What it'd take for DAOs to actually become the "new paradigm of human coordination"
Without wealth recirculation, Web 3.0 will become fancier Web 2.0
Suddenly in 2021 everyone started overusing the term Web 3.0.
It’s edgy, it’s cool, but nobody ever seems capable of explaining what it means exactly.
While I don’t claim to be an absolute authority on this, Web 3.0 is fundamentally about user ownership. The various DeFi and GameFi platforms make a point of rewarding their users with ownership in the protocol, expressed through the governance token.
Skeptics will say that this is mostly so that they can dump their insider allocations on plebs quicker, and that this whole trend is motivated primarily by regulatory caution surrounding “sufficient decentralization” clauses (non-existent de jure, but de facto acting doctrine).
I don’t deny that some of these projects are precisely like that, some more openly than others. But there is still something truly meaningful about this user-centric structure, and I think it’s the key to understanding how Decentralized Autonomous Organizations (DAOs) can catalyze a true change from Web 2.0.
The Tragedy of the Commons and other incentive failures
In economics, there are a group of phenomena where free market stabilization mechanisms fundamentally fail.
One case is the Free Rider Problem, applicable to any sort of public goods and infrastructure. If a group of capitalists build a road and leave it open to the public, people who have not paid for any of its costs will still be able to use it. This includes, for example, competitors of said capitalists. This naturally disincentivizes private groups from building public infrastructure, with the result that nothing gets built.
Solving the Free Rider Problem is one of the primary mandates of modern governments, and they do so via taxes paid by everyone.
There is another problem involving public utility infrastructure, which is called the Tragedy of the Commons.
The best analogy is that of fishermen and a pond. There is only so much fish that you can capture before their population drops. By fishing too much, you risk finding yourself with no fish at all in the future.
This seems easy to fix, right? Just don’t fish too much. But what if the fishermen don’t coordinate with each other?
In what is a classic example of applied (3, 3), each individual fisherman could fish just enough so that the pond doesn’t get depleted. But if there is one fisherman who extracts as much value as he can, it’s all for nothing. The pond gets depleted, and the honest fisherman gets less than he could’ve taken.
The natural, game-theoretically optimal choice for the individual is to always fish as much as possible. That is, however, a bad long-term outcome for everyone involved.
How corporations “solve” the tragedy
Imagine the pond gets privatized by the fishermen initially involved. A new business is formed, called Fishing Pond Inc., which derives value by extracting a fee for fishing. This business is now financially aligned with the long-term survival of the pond, and limits fishing activity from its users to maximize long-term value.
The owners of this business, who at the initial point in time are also its users, have essentially formed a cartel with each other. They agree to cooperate in a (3, 3) way to improve their long-term outcome. Everyone is happy.
But the world moves on. Let’s imagine that Fishing Pond Inc., interested in making more than just scraps from its pond, buys other ponds. It then expands so much that it now has fishing rights in all the oceans and rivers of its country.
Its owners are still mostly those early fishermen, plus a few big businessmen, government officials etc. (you know, to grease some wheels). Every other fisherman now has to pay Fishing Pond Inc. to make their living and sell their fish.
But man those original fishermen finally tasted money. They know that the entire country depends on them now. Maybe they even have a few of those businessmen investors constantly bugging them, wanting to see eternal growth even if the world is finite.
So Fishing Pond Inc. starts to get creative. They raise the fees, they start selling fishing boats, maybe they start adding bogus overfishing fees. They know that their fishermen have no other choice. They start exploiting their users, trapping them in unfair contracts, using every dirty trick on the book to keep revenues going up.
But the users get pissed at some point. And lo and behold, a new startup called Fish 3.0 joins the market. Fishing Pond fights valiantly, but at this point they can’t change. They’ve reached maximum potential, while Fish 3.0 is exciting and it promises to never charge for overfishing.
Fishing Pond fails, and Fish 3.0 becomes the new leader. After some years, Fish 3.0 begins getting grilled by investors because growth is slowing down, so they add overfishing fees, make it impossible for fishermen to leave and……….
Basically, the cycle continues.
The trap of privatizing the commons
This allegory of the fishing pond is pretty heavy, so let’s unpack what happened at a fundamental level.
The initial idea for Fishing Pond was that of a cartel. The users banded together and made this entity to coordinate themselves. The incentives of Fishing Pond were entirely aligned with those of its users, and the users benefited from the continuing survival of the company.
But then Fishing Pond decided to grow, and the set of owners became radically different from that of its users. This would’ve happened even without expansion, maybe some of those fishermen just got tired of that life and decided to become carpenters. Yet, they still would’ve held shares in Fishing Pond Inc.
At this point, Fishing Pond became a very traditional corporation. The corporation does depend on happy users to survive, but only to a certain point. If it becomes strong enough, it starts to put users into a position where they have no other choice but to use its product.
Fishing Pond thus became a monopoly. But note that this is an idealized example. It doesn’t have to be literally one company, it could be an oligopoly or even an entire industry — the specifics don’t matter if the end result is that users do not have full freedom of expressing their wishes.
Eventually, Fishing Pond failed because markets did finally work and brought up a better competitor. But Fish 3.0 suffered from having the same fundamental structure and incentive set of Fishing Pond. Once the growth fumes ran out, it too had to resort to the tactics applied by Fishing Pond.
And it all started out from this ideal world where the users were Fishing Pond owners. But as it expanded, the new users did not in turn become owners. They had no say in the development of the company, which was instead entirely relegated to the old users — who by this point, weren’t even users anymore.
You think DeFi’s airdrops and liquidity mining is innovative? It’s literally the same concept as the Mutual Savings Bank, a credit entity owned by its users. In the 80s they started privatizing en masse because they realized that creating stock would reward the members far more than just continuing regular operations.
A famous Wall Street guy named Edward Thorp (and his son) would go and open accounts in the MSBs that remained, hoping to get shares of the new company once it was privatized. This was literally ancient airdrop farming, and it worked. Once they privatized, of course, MSBs became very much like regular banks.
(This is all written in A Man for All Markets, highly recommended reading).
So, how can DAOs make a meaningful difference?
The key point is all about wealth recirculation. The problems of Web 2.0 today are simply those of a late-stage society where the incumbents have been allowed to take all control, and are now extracting value from the users.
Don’t get me wrong, corporations and independent ownership still have their place. Users could be opportunistic and extract value from the company. Or they may simply not have the perspective of the entire company — thus making decisions that are good for them, but bad for the enterprise (we go back to the Tragedy of the Commons scenario).
Web 3.0 can reduce the dominance of the incumbent owners, but only temporarily. Without effective sharing of power between users old and new, the new system we’re building is bound to repeat the same path, just maybe with apes and wassies instead of suits.
Much like Zion, the aberration of crypto is in reality part of the system itself. Most DAOs are little more than structures designed to reward an early set of users, founders and investors.
These early-stage DAOs look like they’re equitable now, but their economic structure is set up in the same way as the corporations that preceded them. It’ll take more than that to make a “new paradigm of human coordination” or whatever fancy words they use.
If you’re looking for concrete proposals, the first step might be to introduce a system that continuously reduces power from existing holders, unless they continue putting in work to maintain their relevance (and staking is not work ;) ).
Here’s hoping someone will end up breaking the cycle.