Arbitrum Governance Fracas Reopens the Question: Why DAOs?

A messy governance dispute over a major Ethereum scaling system has some complaining about “decentralization theater.”

AccessTimeIconApr 4, 2023 at 5:19 p.m. UTC
Updated Apr 4, 2023 at 9:00 p.m. UTC
AccessTimeIconApr 4, 2023 at 5:19 p.m. UTCUpdated Apr 4, 2023 at 9:00 p.m. UTC
AccessTimeIconApr 4, 2023 at 5:19 p.m. UTCUpdated Apr 4, 2023 at 9:00 p.m. UTC
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Daniel Kuhn is a features reporter and assistant opinion editor for CoinDesk's Layer 2. He owns BTC and ETH.

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

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

However, the recent governance fracas at Arbitrum, one of the most-used Ethereum layer 2 blockchains, reveals how far DAOs have to go. If these systems are ever able to scale to replace or supplement centralized corporations or state activities, the industry needs to figure out what they’re actually good for. This isn’t to suggest that every DAO needs to follow a predetermined plot. (In fact, like any decent “general purpose 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’re signing on.

Arbitrum’s DAO was pitched 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 some 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, which would continue to direct protocol development. Some 750 million ARB (then worth about $1 billion) had been earmarked to pay off debts related to Arbitrum’s startup expenses, with much of the remaining tokens to be disbursed as the Foundation saw fit, The Defiant reported.

That in itself isn’t an issue. Many crypto projects have awarded tokens and granted “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 granted 5% of the OP token supply to its foundation, or the Solana Foundation, which was given more than 12% of all SOL tokens.

It’s not worth relitigating exactly what happened, especially considering the Foundation is set to be reformed. But the trouble started because Arbitrum power brokers decided before votes were even cast to fund the organization. Described as a “leaderless cooperative,” the DAO was essentially reduced into a rubber stamp. This shows that there are often human actors behind autonomous smart contracts who get to decide exactly what decentralization looks like.

As Foundation member Patrick McCorry wrote on the DAO governance forum: “The Foundation treated this as a ratification of its initial setup, not an initial grant request from the DAO Treasury, and indeed has begun to use these tokens in the interest of the DAO, including conversion of some funds into stablecoins for operational purposes.”

There are legitimate questions over whether a layer 2 even needs a token to operate, as well as whether tech should be built via direct democracies, sham or otherwise.

This is a lesson crypto learned with perhaps the most well-known DAO experiment to date: ConstitutionDAO, which failed in its goal to acquire an historic copy of the U.S. Constitution. That project was beset with issues – including who would bid at the auction and how the capital would be refunded to crowdfunders – that still seem to plague crypto governance. Abstract away the tech that’s meant to abstract away human decision making and often you’ll find just a few key decision-makers.

There’s a silver lining in that the Arbitrum community has thoroughly rejected the initial 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 to crypto market-maker Wintermute. It’s not so much that the ARB is a “useless governance token,” as many have argued, but that the governance was lopsided from the beginning. Perhaps that is unavoidable with any system that grants power in proportion to wealth, giving some users more power than others to dictate how the system operates.

Crypto today needs competent decision-makers to oversee the development of new technologies. DAOs can be powerful tools to increase participation. There are many examples of functioning organizations that are run collectively and state upfront that they’re really just Discords with a branded token. But before they “decentralize,” project leaders need to ask whether a DAO is needed in the first place, and what exactly their DAO should be.

Edited by Ben Schiller.

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Daniel Kuhn is a features reporter and assistant opinion editor for CoinDesk's Layer 2. He owns BTC and ETH.