Community governance systems have seen considerable adoption over the last few years. Interestingly, these systems have been in use within the crypto space with great success. Now, they are more common than ever with the DeFi revolution in full swing. Here are some key things to understand about these unique governance protocols.
Why Community Governance Became Popular
When you research the history of the crypto market, there are some instances where you can see major projects suffer due to a lack of cohesion within the ecosystem. Whenever a community is split on a major issue it can cause serious issues. The issues can be exasperated when the community and the developers see things differently as well.
Decentralized governance systems were designed to give communities a way to express their opinions and have their voices heard. Community governance systems are much more effective at keeping communities together than previous setups because they put the community in charge.
Unlike traditional projects, there is no centralized group that makes the final approval of community governance upgrades. Instead, users can put forth their proposals for the community to vote on. If approved, the network treasury will automatically issue the corresponding funding to begin the project. This level of automation has made community governance systems the new norm.
Community Governance Keeps Communities Together
Despite their early use, it wasn’t until the introduction of DeFi (decentralized finance) systems that community governance took off. DeFi systems eliminate the bank from finance. They replace centralized systems with decentralized protocols known as smart contracts.
These contracts are designed to operate transparently and securely. They can be triggered upon the completion of certain parameters and can be programmed to meet certain requirements before transfer. One of the main things that DeFi did was drive home the need for new community governance systems.
For a DeFi network to be truly decentralized, it needed to have a way for the average users to participate in the larger decision-making process. This desire has led to the introduction of a couple of different community governance systems.
DAOs
The first style of community governance was the DAO (decentralized autonomous organization). These systems accomplished all the goals of developers. Regular users gain the ability to stake their tokens and enter the protocol. They could put forth proposals regarding any of the platform’s technical or financial aspects. Notably, DAOs are still very popular today.
The concept for a DAO began during a conversation between developers and Ethereum founder Vitalik Buterin. He discussed how a community government system could be plausible using Ethereum and how it would improve transparency. He also advocated for an open-source governance system as part of this strategy. In 2016, the first DAO was launched on the Ethereum network.
Notably, this code was written by Christoph Jentzsch, an open-source coder, and early crypto supporter. The project saw participation from his brother Simon Jentzsch as well. Bth are credited as the creators of the first operational public DAO. Best of all, the entire project was shared on GitHub as open source with others contributing to its development.
Gamechanger
The DAO was a game changer with all managerial roles replaced with smart contracts. This approach eliminated inefficiencies and enabled all parties to monitor the progress via blockchain explorers. Smart contracts are wise maneuvers because they are devoid of human emotion, bias, or errors. In theory, this approach had many advantages.
Since there were no employees, the cost of running the DAO was a fraction of the cost of having real people manage the project. Consequently, there wasn’t even a physical address associated with his management mechanism. These savings continued to add up as it became evident that this strategy was far more efficient.
First DAO – Rise and Fall
The first DAO went live in 2016 as part of the Ethereum ecosystem. However, its success was short-lived. Only a few days later in June 2016, the DAO was hacked. The hackers were able to exploit a vulnerability in the coding that enabled them to duplicate certain aspects of the process and redirect funds.
The hackers were able to redirect nearly $50 million in ETH from the DAO’s crowdfunding wallet. The hacker tricked the software into thinking that a duplicate address was correct. The loss was so major that Ethereum went into panic mode. For days, Buterin and a team of Ethereum developers pondered how the hack occurred and what to do next.
The Hack Reveals
The hacker’s strategy was figured out and the team went into overdrive to try and do damage control. The first thing they noticed was that the hacker didn’t have access to his stolen ETH just yet. Because he had to create a duplicate command to trick the system, he was locked into the same 28-day hold period as the original contract.
This hold period gave Buterin and the community some time to decide how to react. Buterin reached out to the Ethereum community asking for advice on the issue. However, the time sensitivity and overall potential loss made the Ethereum team get desperate.
Fearing Losses
Fearing the tokens would create devastating losses for the project, Buterin and his team made the controversial decision to roll back the blockchain right before the hack took place. This maneuver was met with severe pushback from the crypto community. Blockchains were meant to be immutable and rolling one back would have far-reaching effects on the project.
Even the Hacker Questions the Move
Even the hacker took to Twitter to question the decision. The attacker stated that if you want to have a DAO then you need to stand by its decision. They even went as far as to offer bonuses to miners who were against the rollback strategy. The rollback strategy was a major decision that would split Ethereum into two separate coins.
All transactions before the rollback would remain on the Ethereum chain which would now be referred to as Ethereum classic. Any transactions after the hack would go to the new Ethereum blockchain. The decision to roll back the network created a lot of stress, disrupted the community, and added to new users’ confusion in the market.
Worst of all, it made Ethereum ineligible for security token services. It would be impossible to get an asset that’s finality is legally binding to issue on a network that developers could roll back to prevent losses. Even today, Ethereum has not been able to recover in the security token department. However, the rise of DeFi has added new DAO opportunities to the market
Governance Tokens
Another popular community governance method is the use of governance tokens. DeFi governance tokens are specially created digital assets that enable users to access the voting and proposal aspects of the network. The cool thing about this approach is that it permits developers to incentivize governance systems rather than just provide access
No Accident
The popularity of community governance systems is no accident. These networks continue to thrive for multiple reasons. For one, their user base stays cohesive. Additionally, community governance systems provide developers and the community with more ways to control the value of a token.
It’s common for community governance networks to order token burns or buybacks to drive value. These strategies and more are just some of the ways community governance systems help. Here are some other benefits these protocols introduce to the market.
Pros of Community Governance
Transparency is the main benefit of community governance systems. When you provide the user base with the final say, there is always a feeling of community. Additionally, these systems make it easier for developers to measure their user’s sentiments toward certain upgrades and changes. If the community votes in favor of a concept, the project can automatically release funds from the community chest.
Average Users Heard
There are a lot of reasons why developers would want to listen to their users more. Users are the best way for a project to measure its options and features against competitors. If there is a constant drum of people asking for a certain feature, like staking, it can be time to put forth a proposal to the vote.
Community governance systems also make cryptocurrencies a better option than stocks. When a user trades stocks, it’s seldom that they have any of their input heard by the firm. The reality is they sign on for whatever the company decides to do until they sell their shares. Community governance in DeFi addresses this issue and makes participation profitable.
Incentivizes Participation
Community governance systems are popular for another reason, they incentivize users. Users can often stake or farm their governance tokens to earn profits. These profits are on top of any improvements to the value of the project’s utility token and ecosystem.
Many DeFi networks enable users to stake their governance tokens and secure profits. Incentivizing community governance drives more users to join. The higher participation level means that developers get a better consensus during votes. It also improves the innovative nature of the market as more users can mean more proposals and concepts come forth.
Network Safty
Community-governed networks are generally safer for users than centralized networks. The main reason for the added safety is the fact that the developers have less control over the project. In many instances, the developers don’t have access to the community funds unless authorized by a vote.
This approach provides another layer of user-confidence against rug pulls. A rug pull occurs when developers suddenly remove funding from a project and leave token holders with major losses. DAOs protect users from these incidents because the treasury is not under the control of developers but rather a vote is needed to unlock funds.
Cons of Community Governance
Not everything is improved by the introduction of community governance to a network. There are still many issues and concerns that you should be aware of when joining one of these networks. As you now know, a DAO is only as good as its coding, but there are some other risks to consider. Here are some of the most common pitfalls these networks face.
Centralization
The main drawback to these systems is that they can become centralized very quickly. Unless you are participating in a fourth-generation network like META 1 that eliminates whale manipulation via a human-only requirement, there is always the risk that someone may just buy up the most tokens and take control of the network.
It can be a real bummer when a whale trader hijacks a DAO. Whales control significant funding and can use that to buy up governance tokens on a scale that the average user can’t compete against. Once they have the majority vote in the community, it’s very difficult for regular traders to regain control and retain a democratic environment.
Developers
There is also a risk that developers maintained most of their tokens from the launch. When developers keep control over their tokens, they retain control over the project. If the system provides more weight to those who hold more tokens, this can lead to an illusion of community governance. However, if the developers always have the final say, it’s just a farce that usually ends badly for traders.
Security Concerns
Another major issue that has plagued community governance systems since day one is security concerns. You now know how the very first Ethereum DAO was hacked for $50 million which led to the creation of Ethereum Classic and today’s ETH. DAOs require significant coding. As such, it’s recommended you stick to only open-source community-governed projects.
Additionally, you need to ensure the project has undergone security audits. As you learned from the tragic first Ethereum DAO events, a community governance system can be hacked when the coding lacks review. Thankfully, today DAOs have taken some cues from their predecessors in terms of security. Despite the upgrades, there are still incidents today of DAOs being hacked and users suffering major losses.
Community Governance is the Way of the Future
Despite some drawbacks, it appears that community governance systems are here to stay. These unique mechanisms provide a new level of transparency and enable projects to finally become community led. For these reasons, you can expect to see more platforms introduce community governance into their core functionalities moving forward.