Measuring a Decentralized Organization's Transparency: A Proposed Framework to Develop a Flexible Standard
Why DAOs Matter: The Inspiration and Call to Action
Many are calling 2022 "The Year of the DAOs," and the industry is eagerly watching to see what this year will bring to the table: innovations in DeFi and decentralized protocols, breakthroughs in interoperability, the rise of new unicorns, and of course the drama, scandals, and rug pulls that is all too familiar in this space. Many of you are probably sick of hearing about DAOs, DeFi, and Web3; in fact, I bet your mouse is already inching closer to the next tab or link. DAOs are the future, DAOs are cool, we’re all frens, ape into DeFi, NFTs are over-hyped, et cetera et cetera — you’ve already read dozens of articles like this before. However, reading about it and actually being in ground zero watching the beautiful chaos go down gives you a completely different viewpoint.
With the DAO space evolving so quickly, we are already seeing rapid changes and evolution in both how we perceive DAOs, as well as how DAOs operate. Since the early days of The DAO up until just last year, DAOs were almost universally seen as groups of extremely forward thinking engineers and mathematicians working on a service or protocol that would ultimately play a role in the proliferation of the decentralization movement — public servants in a sense. At least that’s how the industry tried to impose their views on what a ‘respectable’ DAO was. DAOs were almost instantly associated with early stage DeFi projects, open source protocols and networks, and a bunch of really smart people that regularly held public Zoom meetings before it was cool.
This — perhaps unfair — preconceived notion that we have imposed on DAOs for so long has already begun its inevitable evolution and there is an odd, electric feeling in the air… that gut feeling that you know something is about to explode. DeFi was revolutionary for those who already had assets on hand to experiment with, but let's admit it: the DeFi party was both life-changing and industry propelling, but something about the party felt off... almost as if we had forgotten to invite someone important. Oh shit, we forgot to invite the people that the party was thrown for— the unbanked and the oppressed.
Whereas DeFi revolutionized the way that assets could be invested and spent, DAOs are beginning to revolutionize the way that knowledge, ownership, and work is being distributed to unprecedented corners of the world. Simply put, DAOs are spreading the 'crypto gospel' around the world at an unprecedented pace, and this powerful knowledge is already changing the lives and livelihoods of countless early participants. DAOs will be the main proliferators that will bridge the gap between the unbanked and the wonderful world of DeFi. DAOs can not exist without DeFi, and DeFi doesn’t seem as exciting without the existence of DAOs that will bring the people.
It ain't no fun, if the homies can't have none
It ain't no fun, if the homies can't have none
It ain't no fun, if the homies can't have none
- Snoop Dogg
This “DAO-volution” is breaking the molds of one of the longest standing forms of systematic oppression which had affected every civilization and era that came before us: jobs, work, and reward (or lack thereof). Re-defining the meaning of work, how it is conducted, and how the fruits of labor are distributed is a mind-blowingly dangerous, yet the incredibly liberating concept that could be the change of course that we as a species desperately needed. The economic playing field has a chance of trending more equal than ever before, reversing a millennia-old trend of the latter.
If all this sounds absolutely crazy and extreme, then you can let out a breath of relief knowing that you are completely normal. Most people thought the same about electricity, automobiles, and the Internet — but having watched the crypto industry grow since late 2015, I have become fully convinced that once a movement has begun in this space, the train will not stop for anybody or anything.
Impending doom from iron-fist regulators? Not so fast.
In recent days there’s been a lot of talk about President Biden’s Executive Order on the “Responsible Development of Digital Assets,” and now Senator Elizabeth Warren’s new bill that was proposed just today, which calls on the might of the U.S. government to make it harder for Russia to avoid sanctions through cryptocurrencies. Well-intentioned on the surface, but the bill would realistically affect Americans more than Russia (not to mention, impossible to enforce), as it would require the invasion of privacy of U.S. taxpayers with more than $10K in digital assets offshore through a mandatory self-reporting to FinCEN (again, good luck enforcing this). To put it bluntly, both initiatives have a lot of bark but no bite.
SEC’s Identity Crisis — Crypto’s public enemy number 1 wants to be frens?
When it comes to blockchain and regulation, most people think of the SEC. For a decade the SEC was hell-bent on going after project after project, and is undoubtedly the most influential regulatory body in the United States when it comes to crypto. SEC has been uncharacteristically quiet, and it has become obvious that they have come to the realization that this worldwide movement is something they can not tame. SEC Commissioner Caroline Crenshaw released a statement titled “Statement on DeFi Risks, Regulations, and Opportunities” on Nov. 9, 2021 that went largely unnoticed, and could explain why the SEC has been so (relatively) quiet lately. I’ve read many SEC briefings and statements over the years, but this one was particularly uncharacteristic and I, dare I say, agreed with most of the contents. Key segments from the statement:
Whether in the news, social media, popular entertainment, and increasingly in people’s portfolios, crypto is now part of the vernacular. But what that term actually encompasses is broad and amorphous and includes everything from tokens, to non-fungible tokens, to Dexes to Decentralized Finance or DeFI. For those readers not already familiar with DeFi, unsurprisingly, definitions also vary. In general, though, it is an effort to replicate functions of our traditional finance systems through the use of blockchain-based smart contracts that are composable, interoperable, and open source
Looks like after all these years of litigation they know their crypto pretty well!
... DeFi presents a panoply of opportunities. However, it also poses important risks and challenges for regulators, investors, and the financial markets. While the potential for profits attracts attention, sometimes overwhelming attention, there is also confusion, often significant, regarding important aspects of this emerging market.
It’s refreshing to see the SEC acknowledge the real, valid opportunities that DeFi brings to the world. And don’t worry, I already Googled the definition for you.
panoply (noun): 1) a magnificent or impressive array; 2) a complete or impressive collection of things.
...While DeFi has produced impressive alternative methods of composing, recording, and processing transactions, it has not rewritten all of economics or human nature. Certain truths apply with as much force in DeFi as they do in traditional finance:
Unless required, there will be projects that do not invest in compliance or adequate internal controls;
when the potential financial rewards are great enough, some individuals will victimize others, and the likelihood of this occurring tends to increase as the likelihood of getting caught and severity of potential sanctions decrease; and
absent mandatory disclosure requirements, information asymmetries will likely advantage rich investors and insiders at the expense of the smallest investors and those with the least access to information.
The SEC Commissioner’s concerns are completely valid; because they are happening right now, this exact moment. Someone out there, right now, is putting money into a project or asset that has no intentions of delivering a product, service, or return on investment.
As an SEC Commissioner I have a duty to help ensure that market activity, whether new or old, operates fairly, and offers all investors a level playing field. I would expect this goal to be one DeFi market participants also support. To do this, the SEC has a variety of tools at its disposal ranging from rulemaking authority, to various exemptive or no action relief, to enforcement actions.
The statement also briefly touched on the DeFi Money Market (“DMM”), providing an explanation of why the project was targeted in a recent action which only resulted in a slap on the wrist. DMM raised funds in the United States with promises that did not pass the Howie Test, but more importantly DMM had allegedly misused the raised funds for personal pleasure. So DMM, according to the SEC, sold securities and scammed investors. If what the SEC alleged is true, it was simply doing its job, and the last time I checked the Securities Act of 1933 was never repealed. Whether this outdated law should apply to crypto is a completely different topic which I do not wish to go into, but I thought it was interesting that out of all the projects they could have gone after (and there’s a lot, if we’re being honest with ourselves), they explicitly went after the project that they could prove misused investor funds.
In the closing paragraphs, Commissioner Crenshaw made some clear call to actions:
“I recognize it is not the SEC’s role to prevent all investment losses. It is also not my goal to restrict investor access to fair and appropriate opportunities. But it is my job to demand that investors have equal access to critical information so they can make informed decisions whether to invest and at what price. I am similarly committed to ensuring markets are fair and free from manipulation. Given this, it seems that there are two specific structural problems that the DeFi community needs to address: Lack of Transparency and Pseudonymity.
First, although transactions often are recorded on a public blockchain, in important ways, DeFi investing is not transparent. I am concerned that this lack of transparency contributes to a two tier market in which professional investors and insiders reap outsized returns while retail investors take more risks, get worse pricing, and are less likely to succeed over time. … Retail investors are already operating at a significant disadvantage to professional investors in DeFi, and this information imbalance exacerbates the problem.
While I do not fully agree with the call for pseudonymity, much of the statements showed surprisingly level-headed thinking and rationale that I believe the industry can get behind. While interpretations may vary from person to person, the key points that the SEC made, whether intentionally or unintentionally was, 1) decentralized projects will not be hindered as long as no existing laws are blatantly being broken; 2) the SEC is willing to — uncharacteristically — take a passive approach and allow the industry to experiment and grow, but as soon as retail investors are being exploited, they will come down with the hammer; 3) more transparency is needed to gain the trust of both investors as well as the SEC itself, so figure it out if you want continued unhindered growth.
It appears that the SEC has given the green-light for DeFi and decentralized organizations to continue. As previously stated, the SEC is the most influential regulatory body in the blockchain space, and if they maintain this stance, the chances of Biden’s executive order following a similar approach is, in my opinion, very high.
If there was a time for the community to come together and begin discussions on how to improve transparency and raise trust in the decentralized space, it is now. As early adopters in web3 and the decentralized networks, we must take ownership of the responsibilities bestowed, to set open standards that will bring unity and strength in web3, self-regulate the best we can, and that we do not need regulators to come in and set their own terms. It’s in our blood as DAO workers, contributors, and leaders — just as we have shown the world that decentralized organizations can successfully operate without a central figure, we must now tackle the issue of DAO and DeFi transparency.
The DAO Transparency Index & Dashboard
DAO transparency dashboard that actually gives the DAO value, we must first set some boundaries and definitions. This is especially hard to do since the term "DAO" has in recent months become muddied with misconceptions and misrepresentations. At the same time, the very nature and core concept of DAOs does not permit anyone to judge or try to impose "their way" on others.
The spirit of free innovation and experimentation is how the space got this far, and no one has the right to try and hinder a DAO's growth regardless of how radical or silly its ideas might seem to be. There will certainly be criminal organizations that take the form of a DAO, but web2 has shown the world the terrifying power of angry communities and their capabilities in taking entire organizations down -- and I believe that spirit will continue on to web3.
The ideal outcome is to use the power of data to make it obvious without having to blatantly announce it whether or not a DAO is trustworthy, or even a DAO at all. Since data requires parameters and values, almost all DAOs will ultimately "generally defined" under the same or similar frameworks which will be used to 1) Assign a transparency index score; 2) Show areas in which the DAO could improve on; 3) Shine light on areas that the DAO is excelling at.
It is proposed that transparency consists of three interrelated principles:
- Metric A: Finance (i.e., financial health, token liquidity, revenue streams and debts, etc.)
- Metric B: Governance (i.e., degree of decentralization, token holder participation, consolidation of power, smart contract execution, etc.)
- Metric C: Communication (i.e., financial disclosures, internal communications, social and press/media presence, etc.).
Independently, all three principles of transparency are necessary but not sufficient for information to be considered transparent. Further, all three principles have major components that can be tracked on-chain and off-chain.
The three proposed principles are also measured in overlapped sections that give an even clearer, segmented view of the inner workings of a DAO. A depiction of the proposed principles of transparency is offered in the following figure.
The DAO Transparency Index is a WIP and we invite the community to input ideas and thoughts.