Part Two of a two-part series on Decentralization.
This article is part of a limited series of overviews on DAO fundamentals, a collaboration between the DAO Research Collective and The Defiant. Visit www.daocollective.xyz for more information and continue following The Defiant for future pieces on DAO governance, treasury management, community, employment and other topics.
For almost any complex project, a certain level of activation energy is necessary to get the project off the ground. Individual leaders driving change, rapid iteration cycles, well-informed roadmaps — projects that want to move forward with some momentum naturally find it near-impossible to be decentralized in any significant way in the early days. Jesse Walden wrote a useful playbook for progressive decentralization for founders in crypto.
The normal course of action for blockchain-based applications undergoing the process of decentralization today is roughly:
- Create a governance token that gives holders the right to vote in some sort of directly- democratic process;
- Distribute governance tokens, usually as an airdrop to past users and stakeholders based on specific criteria determined by the initial project team;
- Invest in processes that relinquish the founding team’s control over the project, like creating a constitution to help navigate future challenges, forming internal working group structures, passing control of administrative controls and treasury management to the community of stakeholders, and providing a venue for stakeholders to participate in governance discussions.
Below, we will walk through a few examples of projects that have used different iterations of this general methodology to begin the continual process of decentralization. These case studies demonstrate the different ways that application-level decentralization can manifest.
Optimism and Hop
Optimism, a Layer 2 scaling solution built on top of Ethereum, recently announced their plan for decentralization by painting an ‘Optimistic vision’ for their future as a decentralized system.
For Optimism, the decentralization process revolves around giving their network of users the administrative power to push upgrades, and creating a governance and operating structure.
Optimism launched the OP token, which distributes ownership of the project to stakeholders based on a list of criteria, but critically, Optimism kept the door open for future planned airdrops (to disincentivize short-termism). Optimism also launched the Optimism Collective, “a new model of digital democratic governance”, and heavily emphasized public goods funding programs as a way to bootstrap an ecosystem of applications and users on Optimism.
Optimism’s TVL Doubles as Trading Activity Surges on Layer 2s
Optimism leaned on transparency and vocal discussion with existing users during the decentralization process (which remains ongoing), releasing an Optimism Operating Manual, experimenting with a bicameral governance structure, and laying the groundwork for public goods funding within the Optimism ecosystem. Optimism emphasized the idea that funding public goods in the decentralization process is highly important, since without decentralization, public goods projects might not exist or might rely on a centralized entity to fund.
Ultimately, while the participation of centralized entities in public goods funding should be applauded and encouraged, relying on only one central entity to fund public goods project leads to a risk vector – if funding for public goods is centralized, funding might only be distributed to projects that appeal to the centralized entity, which is by itself a form of censorship.
Hop, a bridge for assets between different blockchains, also recently announced their plans for decentralization, which included a standard snapshot of participation in anticipation of a token drop to community members. The most noteworthy aspect of Hop’s airdrop is Hop’s attempt to incentivize third-parties to specifically carve out Sybil attackers — fake accounts made in an attempt to game the airdrop system for economic benefit — by asking community participants to search for purported attackers and report them.
Check out Part One of The Center Will Not Hold: How Decentralization is Reshaping Technology and Governance
Hop included a 25% reward to those that caught Sybillers, with the remaining 75% distributed back out to every real participant receiving the airdrop. Hop acts as a case study for how projects might prevent bad actors from gaming the system, and how economic incentives can be the strongest motivator for distributed, decentralized communities. (Optimism later utilized a similar methodology for removing Sybil attackers).
One other project of note briefly worth mentioning is Juno, a smart contract network built on the Cosmos blockchain. While Optimism and Hop specifically implemented processes for fair distribution of their tokens, a poorly designed Juno airdrop was gamed, leading to a huge stake airdropped to one ‘whale’ user.
The implication here is that, in part, the network could be less decentralized given this structural failure, with a lopsided amount of influence and decision-making power going to one user. The Decentralized Autonomous Organization that governs the Juno project later voted to confiscate the stake from the single user, but the Juno saga demonstrates the importance of thoughtful mechanism design in the decentralization process.
Uniswap and Sushiswap
Uniswap is arguably the most decentralized application in the crypto world today and the best example of a hyperstructure. Uniswap is a decentralized exchange — essentially, a set of smart contracts that allow anyone to trade crypto assets without requiring a trusted intermediary — and one of the first projects to airdrop a token to users.
In the midst of 2020’s DeFi Summer, Uniswap distributed 15% of tokens to past users, while reserving most of the remaining tokens for community member distributions. Governance of the Uniswap treasury was transferred to holders of the UNI token, who could decide the future of the protocol in a direct democracy governance process, and the Uniswap protocol is governed and upgraded by UNI token holders in the same process.
Interestingly, end users of the decentralized exchange don’t pay fees to UNI token holders, although governance holds the power to turn on the fee switch. This ‘fee switch’ mechanism has since followed into many other projects, and conversations about turning on the fee switch have been ongoing in Uniswap governance since the first few days after the initial airdrop. These discussions present an interesting insight into incentives and decision-making in decentralized governance systems.
If Uniswap’s governance actions were to halt for some reason, the smart contracts (deployed initially on Ethereum, but since expanded to other blockchains) would continue to run for as long as the underlying blockchain continues operating, without any additional human intervention. Uniswap also operates a centrally-managed front end to make it easier for users to interact with those contracts, but users can opt out of using the Uniswap-branded interface and can choose to interact with the smart contracts directly or create a new front end for interacting with the contracts.
SushiSwap, a decentralized exchange formed specifically as a community-owned alternative to Uniswap before the UNI airdrop, forced Uniswap’s hand towards (more rapid) decentralization. SushiSwap forked (i.e, replicated) Uniswap contracts, built a frontend around them, and vampire-attacked Uniswap by offering incentives for users to move over to SushiSwap’s exchange.
This was done in tandem with a SUSHI token drop to Uniswap users, further incentivizing the user move from Uniswap to SushiSwap. Basically, SushiSwap launched with the premise of decentralization, showcasing how a decentralized-from-the-start project might launch. SushiSwap encountered significant challenges almost immediately with this approach, with the de facto project lead leaving the project, selling tokens, and ultimately returning the tokens.
The results from the vampire attack were both successful and unsuccessful. On one hand, SushiSwap was able to effectively bootstrap the community and network effects necessary for decentralized exchanges to operate by siphoning users from Uniswap.
On the other hand, despite SushiSwap draining hundreds of millions of dollars in assets from Uniswap in 2020, Uniswap is still the most widely-used decentralized exchange in the world, bar none. Sushiswap, meanwhile, has dealt with significant governance issues over the past two years, and has floundered in recent months. Aaron Brown of Bloomberg Opinion said “The two basic problems with SushiSwap are too many opportunists in its initial creation and failure to align incentives carefully.”
Loot, an NFT project that launched as just a single tweet from its’ creator Dom, took a different approach to project decentralization. Loot was deployed as a smart contract to the Ethereum blockchain with no fee for minting the NFTs.
The collectibles themselves are short lists of ‘randomized adventurer gear’. Collectible holders were prodded to interpret the project freely, and because the project was deployed to a public blockchain — Ethereum again, in this case — others could build other stuff on top of the NFTs. The concept of Loot is further summarized in this thread by Avichal Garg.
Because of the free-to-mint mechanism and the low-touch launch, the ‘airdrop’ for Loot was more of an open buffet, where users that became aware of the project could opt-in to participation by minting a free collectible.
Communities quickly organized around the project and began identifying opportunities to use Loot in their own creative interpretation of the project. Dom, in an effort to remove the possibility of any “figure or organization to ever act as its owner,” offered a proposal to Loot holders to burn the administrative keys to the Loot contract, creating a hyper-decentralized structure from Day 1.
The project immediately became the most interesting story in crypto and skyrocketed to $200M in trading volume within 10 days. Loot became a case study in collaborative value creation, with projects like Loot Character, Loot Mart, and an entire ecosystem of other projects springing up around Loot.
As of mid-2022, the interest around the Loot project has waned, partially due to the launch of Synthetic Loot, a derivative created by Dom to limit the scarcity of the initial drop (which probably resulted in a decrease in the initial speculative behavior surrounding Loot).
The lack of a central authority dictating initial project focus possibly impacted the future of the project as well, although these factors clearly sparked some of the initial interest in the project. Either way, it’s clear that Loot embodies the concept of project decentralization and remains one of the most innovative projects in the space. For a more detailed summary of the Loot project, Kyle Russell of TechCrunch wrote a good summary.
Thank you to Connor Spelliscy, Jacob Robinson, and Mike Wawszczak for providing feedback on this paper, and thank you to all of the researchers whose work we relied on while drafting this paper.– Finally, thank you to the DAO Research Collective for their support.
Bruno Lulinski is the author of “A Simpler Guide to Ethereum”, a guide for understanding the different components of the Ethereum ecosystem. David Kerr is the Head of Research at the DAO Research Collective, and the principal consultant at Cowrie LLC.