5 Ways to Fix DeFi Tokens

Dear Bankless Nation,

A key catalyst of the 2021 bull market was linking DeFi protocols with governance.

Via tokens, of course.

Led by Compound and Uniswap, DeFi apps began issuing valueless governance tokens to their communities in order to decentralize power and give control over to the community.

The idea of a community-driven financial system captured the imagination of the normies, the crypto curious, and even some crypto skeptics, to join in the fun of the 2021 bull market.

But now the bull market is over, and the industry is realizing that valueless governance tokens are not the end-game.

It’s the starting pistol.

Today on the podcast, we release a crucially important episode, unpacking the state of DeFi tokens, DAO governance, and all the progress left to be made.

Hasu, crypto-economic researcher and frontier explorer, returns to the show to help unpack the deficiencies that DAOs have, why they exist, and what we need to do about them.

On Bankless, we’ll make a particular podcast for any variety of reasons; it’s good info, philosophically relevant, or just good entertainment.

But this episode is none of that. This episode (I hope) marks a turning point for DAOs, to turn their useless governance tokens into powerful drivers of value-capture, sustainable compensation for contributors, and meaningful growth of the organization.

Perhaps one day, DAOs can join in on buying the naming rights to big sports stadiums…but first, they must fix their relationship with their token.

Here are the 5 steps that DAOs need to take in that direction.

1. Run the DAO Like a Business

DAOs aren’t magically immune from the laws of economics.

They must take in more value than they expend.

Corporate governance is a tried and true science. Just because it has the word “corporate” in the name doesn’t mean it’s evil or antithetical to what we’re doing here in DeFi.

Good DAOs will apply the lessons of corporate governance structures to their own organization, while also being cognizant of the aspects that are meant to leave behind in TradFi. They will think critically about how to map corporate governance onto this new decentralized form factor: DAOs.

And then they will execute on it.

DeFi tokens that represent their respective DAOs will go up or down based on the value that flows into or out of the DAO.

Sure, Uniswap...it’s great that you’re directing $9M every day in fees.

So let’s start putting some of that into the DAO treasury and funding sustainable compensation for DAO growth.

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Source

$9M per day is ~$3.3B per year. If Uniswap charged just a 1% fee on its LPs, it would be earning $33M in yearly revenue for the DAO and its contributors, going from cash-flow negative to positive.

However, this doesn’t just mean that DAOs need to turn on their fee switches. It also means they need to become far more judicial with their expenses. There’s no point in pouring water into a leaky bucket!

All DAOs have a PnL (profit and loss), and the health of that PnL needs to be considered! The profit mechanism is a market test of whether the product is of value to consumers. Without that test, we don’t know if it holds up against market forces.

This is no longer 2021 where we could print billion-dollar treasuries whenever we feel like it.

This is 2022. Interest rates are high, and money is tough.

Won’t anyone consider the PnL? 😭

2. Define a Constitution

All DAOs need to write a constitution.

This constitution should instantiate the purpose and vision of the DAO. It should codify the core values and high-level strategy of the organization. It should be used as a document to refer back to and reference when making decisions in the DAO.

Having a clearly defined constitution for what a DAO is, what it’s here to do, and how it’s going to do it will help eliminate redundant and unhelpful conversations in DAO discourse.

If the members of a DAO cannot agree on what its mission is, then different parties in a DAO will engage in rent-seeking efforts to try and pull in the direction that they see as best. These efforts will often be antagonistic to other parts of the DAO and therefore will soon come into conflict, rather than working towards a common vision.

Organizations need to move together, as a unit!

But without a defined goal, no one knows where we’re going!

Blindly into the night they go, funding random things along the way.

3. Stop Having Global Token Votes

Governance decisions impart a huge cost to the DAO.

Every time there is a governance decision, it’s crucial that the DAO carefully consider it, in order to produce the correct outcome. Good business management means making good business decisions!

DAOs should optimize for having 100% hit rates on making the correct decision.

The easiest way to do this? Make fewer decisions - especially only on the ones that matter.

Each decision should be carefully considered, analyzed, and debated. Therefore, the kinds of decisions that go to a global token vote need to be only the most crucial ones; ones that cannot be decided alone by smaller sub-components of the DAO.

Global token votes are only for decisions that affect the DAO in its entirety.

Global token votes should be considered the “Supreme Court of the DAO”. Good DAO decision-making processes should have 99% of decisions decided upon before being elevated to the highest level of DAO decision-making.

SubDAOs are critical for this. The engineering department doesn’t make marketing decisions, and marketing doesn’t make product decisions.

SubDAOs need to be enabled to make decisions independently, without having to ask the broader DAO for permission. Any organization that forces all departments to ask for permission to do things is simply NGMI.

Asking for forgiveness runs circles around asking for permission.

A simple addition to this makes this very crypto-economically awesome: All subDAO decisions can be vetoed by a global token vote. This gives the entire organization the power to say no to an errant subDAO decision but doesn’t require the organization to be analyzing every single decision of every single corner of the DAO.

Remember: when people are making governance decisions, they’re not doing work.

The goal is to do work.

4. Stop Paying For Liquidity

Just stop the yield farming.

You shouldn’t pay for liquidity, you should earn it.

Liquidity incentives are a bull market thing. They’re not sustainable. The reasons why a team might start up liquidity incentives are twofold:

  1. To distribute tokens to the market, and decentralize power away from founders
  2. To boost liquidity, so they can dump their supply and get their “exit”

Both of these violate the first bit of advice above: “Run the DAO like a business”.

Many DAOs or DeFi apps are still—to this day—paying for liquidity… for no reason.

It’s destroying the cap table and draining the treasuries of these organizations, and the outcome is that the actual decision makers of a DAO become smaller proportional holders of the respective governance token. This discourages them from having the incentive to operate the DAO in the first place, and even if they wanted to stick around and lead the DAO, they have a much smaller say in its governance.

All because the DAO paid a bunch of misaligned yield farmers a bunch of money who sold that token for ETH.

Stop paying for liquidity.

5. Turn on Fees and Fund DAO Operations

People have been clamoring for Uniswap to “turn on the fee switch!!!” so that UNI can be a dividend-paying token.

Not so fast, fam. High-growth companies don’t pay dividends to investors; they invest profits back into the company.

Let’s turn on the fee switch just enough to pay for the operations of the DAO.

This will do a few things:

  1. Show the world that the fee switch is on 🎉
  2. Produce a positive PnL for DAO operations
  3. Compensate DAO contributors for work, and encourage further contribution

Even without paying fees directly to token holders, I promise you it will change the momentum.

DeFi tokens don’t need to pay their holders money. They just need to produce a compelling story behind the investment thesis of the token.

If the governance token is governing over an effective organization with a positive PnL and that effective organization is growing in scale, that is plenty sufficient to encourage some meaningful bids on the token.

SEC’s Fault?

A lot of the broken nature of DAOs is due to the SEC.

Liquidity incentives were a downstream effect of needing to distribute tokens away from the founders and to the community. But sadly, you can’t just expect to give tokens to the community and expect them to become DAO workers.

They’ve probably already got jobs.

But the founders can’t keep the tokens, because they need the token to not be a security, lest it falls astray from U.S. securities laws.

DAOs have been hyperfocused on “decentralizing decision making”.

That’s nice, but it has also meant accumulating unnecessary inefficiencies.

How do we fix this unfortunate position?

First, the SEC should get its sh*t together and allow for a regulatory sandbox in the DeFi/DAO space.

But barring that, one path forwards is to simply compensate leadership for the risk.

If DAO leaders are worried about the risks that come associated with being in a DAO leadership position, then the DAO simply needs to pay them more, so that they’re worried and wealthy, instead of just worried.

Legal costs need to be accounted for and budgeted.

But mainly, the SEC needs to get its sh*t together.

Watch the episode with Hasu for a full deep dive into this topic. If you’re a part of a DAO, consider it required material!

Happy Monday.

- David Hoffman

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David Hoffman

Written by David Hoffman

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Co-owner at Bankless. Optimistic storyteller of frontier technology.

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