Maker DAO's Governance Crisis Reveals Challenges of Decentralized Decision-Making in DeFi
by Ryan Shea
Key takeaways
- DeFi lenders have weathered this latest crypto winter better than many CeFi lenders.
- Maker - one of the oldest DeFi protocols - has returned to the top of the TVL ranks. Despite this, the DAO is witnessing an internal tussle over governance.
- Two competing proposals have been put forward by leading members of the community to address the challenges facing the protocol.
- This debate has been contentious with accusations of VC-influenced voting and conflicts of interest flying around the Maker forums and blogs.
- What this episode demonstrates is that DAOs are not the silver bullet many hope. The trade-off between decentralization and the need for efficient decision-making begins to tip in favour of the latter as organizations scale.
- How the situation resolves will be important, not just for Maker DAO’s Tao (meaning road, path or way), but many other projects in the tech sector, especially the Metaverse and Web3.
One of the early conclusions to be drawn from the liquidity crisis, which has been the latest storm front in the crypto winter, is how well decentralized lenders have operated relative to centralized lenders. While the latter camp includes several companies that have either gone to the wall/going to the wall/bailed out/subject to fire sales decentralized lending platforms have come out relatively unscathed. Clients funds have not been suspended or locked-up, with redemptions met by liquidating underlying collateral assets in an orderly fashion (albeit it with negative consequences for crypto-asset prices).
One would think the decentralists would be out celebrating their protocols having passed another real-world stress test, but you would be wrong. Maker, a decentralized crypto lender that uses over-collateralized crypto deposits to back its DAI stablecoin, is one of the oldest Defi protocols and it recently reclaimed the top spot in TVL rankings. Despite this (relative) success, the DAO is witnessing an internal tussle over governance.
In late May Rune Christensen, one of the co-founders of Maker, put forward his End Game Plan. It sets out his long-term vision and roadmap for Maker, which - if adopted - would significantly alter the way it is governed. According to a series of long and convoluted posts outlining the proposal, Rune states his motivation for putting forward the proposal is that Maker should be able to benefit from the opportunities created by the recent pull-back in crypto activity, but there are substantial obstacles to unlocking this value. Chief amongst these obstacles is that as Maker has scaled its operations it has become increasingly complex, placing substantial burdens on MKR holders tasked with guiding the protocol’s every twist and turn via on-chain voting. A direct consequence of this, and entirely consistent with the Ringelmann effect, is voter apathy. This is hardly a positive development for a protocol whose raison d’etre is decentralization because it means just a handful of voters can, potentially, dictate how Maker evolves. Moreover, given Maker’s intention to widen further its underlying collateral to include real world assets (RWA), the burden on Maker voters will only increase further absent a change in the way governance is implemented.
Proposal One - MetaDAOs
The key element of Rune’s proposal is the creation of MetaDAOs. Each MetaDAO is self-contained and allows for specialization with the required elements – people, technologies etc - clustered together via Maker Governance Proposals prior to launch leading to the formation of decentralized voter committees (DVCs). Rune envisions these Meta DAOs as having varied purposes, but expects the most common to be a creator MetaDAOs focused on innovation and experimentation. Once each MetaDAO reaches a decision voted on by its own community they are then included in the Maker Governance process and put to a Maker executive vote.
I think what I just wrote is correct, but having spent numerous hours reviewing the elements of Rune’s End Game Plan (including listening to several hours of MakerDAO conference calls) I am not 100% sure because the structure – at least as described - is rather complicated. Probably the best way to explain it is by analogy and the one used by Rune himself was the corporate structure of Alphabet, where the core company has relationships with separate autonomous offshoots, such as Google Ventures, YouTube or Google X.
Proposal two - Council of Makers
Rune’s complex – some argue over-engineered - MetaDAO proposal is not the only one on offer. A couple of weeks later Hasu, a well-known anonymous crypto researcher and leading Maker delegate, proposed an alternative governance structure for the protocol. His proposal is, thankfully for my brain, much more straightforward to understand. It contains two key elements, the creation of a Constitution, which would define the DAO’s vision, values and principles of the system, and the establishment of a Council of Makers tasked with setting the strategy and streamlining the decision-making process.
Aside from differing levels of complexity, which is very evident in the screenshot shown below, a major difference between the two proposals is Hasu’s Council model is designed to ensure all members of the Maker protocol are moving in the same direction as designated by the Constitution, whereas Rune’s proposal is a looser, more free-for-all approach.
Maker Governance Proposals
The title of the community call where Hasu outlined his proposal was “Building a resilient, decentralized and uncensorable stablecoin”. I have no idea whether Hasu had a hand in setting the title, but I suspect not as his proposal clearly does entail less decentralization. The reason is because the proposal makes the Council the gatekeeper for Maker Improvement Protocols (MIPs). Only the Council can put proposals up for an on-chain vote, the contents of which are determined by mandated actors, who are the leaders of different Maker core units. As such, it gifts the Council the ability to influence markedly how the protocol evolves.
I have not been able to establish whether under this proposal Council members are obliged to passively accept all proposals put forward by mandated actors, but logic would suggest not. Part of the reason why Maker is struggling with governance at present is because of voting overload on MKR holders and delegates. Unless the Council is able to streamline this process by reducing the number of on-chain votes then it is hard to see what benefit it accrues. Furthermore, if the Council has no ability to influence the proposals put forward for on-chain voting how will the Council be able to direct the high level strategy? It can’t. That said, even if the Council does not have direct control over proposal submissions by mandated actors as suggested above, they certainly will have influence because under the proposal Council members have the ability to hire and fire mandated actors.
Given one of the best definitions of centralization is “the ability of a single entity or a small group of them to exclusively observe, capture, control [my emphasis], or extract rent from the operation”, it is hard to argue that the establishment of a single Council with the sole ability to implement on-chain votes is anything other than a centralizing force.
Representative Democracy Reinvented
In order to weaken the Council’s potential control over Maker, and to ensure MKR holders and their delegates retain the final say in all protocol decisions, the proposal states that its members will be subject to periodic elections. (Hasu proposes a one year term - long enough for MKR holders to decide whether Council members are achieving their objectives or not, but not too long as to undermine the democratic aspect of holding a vote). In addition, with a sufficient quorum, MKR holders can fire Council members at anytime.
If this set-up sounds familiar, it should. It is an attempt to transform Maker from a direct democracy model to a representative democracy model - think repeated referendums versus votes by elected parliamentarians - utilized by almost all countries around the world (dictatorships excluded).
One ???? = One Vote
That said, there is one crucial difference. In democracies it is one person = one vote. In Maker, and pretty much every other successful DAO, it is one token = one vote. Under this set-up, the whales retain the upper hand irrespective of how decentralized the protocol has been designed to be (see chart for the distribution of MKR holdings by wallet address). Naturally, this can create suspicions about possible collusive behaviour, VC-influence and/or conflicts of interest. Indeed, one such instance recently occurred in Maker.
Maker – Top 100 Holders
No LOVE Lost
As mentioned, Maker as a community is exploring widening the collateral base backing DAI issuance to include RWA. One of the first companies to apply for a RWA-backed loan was a startup credit fund called Monetalis, which had Rune as one of its backers. On June 13, MIP39c-SP33 (aka LOVE), a proposal aimed at facilitating the onboarding of new use-cases that included adding an advisory committee to manage internal checks and balances, was put to an on-chain vote. Given the unit behind LOVE had expressed negative opinions about the Monetalis deal, the vote turned into one of the most contentious in Maker’s history and, at least temporarily, voter apathy vanished with turnout rising to historic levels.
In effect, the vote turned into a proxy war between Rune and the decentralists, who were opposed to the creation of the new oversight committee seeing it as a blatant attempt to introduce centralization (mumblings of it being VC-backed also surfaced), and the opposing camp who wished to see more streamlined and transparent processes applied to collateral on-boarding, especially in light of their concerns about possible conflicts of interest. Accusations flew on the Maker forum and associated blogs. In the end the LOVE proposal was voted down, which seems to have been the prompt for Hasu to fast-track the publication of his alternative governance proposal.
Natural Tendencies
The tendency amongst crypto users is to default-assume that decentralization makes everything better, but this ignores the fact that centralized systems do have advantages over decentralized systems – they evolved for a reason. By far the greatest advantage is efficiency. Doing things once, as opposed to replicating them multiple times over, is clearly a better use of scarce resources. It also allows for specialization, which is often needed to complete tasks quickly, or even at all, and it is better able to capture economies of scale. A final significant advantage is that because centralized structures are, by definition, hierarchical long-term goals can be articulated by those at the top of the pyramid. Through their power and influence they are better positioned to ensure that all users are striving for the same goal whereas decentralized structures can quickly become so unwieldy as to bring about decision paralysis making it impossible to define, never mind align with, a long-term goal.
Of course, the riposte of crypto users is that there are significant negatives associated with centralization. The biggest negative being control is handed to a smaller-subset of users and they must be trusted to ensure their decisions are in the best interests of all users and not just in their own self-interest (in economics this is known as principal-agent problems). Centralized systems also are, to borrow Nassim Taleb’s lexicon, less anti-fragile. The additional redundancy in decentralized systems resulting from duplication makes them more resilient to shocks/attacks than centralized systems, that is to say they have less critical failure points.
There are pros and cons to both centralized and decentralized frameworks.
What the recent governance debate in Maker illustrates all too clearly is that whenever a project begins to scale, there is a natural tendency to gravitate towards centralization. Rune’s MetaDAO proposal, at least taken at face value, is an attempt to try and bridge this divide by allowing the DAO to scale while maintaining as much decentralization as possible. However, the notion of solving complexity with even more complexity has me and others – including some large Maker delegates – wondering if it can even work in practice.
Maker And Beyond
This centralized/decentralized governance debate is not just of interest to Maker holders, it has substantial implications for many tech projects. In my previous article diving into the world of NFTs I briefly touched upon the Metaverse. There is no inherent reason why the Metaverse should deploy decentralized blockchain technology, but the concern of many developers building metaverse projects is that without it all that will happen is that the stranglehold of large tech companies will be reinforced – a concern driving another area of tech development, web3 (or web 3.0). Indeed, for many the metaverse and web3 are complimentary, if not symbiotic, innovations.
Web3 is envisaged as a decentralized version of the internet, effectively returning it back to its more anarchistic roots. It is almost entirely based on open source software, publicly available code that anyone can review, edit or deploy. Open source has proved very successful in mobile OS – android being the dominant player – but it has not really taken off outside this area. A major impediment to its wider adoption is that it is difficult to compete with centralized tech companies who are able to draw on financial resources extracted from their user base. The hope of the Web3 builders is that open source software projects operating under a DAO structure and financed by the issuance of cryptocurrencies to ensure user incentive alignment will be the key to unlocking this decentralized future.
Conclusion
The Maker experience highlights that DAOs are not the silver bullet many hope. The trade-off between decentralization and the need for efficient decision-making begins to tip in favour of the latter as organizations scale. It seems to be unavoidable and this should be taken into consideration when a project is in the design phase.
For some projects, especially for those that seek also to do many complex things, centralized decision-making is probably the way to go. For others, decentralization is best. It all depends upon the perceived payoffs.
For example, if users view data privacy and the ability to access information without the threat of censorship to be more valuable to them than the increased cost of providing those services in a decentralized manner then Web3 is the way to go. Similarly, if the cost of trust associated with centralized systems is considered too great, decentralization is the way to go, but with the important caveat that the system cannot become overly complex. This is the Bitcoin model. It is about as decentralized as one could hope for and is successful because it only seeks to do one thing: provide secure, censorship-resistant money.
That said, maybe I am wrong about the limitations of DAOs, maybe Rune’s complex End Game Plan can work, or maybe they can work at scale when presented in a different forum as this twitter user recently quipped – see image.
A lot depends upon MakerDAO’s tao.
Until next time.
Ryan Shea, Crypto Economist
[1] Some on crypto-twitter have argued that Terra’s Anchor protocol was a DeFi lending platform, but as I noted in an earlier piece, this was not really a true description of reality given how influential Do Kwon was to the Terra/Luna ecosystem – see: https://trakx.io/crypto-carnage/
[2] Last week Voyager Digital filed for Chapter 11 bankruptcy – see: https://cointelegraph.com/news/voyager-digital-files-for-chapter-11-bankruptcy-proposes-recovery-plan
[3] See: https://defillama.com/. A marked contrast to the now defunct algorithmic stablecoin Terra – see: Crypto carnage
[4] TVL has declined 60% since its December high to $7.75bn, but other protocols have fared even worse.
[5] See: Endgame Index List
[6] 10X according to Rune’s estimates.
[7] See: Ringelmann effect - Wikipedia
[8] Feel free to correct me if you think I have got something wrong. Also, if anyone can find a less wordy and hand wavy explanation for the End Game Plan than that offered by Rune please could you send me a link. Thanks!
[9] I know it sounds like an oxymoron to me too – see: https://twitter.com/hasufl
[10] See: https://forum.makerdao.com/t/simple-makerdao-governance-from-first-principles/16207
[11] The image is a screen grab from one of the many Maker community conference calls I viewed to gather background information – for the link see footnote 13 below.
[12] This description may sound like it has negative connotations but this is not my intention.
[13] See: Hasu's Proposal | Community Call on Building a Resilient, Decentralized and Uncensorable Stablecoin
[14] In the Youtube video Hasu stated that only the Council could propose MIPs but in a bilateral conversation he confirmed to me that this was incorrect and that mandated actors decide what goes into the proposal.
[15] See: Centralization, Decentralization, and Internet Standards
[16] I have not come across a quorum threshold in any of the online discussion.
[17] Despite it being written often the plural of referendum is not referenda.
[18] Given the apparent increase in voter disenchantment with elected officials over recent years (the ousting of Boris Johnson as the UK’s prime minister being the most recent example) one wonders whether replicating a representative democracy really is such a good idea.
[20] That said, it still only accounted for barely a third of outstanding MKR tokens, evidence as to how powerful the Ringelmann effect is.
[21] See: https://forum.makerdao.com/t/mip39c2-sp33-adding-lending-oversight-core-unit-love-001/15098/38?u=luca_pro and for some especially fruity language this A few thoughts before I finish voting
[22] Hasu was firmly in favour of the LOVE proposal.
[23] See: https://newsletter.tally.xyz/p/the-tally-newsletter-issue-73 and https://dirtroads.substack.com/p/-42-valkyrie-makerdao-and-our-side?r=k87cd&s=w&utm_campaign=post&utm_medium=web[24] See: NFT WTF
[25] The most succinct definition of the two concepts is Web 3.0 is primarily concerned with who will rule (tech giants or individuals) and govern the internet in the future, the Metaverse is concerned with how users will interact with it - see: Web 3.0 vs. Metaverse: A detailed comparison
[26] The article is being written on a desktop running the free Ubuntu Linux distribution, but I am somewhat unusual. Linux’s market share of desktop OS is barely above 2% globally.
[27] A natural extension of centralization is for government regulation to be applied in order to mitigate the oligopolistic nature of decision-making. For more thoughts on how regulation and crypto will evolve – see: https://trakx.io/roadmap-to-utopia/
[28] Satoshi Nakamoto’s decision to step away from leading the project was also, in decentralization terms, a very smart decision, because there is no obvious leader for users to defer to.
[29] Bitcoin, as I noted in an earlier article, doesn’t scale well. The Layer 2 Lightning network seeks to overcome this issue, but it is more centralized than the Layer 1 Bitcoin network – see: https://trakx.io/bitcoin-the-inside-out-narrative/
[30] Tao is a nebulous concept but I am using the most common definition meaning “the way” or “the path”.
