Governance for public Blockchains and DAOs

1. Governance for Public
Blockchains and DAOs
It looks like an open source
project, it quacks like a
corporation, it walks like a genetic
algorithm, it smells like a
political party... what is it?

2. What we're covering
● What is the right model to use to look
at public blockchain projects?
● Voice and exit
● Differences between standalone projects
and dependent projects (and hybrids)
● From cryptoeconomics to crypto-
political science
● Schelling: brinksmanship as
probabilistic punishment (and other
insights from mutually assured
destruction theory)

3. The Old Model
● Public blockchains have a static
protocol
● It is guaranteed that “honest”
users will follow this protocol
forever, the only risk is attacks
● No governance challenges whatsoever
(It's all algorithmic! Non-
political money!!!1!)

4. Is this person describing...
A) The traditional banking system
B) Regulators
C) The shiny newfangled thing
that's supposed to be nimbler and
faster than the above?
“It's a system that has been
designed to resist change”
https://www.reddit.com/r/Bitcoin/comments/4946ku/its_a_system_that_has_bee
n_designed_to_resist/

5. A Taxonomy of Forks
● Soft fork: valid messages under new
rules a strict subset of valid
messages under old rules
● Kinda hard fork: valid messages
under new rules a strict superset
of valid messages under old rules
● Maximally hard fork: arbitrary new
rules

6. Forks depend on...
● Soft fork: miners
● Kinda hard fork: miners and
developers/users
● Maximally hard fork:
developers/users

7. Failure modes
● Soft fork:
– Developers/users sign up but not most
miners: chain split (hence 75%+ threshold)
– Miners sign up but not developers/users:
success
● Kinda hard fork:
– Developers/users sign up but not miners:
no change
– Miners sign up but not developers/users:
chain split (hence adequate warning time
required)

8. Failure modes
● Hard fork:
– Miners don't matter at all (except in
so far as they are users)
– Some users sign up but not others:
chain split (hence social consensus
required)

9. Reminder: Schelling Points
● Two prisoners in separate rooms are
shown the following numbers:
162 281 296 1000 1209 1612 1728 1837
● If both give the same answer, they
are freed, otherwise both are
tortured to death
● Which do you choose?

10. Hard fork decision-making
● In this model, the choice is
whether or not to install a
software package choosing to fork
● If you are on the same chain as
everyone else, all is good
● Otherwise, you suffer inconvenience
● What's the schelling point?

11. The pre-game
● Each side's incentive is to “puff
itself up”, make its victory seem
inevitable
● If a Schelling point exists, try to
manipulate it
● Examples from Core/Classic dispute

12. The pre-game
● What if no Schelling point is
agreed?
● Controversial hard forks are
dangerous (maybe, will return to
this later)
● But they are a highly useful
negotiating tactic (for both sides)
– Brinksmanship as probabilistic “tit
for tat” in prisoner's dilemma

13. Non-convergent post-game
(maximally hard forks only!)
● 1-4 hours: community realizes that a split is
occurring, neither side willing to back down (main
battlefield: Reddit)
● 1-2 days: quickest exchanges start trading “BTC-A”
and “BTC-B”
● 1-7 days: businesses make a decision to support
one or neither or both
● 1-2 weeks
– (option I): one of the two is clearly ahead, the other
dies
– (option II): both chains soft-fork (or one chain hard-
forks) to ensure transactions are bound to one chain
● Is total market cap higher or lower than original?

14. Network effects and anti-
network-effects
● Positive: currency acceptance and
liquidity
● Positive: developer mindshare (may be
cross-protocol!)
● Positive: economic security (hashpower,
size of deposits, etc)
● Negative: blockchain congestion
(transaction fees, full node costs)
● Negative: political infighting
● Negative: bigger applications invite
bigger attackers

15. Firm theory
● Left-side failures (everyone is a
contractor): underproduced public
goods, lack of coordination,
transaction costs (eg. bureaucratic
costs, high cognitive overhead,
costs of gaining trust)
● Right-side failures (everyone works
for one giant corporation): see,
North Korea
● There is a balance

16. Firm theory in Blockchains
● Left-side failures (everyone has
their own currency): low liquidity,
high cognitive overhead, developer
confusion
● Right-side failures (one currency
to rule them all): failure to
satisfy differing views, loss of
cohesion, fighting rather than
coexistence

17. Blockchains vs other
governance
● Open-source projects: forking often
used (only some developer network
effect lost)
● Countries/corporations: forking not
possible at all, only exit
– Secession exists, but in case of countries
requires camps to be geographically
localized
– Puzzle: why don't we see corporate
secession? Is it because exit is too easy?
● Blockchains are somewhere in the middle

18. DAOs
● DAOs on Ethereum are, at least to
some degree, dependent projects
● They sit on an underlying layer
that provides “ground truth”, so
truth no longer subjective
● This makes DAO governance much more
like governance of corporations

19. So, how do DAOs decide?
● Naive answer: we vote!
● Problem: voting is not incentive-
compatible
● Rational ignorance/irrationality
(see Caplan etc)
– Less of a problem for
DAOs/corporations than countries
● 51% attacks
● Voter bribery

20. 51% Attacks
● 51% of shareholders move all assets
into new DAO, expropriate the other
49%
● If DAO assets are primarily social
capital / goodwill, then grim
trigger argument discourages this
● Otherwise... this is why we need
shareholder regulations!

21. Subjectivocracy
● DAO should only hold assets that
are defined by itself
● In the event of a disagreement, the
DAO can “fork” on the chain
– Users free to follow whichever fork
they wish
– Indifferent users check market price
to determine to gauge which fork is
more popular

22. DAO splitting
● If the DAO holds externally defined
assets (eg. ETH, digix gold, assets
defined by other DAOs), then there
is a “splitting” protocol where
these assets are proportionately
split
● No need to specify minimum
percentage, but force costs of a
split on the minority to prevent
spam

23. DAO splitting
● Challenge: what about non-fungible
assets?
● Option 1: probabilistic distribution
(problems: imposes risk, requires secure
RNG)
● Option 2: cut-and-choose protocols
(problem: distribution may not be
perfectly fair)
● Option 3: cut-and-choose plus
compensation payments (problem:
bilateral monopoly negotiation is not
Pareto-efficient)

24. DAO splitting
● Ethereum-specific challenge: how do
we maximally generally split all
positions that the DAO might have
in all other contracts
● Split by address, “mother” contract
does two-way forwarding for
children?
– But then, how do we address cases
where positions can be proportionately
split?

25. Futarchy
● General principle: pick easily
measurable objective function, have
“conditional prediction markets” on
objective function if:
– action is made
– action is not made
● Common objective: share price vs. base
asset (eg. ETH)
● Perform the action only if the
conditional share price if the action is
made exceeds the conditional share price
if the action is note made

26. Futarchy: Implementation
● Let people convert 1 DAO share into
1 yes-share and 1 no-share
● Let people convert 1 ETH into 1
yes-ETH and 1 no-ETH
● Let yes-ETH trade against yes-
shares and no-ETH against no-
Shares, watch prices

27. Futarchy: Manipulation
● What if the action only slightly
affects the share price?
● Then, yes proponents may try to buy
up yes-shares
● If you have accurate information
about the effect of the decision,
you cannot easily trade on that
knowledge without assuming
secondary risk of DAO price; hence,
pool of counter-trades limited

28. Futarchy: Manipulation
● “Limits to arbitrage” argument /
capital limitations can make
shorting harder
● Solution 1: use futarchy for “big
decisions” only
● Solution 2: bet on log(price)
instead of price; log(price)
practically capped at ~30 so
capital is limited

29. Futarchy as Backstop
● If minority unhappy with voting
decision, they may “file a
complaint”
● Futarchy resolves whether or not
the motion goes through
● Expropriators pushing up price of
yes-shares not a problem (!!) as it
lets no proponents “cash out”
gracefully

30. Governing blockchains like
DAOs?
● Problem: no “base asset” to make
markets against
– Difficulty futures could substitute,
but only in PoW blockchains
– Schelling-USD could substitute, but
introduces stronger economic
assumptions into base protocol
● Voting can be done... miners do it
already
● Blockchain splitting can be done...
it's called a hard fork