Decentralized Finance (DeFi) has brought revolutionary changes to the crypto world, not only by enabling trustless and permissionless transactions but also by introducing decentralized governance. The goal is to shift decision-making from centralized core teams to community participation and voting.
This article explores the current state of DeFi governance, examining what works, what doesn’t, and the potential evolution of these systems.
Understanding DeFi Governance
DeFi governance refers to the process through which participants in a protocol collectively make decisions about its future. Participants are often rewarded with governance tokens for performing actions that benefit the protocol. The number of tokens held usually correlates with voting power.
Most decentralized protocols follow a one-token-one-vote model, where each token grants its holder voting rights on community proposals. These proposals typically aim to modify or upgrade the protocol.
Forms of Governance
DeFi protocols employ two main governance paradigms: on-chain and off-chain voting.
On-Chain Voting
Pioneered by Compound, on-chain governance involves the entire proposal, voting, and execution process through smart contract interactions on the blockchain. Proposers use executable command lists to call the contract’s propose function. If a proposal passes, these commands are executed automatically.
Voters interact directly with smart contracts to cast their votes. At the end of the voting period, votes are tallied, and the proposal is either executed on-chain or fails.
On-chain voting ensures that successful proposals are implemented automatically through code execution. The integrity of the final vote count is protected by the robust security of blockchain consensus.
However, submitting proposals in on-chain governance systems requires a high level of technical expertise. Additionally, depending on the underlying blockchain's mechanics, proposers and voters may incur significant transaction fees.
Off-Chain Voting
Off-chain governance systems allow users to submit proposals and vote without conducting blockchain transactions. Snapshot, a popular off-chain voting platform, stores proposals and votes as signed messages on IPFS. It enables protocol teams to create their own spaces with customizable rules for determining voter eligibility.
Off-chain voting avoids transaction fees, encouraging broader community participation. However, it relies on a trusted third party to tally votes. Moreover, implementing successful proposals isn't as straightforward as executing code. Approved proposals may require core teams or other representatives to take off-chain actions, such as writing new code, hiring personnel, or conducting financial transactions.
A Look at Major DeFi Protocols
Each protocol has a unique history and tokenomics, which help identify what works and what doesn’t in decentralized governance.
Compound
Compound’s on-chain governance launched in April 2020 with the GovernorAlpha smart contract. The community later migrated to GovernorBravo after Proposal 42 in March 2021.
Initially, any address delegating over 100,000 COMP could create a proposal. Proposal 52, executed in July 2021, lowered this threshold to 65,000 COMP. Proposals require an absolute majority and a quorum of >400,000 COMP.
Compound also introduced Compound Autonomous Proposals (CAPs) to lower the barrier for proposal creation. Anyone with 100 COMP can create a CAP, a smart contract that allows other community members to delegate votes to it. Once a CAP accumulates enough delegated votes to meet the COMP threshold, it automatically initiates a formal on-chain proposal.
Proposal Statistics:
- Total proposals: 57
- Executed: 48
- Failed: 4
- Canceled: 4
- Ongoing: 1
Tokenomics:
COMP has a maximum supply of 10,000,000 tokens. Initial distribution allocated 22.3% to founders and team members, with a four-year vesting period. COMP is distributed at a rate of 2,312 tokens per day, proportional to the interest accrued in each market.
Uniswap
Uniswap’s on-chain governance is a fork of Compound’s GovernorAlpha (though a proposal to migrate to GovernorBravo exists). The proposal threshold was initially set at 10 million UNI but was reduced to 2.5 million UNI via Proposal 4. The quorum remains 40 million UNI.
Uniswap encourages off-chain signaling before creating on-chain proposals. The process involves discussion forums, Snapshot Temperature Checks, and Consensus Checks.
Proposal Statistics:
- On-chain proposals: 7
- Executed: 3
- Failed: 2
- Canceled: 1
- Ongoing: 1
- Off-chain proposals: 29
- Passed: 18
- Failed: 11
Tokenomics:
UNI launched with a supply of 1 billion tokens. The initial four-year distribution allocated 60% to the community, with 15% airdropped to liquidity providers, users, and SOCKS holders. The remaining portion is managed by community governance.
Sushiswap
Unlike Compound and Uniswap, Sushiswap’s governance occurs entirely off-chain using Snapshot. Only core team members can create binding proposals. Approved proposals require manual implementation by the team.
Sushiswap aims to transition to a full DAO by Q4 2021, as indicated in its roadmap.
Proposal Statistics:
- Total proposals: 243
- Core team proposals: 61
Tokenomics:
Voting power is determined by SUSHIPOWAH balance. Each SUSHI in the SUSHI-ETH pool is worth 2 SUSHIPOWAH, while each SUSHI held via xSUSHI is worth 1 SUSHIPOWAH. SUSHI has a hard cap of 250 million tokens.
Yearn
Yearn’s governance has evolved significantly since its inception. Initially on-chain, it migrated to off-chain Snapshot voting to avoid transaction fees and encourage broader participation.
A unique feature of Yearn’s governance is its participation incentive. Proposers whose proposals reach the implementation stage receive a 500 yCRV bounty from the protocol’s treasury.
Proposal Statistics:
- Total proposals: 37
- On-chain (first contract): 7
- On-chain (updated contract): 16
- Off-chain: 15
Tokenomics:
YFI launched with a supply of 30,000 tokens. Users earn YFI by providing liquidity to Yearn products and participating in governance. Staking YFI grants voting rights and a share of protocol profits.
How Effective Is DeFi Governance?
To evaluate the effectiveness of DeFi governance, I analyzed four parameters: voting power distribution, influential voters, proposal sources, and voting participation rates.
Voting Power Distribution Is Highly Unequal
Despite differences in tokenomics, each protocol exhibits a high Gini coefficient, indicating severe inequality in voting power distribution. Less than 1% of voters hold 50% of the delegated votes, meaning a tiny minority can determine the outcome of every proposal.
A Few Influential Voters Control Outcomes
For each proposal, I identified the number of addresses accounting for 50% or more of the total votes. The results show that 2–7 voters typically determine the outcome of each proposal.
Proposals Come from Core Teams or Whales
Proposal creation is concentrated among a small group of addresses. For example, in Compound, three addresses submitted 34 out of 57 proposals. In Uniswap, Dharma submitted the first two proposals, followed by autonomous proposals and others from institutional entities.
In Sushiswap, only core team members can create binding proposals. Similarly, Yearn’s proposals are primarily drafted by core team members.
Voting Participation Rates Are Low
Statistically, participation rates vary widely across proposals. Some proposals see high engagement, while others attract minimal voter attention. On average, a small fraction of circulating tokens are used for voting.
Case Studies in DeFi Governance
Uniswap’s DeFi Education Fund
Uniswap’s Proposal 5 allocated 1 million UNI to the DeFi Education Fund, sparking controversy. Community members criticized the lack of transparency and the swift liquidation of donated tokens. The proposal passed due to support from a few influential addresses, leading to widespread discontent and even satirical proposals.
Sushiswap’s "Phantom Troupe"
A proposal to sell 51 million SUSHI tokens to institutional investors at a discount caused community outrage. The negative response forced the team to withdraw the proposal, demonstrating the power of community feedback in shaping governance outcomes.
The Future of Decentralized Governance
While current data suggests that DeFi governance is still centralized and experimental, it is evolving rapidly. The early stages of any project require a degree of centralization as the community grows and the protocol establishes itself.
Tokenomics
Unequal voting power distribution remains a significant challenge. However, fair token distribution and continuous allocation to users can encourage broader participation. Quadratic voting is one potential solution to address power concentration.
Proposal Accessibility
Lowering proposal thresholds and introducing autonomous proposals can democratize proposal creation. Strong governance forums also play a crucial role in fostering inclusive discussions.
Transparency
Improving documentation and transparency is essential for reducing barriers to community participation. Protocols should provide comprehensive, accessible resources to help new members engage in governance.
Frequently Asked Questions
What is DeFi governance?
DeFi governance refers to the process by which participants in a decentralized protocol make collective decisions about its future. This often involves voting on proposals using governance tokens.
How does on-chain voting work?
On-chain voting involves submitting proposals and casting votes through smart contract interactions. Successful proposals are executed automatically on the blockchain.
What are the challenges in DeFi governance?
Key challenges include unequal voting power distribution, low participation rates, and high barriers to proposal creation. These issues can lead to centralization and reduced community engagement.
How can governance be improved?
Potential improvements include fairer token distribution, lower proposal thresholds, quadratic voting, and enhanced transparency and documentation.
What is the role of governance forums?
Governance forums allow community members to discuss ideas and proposals before they are formalized. They help ensure that proposals reflect community sentiment and reduce the risk of controversial decisions.
Why is transparency important in governance?
Transparency builds trust and encourages participation. Clear documentation and open communication help community members understand how governance works and how they can contribute.
Conclusion
DeFi governance is still in its early stages, but it holds immense promise for creating more decentralized and community-driven ecosystems. By addressing current challenges and embracing innovative solutions, protocols can move closer to achieving their vision of truly decentralized decision-making.
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The journey toward effective decentralized governance is ongoing, and every community member has a role to play in shaping its future.