Building an Economy Within a DAO

This essay is based on a talk I gave to Crypto, Culture, & Society, which is building a liberal arts education for crypto.

Though more complex activity has moved to the digital world, our tools to coordinate in a digitally-native way haven’t evolved at the same pace. DAOs are emerging as a defining coordination mechanism, but they are still in their infancy. To reach their fullest potential, DAOs — like nation states — should work to build thriving internal economies that serve their missions.

This post covers how DAOs can build internal economies, use their native tokens and treasuries to serve their goals, and apply models from economics, history, and anthropology to operate effectively.

I. How to Build an Economy

Why Japan, Taiwan, South Korea, and China Have Succeeded

The book How Asia Works by Joe Studwell details the economic models implemented by Asian governments including Japan, Taiwan, South Korea, China, and others to build successful economies.

The success of these countries runs contrary to conventional economic ideas emphasized by Western universities and institutions like the International Monetary Fund and the World Trade Organization. Unbridled free markets can be harmful for underdeveloped economies. Successful Asian economies have been intentional about what parts of their economies they open up, and when they open them up.

Strategies cited in the book include:

  • Land reform: distribute land from ineffective, feudal landowners to small farmers
  • Immigration policy: allow selected skilled workers, restrict land ownership by foreigners
  • Import export policy: subsidize exports and impose tariffs on strategically important imports
  • Protection of local industry: protect local farmers and manufacturers from foreign competition 
  • Currency protection: devalue the currency to make exports more competitive
  • Special economic zones: set aside areas like Shenzhen with more economic autonomy
  • Tax incentives: provide tax subsidies to local industries

Countries like Taiwan, South Korea, and China started off with a lot of land and a relatively uneducated labor force. It was too costly to train citizens for highly skilled jobs in fields like information technology and financial services. Instead, the governments adopted land reform policies that distributed land to the agricultural laborers who worked on it.

Smaller parcels of land operated by economically incentivized farmers resulted in increased productivity and crop yield, which raised household income. The success in agriculture in turn fueled local manufacturing industries. Because manufacturers couldn’t become wealthy by local consumption (the local economy wasn’t rich enough), they had to focus on exports to the US, Europe, and other wealthier economies.

The way to spur exports is not to open up the economy completely, but to be selective and set up special economic zones and offer tax subsidies for industries that were strategically important. Governments would selectively revalue the currency; China in particular is famous for devaluing its currency so that its exports were competitive in the global market.

While these strategies are not sustainable in the long term, they are important at the early stages of economic development. The economy needs a strong foundation before it can be fully open to foreign competition.

Applying a Successful Economic Model for Governments to DAOs

So what happens when we apply the Asian model for building an economy to building a DAO?

Let’s use the example of how it’s looked for Friends With Benefits

  • Land reform: Wide token distribution
    • Similar to the way that East Asian governments allocated land away from feudal landowners to laborers, it is important for DAOs to distribute tokens to a wide range of participants, allow people who contribute to earn tokens, and potentially have an inflationary token supply to dilute older, inactive participants in favor of newer, active ones.
    • FWB has done one of these things, i.e. set up several working groups for members to earn tokens in exchange for contributing to the DAO.
  • Immigration policy: Token-gated (75 FWB) and scholarships
    • FWB offers membership to anyone who owns 75 FWB tokens and gets their application approved by the FWB team. They also have a scholarship program for selected applicants.
    • Unlike an open borders policy, this curates the members of the DAO during the early days.
  • Currency protection: Liquidity provisioning and treasury diversification
    • A large portion of FWB’s token supply is held by the treasury, so the circulating supply is limited. The treasury is selectively deployed by the curated community.
    • FWB manages their liquidity program. Most of the large liquidity providers are trusted FWB members who will not sell their FWB positions at a whim.
  • Special economic zones: FWB cities, FWB gatekeeper, FWB radio
    • You can think of sub-DAOs as loosely defined special economic zones. They are delegated authority and given some funding to produce specified products or services.
  • Tax incentives: Funding from the DAO treasury 
    • FWB is a state and has to provide public goods for people to operate within that state. Similar to the way a government will provide tax subsidies for industries that benefit the country, FWB provides treasury funds for activities that help it further its mission.
    • FWB’s treasury has funded a token gating product, an editorial that covers weekly news in FWB, and events in various cities.

Designing Tokens and the Treasury as a Decentralized, Programmable Game

A DAO is an internet-native organization that has its critical rules governed by smart contracts rather than legal contracts. You can encode important things like membership, ownership, key assets, or property the community owns on-chain. And at the edges, you have humans who govern over critical parts of the DAO like the shared bank account or treasury, upgrades to the protocol, and changes to the constitution of the DAO.

Today, most protocol DAOs allocate 40-60% of their native tokens to a community treasury, which is then allocated via on-chain governance. The challenge is that on-chain governance is slow and ineffective, which means hardly any native tokens get allocated.

However, the rules for allocating native tokens over time can be encoded in the beginning of the formation of the DAO. By setting these rules, DAOs create a game that builders, users, market participants, and other stakeholders can participate in to receive native tokens. 

Bitcoin Block Rewards: a Game with Transparent Rules that Created Economic Activity

Bitcoin provides a great example of this idea in action. Bitcoins are created as a reward for mining, which serves an important function of using computing power to verify and record new Bitcoin transactions. The incentives laid out by its creator, Satoshi, have led to a whole ecosystem and economy of participants mining Bitcoin, including mining companies like Bitmain, hydropower plants including ones in Italy and Costa Rica, ASIC miners designed to mine Bitcoin, and more.

While the Bitcoin model is not without its critics, it established a transparent way for market participants to earn Bitcoin that has been very successful.

Curve: An Open, Attack-Resistant Mechanism That’s Led to Complex Economic Behavior

Curve is another example of a protocol that has a very transparent system for distributing native tokens, rewarding participants, and creating utility for those tokens. On Curve, you can lock up your tokens in a voting escrow, and they are subject to Curve’s vesting schedule. By locking your tokens you can not only accrue more tokens, but you also get to vote on distributing token rewards and adding new gauges to the protocol.

An entire ecosystem with a lot of activity both within and outside the DAO has sprung up based on the rules that Curve created for utilizing and allocating its tokens. 

For example, Convex Finance emerged as a protocol that unbundles the governance and economic rights of Curve holders. As Kydo states, a group of people within Curve Finance wanted to maximize their yield on their CRV (their agenda). However, their individual voices were not enough to shift the pendulum. So, they pooled their voting power together (unionizing) in Convex Finance (the union) to achieve it. Holders can give up their Curve governance rights to Convex while maintaining the economic benefits of veCRV (vote-escrow Curve), which include trading fees, yield, and CVX rewards. Additionally, holders can bribe veCRV holders to vote on issuing rewards to particular pools via Votium.

Alliances between DAOs

Business-to-business relationships are strict whereas DAO-to-DAO relationships are fluid. B2B relationships are defined by legal contracts, proprietary software, and private negotiations with key executives at the company. D2D relationships are defined by smart contracts, governance forum posts, open-source software, and public negotiations with the DAO’s community, token holders, and core team.

D2D collaborations are closer to nation state alliances than corporate mergers and acquisitions. A significant D2D token swap is like the NATO agreement, which partly serves to protect each other and not step on each others’ toes. Yearn is a good case study – they’ve helped several protocols like Pickle, Rari Capital, and Alchemix when they were exploited. This helps Yearn build trust with other DAOs.

When the code is open source and forkable, what you want to “acquire” is the community and ecosystem development around the protocol. This can’t be done by force.

Successful collaborations will involve product integrations, sharing of resources, support during attacks, and increase in the economic value of both DAOs. Collaborations will also involve participation in each others’ governance. The collaboration exists as long as both communities want it. If you implement token swap via a Sablier stream, both DAOs can cancel the stream or sell the tokens at any point.

II. Barter and Gift Economy

The Financialization of Everything

Crypto enables almost anything to become financialized – from an open source protocol to a meme to a person’s future income. The financialization of everything combined with the ability to exchange anything for anything else via decentralized exchanges like Uniswap and Sushiswap indicate that we are entering a loosely-defined barter economy.

Anything can compete to be money. It’s easier than ever to create an asset out of anything, and it’s also easier than ever to exchange assets for each other.

Liquidity Is to Web3 as Bandwidth Was to the Web

When exchanges become more common (and more important to the economy), liquidity also becomes more important. 

A useful analogy is that what bandwidth provided to the Internet age, liquidity provides to the blockchain age. Bandwidth is the rate at which data flows across the network, and liquidity is the ease with which you can exchange your asset for something else. Having ample amounts of both is what allows a DAO economy to flourish.

Source: Liquidity Wizard

A Gift Economy Within DAOs

Many anthropologists disagree with the commonly held idea that barter economies evolved before economies based on credit or currency, which was propagated most notably by the 18th century economist and philosopher Adam Smith. In practice, many anthropologists have instead suggested that early economies were gift economies based on generosity and reciprocity. (e.g. I give you something you need and at some point down the road you return it in some way.)

This seems to be emerging in intra-DAO interactions. As trust builds within a DAO, members cultivate trust that they will at some point be rewarded for their efforts to advance the mission of the DAO.

The concern in web3, however, is that every interaction has the potential to become transactional. DAOs must be careful to prevent that from becoming part of the culture because it devalues the intrinsic and social motivations of members. The best DAOs will operate a gift economy internally, even if they are more transactional with other DAOs.

Inexhaustible Treasuries and Infinite Time Horizons

There is value to having permanent capital because some projects require a longer time horizon and an inexhaustible source of funding. Chinese monasteries and university endowments have been built with this understanding – the funds will need to exist in perpetuity. 

DAO treasuries often fund long term, open source projects, which means the funding will need to last as long as possible.

As always, there are exceptions based on the goals of the project – whether for a DAO or a traditional institution. For example, the Gates Foundation plans to spend all its resources within twenty years of Bill and Melinda’s deaths so that they can focus on the most pressing problems today.

Socialists Meet Capitalists in DAOs

DAOs are interesting because they contain elements of both socialism and capitalism, two different ideologies. There’s a hybrid model emerging from both the libertarian leaning beliefs that everything can be financialized, and that money shouldn’t be controlled by any centralized entity AND the leftist view that labor should own more of the economy, not just wages. It’s why web3 contains a multitude of political views – because people can be attracted to it for different reasons and both sides can be right.

In many ways, DAOs offer a better model for coordination and distribution of ownership than some of our existing structures. Successful DAOs will build a thriving internal economy that drives their mission. They should be intentional about how they use their native tokens and treasury to sustain and grow their communities.

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Thanks to Austin Green for discussions on this topic, Sara Campbell for helping write the initial version of this post, and Graeme Boy, David Phelps, Michael Bateman, and Daniel Schlabach for feedback.