January 4, 2023

The Evolution of DAOs


Mark Lurie, CEO of Shipyard Software

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We've talked a lot about DAOs on this podcast, but we still regularly receive questions about what they are and why they matter. In this episode, Mark shares a talk he recently gave on the importance of DAOs, why they’re likely the most game-changing innovation to come out of blockchain, and why they probably won't evolve in the way most people are expecting.

Mark is the CEO & Co-Founder of Shipyard Software, a Venture Partner at FJLabs, and a board member of GMO Trust (issuer of the first Yen-backed stablecoin) and the Foundation for Art & Blockchain. Prior to Shipyard, Mark founded two other venture-backed startups, Codex Protocol and Lofty, and was an investor at Bessemer Venture Partners.

Mark Lurie:

We've talked a lot about DAOs on this podcast, but we regularly receive questions about what they are and why they matter. So today's episode is a bit of a different format. It's a talk I recently gave at a conference about the importance of DAOs in the context of the history of human organization.

In 100 years, historians may look back on DAOs rather than money as the most game-changing innovation to come out of blockchain. But DAOs probably won't evolve in the way most people think today, so let's jump in. Sometimes it's interesting to step back and ask what is our biggest advantage as humans. It's not our strength because we lack both things and claws. It's not our speed because we're slower than most four-legged animals. And it's not our intelligence, we are the smartest, but smarts alone don't explain our dominance. After all, dolphins don't dominate the seas.

Our greatest advantage is our ability to organize. We, humans, evolve to organize. We're instinctually wired to do it because while humans are weak as individuals, we are strong as a group. We can accomplish more together than alone. And throughout human history, that is exactly what we've done, and we've taken advantage of new technologies to do it.

So imagine you're a hunter-gatherer in the Stone Age. You would use flint spearheads to hunt wooly mammoths and squats. Imagine you're a neolithic farmer in the agricultural revolution, you would use organized religion to create shared values that maintain peace between unrelated individuals in the first cities. And imagine you were an ancient Sumerian in 3000 BC, you'd use writing to govern across time and space in the first empire. Imagine you were an Indian craftsman in the fifth century BC, you'd use corporate personhood to speak with one voice against the power of the state in the first guilds called shrenis. And imagine you were a Dutch merchant in the 17th century, you'd use limited liability to enable joint stock companies and exchanges to attract enormous amounts of capital for large private enterprises like the Dutch East India company.

But these systems and institutions were designed in a different age. In the 21st century, we can communicate instantly, transmit money globally, provide services across arbitrary borders, and use computing to amplify our efforts exponentially. It is amazing, but the more people, the more systems, the more interdependencies we layer onto our existing modes of organization, the more stress we put on their foundation. And that foundation is trust. This complexity threatens to overwhelm us because it's not what trust evolved for At such scale as we work at now, our society is brittle. And so, when trust rates, it can be catastrophic. That's why the worst damage comes from those we trust the most, like SVF.

There is clearly a pressing need for a new way to organize around our modern technologies. And DAOs are a response to this need. So what is a DAO? It is surprisingly hard to define, and perhaps that's because there's some tension in the acronym itself. DAO stands for decentralized autonomous organization. But grammatically, it's not clear whether decentralized modifies the organization, which implies it has no central leader or autonomous, implying that the governing code of the organization runs on decentralized service of the blockchain. So it's confusing. And it's even more confusing because DAOs tend to be so diverse, right? Some DAOs are very decentralized organizations like Bitcoin and its blockchain with all changes subject to either a vote or just consensus.

Others are very centralized, like an investment syndicate where a few people make all the investment decisions. Some DAOs are fully autonomous. Again, like Bitcoin with all the rules encoded on chain, while others consist of a simple multi-sig wallet where two of four or three of five people need to sign a transaction in order for it to be sent.

It might be so confusing because influencers tend to describe DAOs rather than define them. For example, Coopahtroopa wrote DAOs are internet communities with a shared cap table and bank account. But not all DAOs have treasuries, nor tokens is a group of artists or open source developers without a treasury, not a DAO. Bankless wrote that DAOs are digitally native communities that center around a shared mission. But this describes World of Warcraft, and we don't tend to think of that as a DAO.

Whatever the reason, we haven't really coalesced around a definition. And this is our Achilles heel because it makes DAOs confusing to the rest of the world, which makes DAOs easy to dismiss. Instead, we need to agree on a standard definition that helps us and other people understand DAOs so that they will engage. And so, I propose for the purpose of this discussion that a DAO is an arrangement between people whose governing rules, like bylaws or terms and membership can be set forth in code on the blockchain in smart contracts and tokens rather than in written documents.

And when you think about what this means, it becomes clear. DAOs are an incredible tool to help us organize. And I want to make this really, really concrete. So here are some specific examples of how this tool is so useful. First, ease of operations. Imagine you have one week to organize a syndicate to bid on an asset. Maybe it's distressed real estate. Maybe it's a fast-moving angel investment. Maybe it's a copy of the constitution. Unless you have enormous money and influence, no law firm is going to turn the docks for you that fast. No bank will onboard you that fast. No accounting firm will track thousands of investors that fast. Legal and financial structuring is just hard to do ad hoc, so you're stuck. But DAOs can make these operations easier. Bylaws can be copied and pasted and configured using code. Membership and voting can be tracked easily because tokens scale infinitely, and funds can be accepted into a simple multi-sig instantly.

So you are unstuck. Then there's compliance. Imagine there's no rule of law like in Venezuela, or Somalia, or Syria. How do you ensure managers won't just run away with funds? You can't rely on contracts since there are no viable courts. You can't rely on banks, since corruption is endemic. You can't rely on votes to be counted fairly. Contracts don't work without institutions.

And even in the US, written rules can only be enforced after the fact by really expensive lawyers. And even then, imagine getting in a contract dispute with Google. What's you going to do? Sue them? They will bury you. So you are stuck. But DAOs enhance compliance code can prevent violations from happening in the first place because the code just won't execute if the conditions aren't met. And the blockchain's transparency ensures that corporate actions like voting and transactions are auditable by members.

In other words, compliance can be assured rather than deterred. And so, you can do business on a level playing field even when there's no rule of law, and even when you're dealing with a more powerful partner. And so, you're unstuck.

There's also just new organizational structures that DAOs enable, right? Imagine you're an open-source developer and you're collaborating with other developers around the world on software. The only reason you help is because there is no hierarchy, no owner to report to. But how do you decide simple things like a product roadmap? You're stuck. But DAOs enabled agreement without hierarchy. So open-source developers can formalize decision-making using code and pre-agreed upon rules without having to have a boss or alienate each other. And so, you're unstuck. And it doesn't just have to be a replacement for corporate entities, right? Imagine you're finalizing a real estate transaction or a domain name purchase, but no one wants to send the money first, right? Today we use lawyers or third-party companies as escrow agents. But when you're buying a home, escrow can be 1% to 2% of the transaction for a fee.

So if you buy a $500,000 home, you spend $10,000 on the escrow agent, why not just use a smart contract, right? The key insight here is that a DAO doesn't have to be a whole company, it's any arrangement between multiple people. And so, we can supplement existing forms of organization instead of replacing them. And in 100 years, we might have entities that do 50% of governance on-chain and 50% off-chain and legal documents. DAOs are not mutually exclusive with traditional entities. All this is to say that DAOs can be useful. Plain and simple.

So now that we have a definition, a description, and clear concrete use cases, we can start answering some of the questions, the key questions that society poses to us. What is a DAO? Well, it's kind of like a company or a contract with bylaws or terms enforced in the blockchain, right? It can just be a contract with terms enforced in the blockchain. How did DAO start? In 2016, the DAO was created as a venture fund, though it was pretty short-lived. What are DAOs used for? Well, any purpose a corporation can be used for and more from high school chess clubs to national governments, they simply enable human organization. They can even be used for narrow and specific purpose within another organization, again, like a contract. So why would you use a DAO? Well, it's a tool to help organize. Sometimes, it is simply more effective and more compliant than older tools like written bylaws.

And who uses DAOs? Well, five million members participate in 10,000 DAOs with over $10 billion in assets. DAOs are here and they can no longer be ignored. And why does this matter? DAOs are to human organization as crypto is to money, trustless. And this is so fundamental as our society becomes increasingly complex, DAOs allow us to overcome our crippling dependence on trust. And the simplicity of all these answers is what makes this definition the right one. It makes it easy for the world to understand DAOs and why they matter, which makes it harder to dismiss them and easier for people to engage with them.

Of course, DAOs are a lot more than just a better company or a more efficient way to do contracts, right? By supplementing our dependency on trust as we organize ourselves, DAOs promise a more grassroots, organic, and free society, they have huge promise and we have yet to see all that they can become. But there are challenges. DAOs can be really complicated to run. How do you prevent social drama and voter apathy? The tooling is just not yet mature. DAOs still need software to help with everything from accounting to tax to project management. And then the code might have bugs, right? Hundreds of millions have been stolen. There are regulatory concerns because membership tokens are transferable, it can implicate securities loss.

And perhaps hardest, sometimes rules are meant to be broken, right? Some rules remove instead of integrate human discretion. Imagine how many fewer non-violent offenders would be incarcerated in the US if Congress had not passed mandatory minimum sentencing laws. And some rules can't be updated and need to be broken, right? Imagine the constitution without amendments, we'd still have slavery. So the right battle-tested code with rules that can allow for updating still needs to mature. Just like corporate law and contract law matured over centuries. DAO evangelists are the pioneers that are maturing this tool, and they have hard work ahead before DAOs can fulfill their promise.

Now, for context, I've grappled with these challenges for three DAOs. I founded Shipyard Software, a developer of specialized decentralized exchanges. We realized that in most automated market makers, retail traders are subsidizing whales because small trades don't really need billions in liquidity. So we developed Clipper, a decks just for retail traders. That's a decentralized exchange and it has the best prices anywhere for trades under $50,000. And we created a DAO, AdmiralDAO to govern Clipper. It is incorporated in the Marshall Islands, which we did with the help of my DAO directory services. I've also founded the Foundation for Art and Blockchain, a 501c3 non-profit as a DAO to empower artists and NFTs. And finally, I've seen what works for traditional entities. I'm on the board of GMO Trust, which issues a regulated yen, back stablecoin, GYEN and ZUSD.

I've sold a venture-backed web two company. I spent years as a VC investor at FJ Labs and Bessemer. And from these experiences, I believe that DAOs may be the most transformative blockchain use case. I believe that one day, all companies will, at least in part, be DAOs. But in my experience, here's the thing holding us back. Even if a DAO is governed on the blockchain, they need people, and people live in the real world. So while DAOs may not need laws to enforce rules, if they don't comply with laws, members face penalties. And DAOs may not need bank accounts or the ability to sign off-chain contracts. But without them, it becomes much harder to operate.

DAOs may not need experienced executives, but without them, DAOs may be pretty ineffective. After all, they're entire business schools built over hundreds of years that research and teach how to manage organization, it is a science unto itself. It is not easy. And yet many DAO evangelists are so focused on DAOs being revolutionary and replacing the existing system that they risk losing the hard one benefits of the past, right? There's important learnings there, and we risk alienating the very society we seek to improve. So when we talk about DAOs as a revolution, you can count me out. Instead, DAOs will be most successful if they engage the traditional world rather than leaving it behind, right? Joint stock companies didn't stop using corporate personhood, and guilds didn't stop using writing. And neolithic farmers didn't stop working in squads. They integrated the old into the new and the new into the old.

We can only do this for DAOs by explaining how one day, all companies will also be DAOs. Not a revolution in human organization but an evolution of human organization. And examples like FTX can help us do this. I recently authored an op-ed in the Wall Street Journal that argued centralization caused the FTX fiasco, which would not be possible in a decentralized exchange because it doesn't take custody. And that is true. But also, a DAO could have prevented SPF's grift. The money could have been traceable on chain. Compliance could have been assured instead of deterred. Controls could have been publicly visible, right? That is almost as important as removing the need for custody of the money itself.

Once again, money is to crypto as organizations are to DAOs, trustless, right? John Ray, the new CEO of FTX said, "Never in my career have I seen such a complete failure of corporate controls." Such a complete absence of trustworthy financial information has occurred here. He cited compromised system integrity, faulty regulatory oversight, no board, the concentration of control in the hands of a small group of inexperienced, unsophisticated, and potentially compromised individuals. He called the situation unprecedented, right? And that is not just FTX, it is Madoff, it's Enron, it's MF Global. And so, when skeptics ask why anyone would use DAOs instead of a normal company, we need to reject the premise and invert the question instead asking in the future, why would anyone use a corporation that wasn't governed as a DAO? Why would you ever want a corporation when code can force compliance and controls?

It would be crazy not to. Do you want management to just forget to ask shareholders or directors before making loans to related parties? Obviously, not. Do you want to rely on auditors, bank statements, and receipts? Obviously, not. You can change those things at Photoshop. I would rather just follow the money on the blockchain. Do you want to visit a notary every time you sign an important document? Obviously, not. It's a huge pain. I would just rather sign with my MetaMask wallet. Do you want to pay a lawyer, $1,000 per hour to draft board resolutions? Obviously, not. I'd rather copy, paste, sign and deploy configurable open-source code, defining organizational rules.

And do you want to pay Carta $100 per employee per year just to manage a cap table or however much it is? Obviously, not. I could go on and on and on in the future. Running a company that's not also a DAO seems like riding a horse on the highway, using snail mail for high-frequency trading, ordering a DVD to watch the latest Netflix show, scanning a Polaroid to post on Instagram. It's cute, but anachronistic beyond comprehension that anyone would even consider wanting to go back. And just think today, there are 330 million corporations in the world. One for every 24 people. In 100 years, they might still call themselves corporations, but they will also be DAOs.

And if you are still a DAO skeptic, you need to know that if you don't get on the train, you're going to be left behind like a hunter-gatherer in the agricultural revolution, like an illiterate in the age of writing, like a local craftsman in the industrial revolution. You won't be able to compete. And maybe that's fine, maybe that's fine with you. But we are at a bifurcation point as a society. Society is getting increasingly complex, while it's foundation of trust is not. That's the reason we need a new form of organization. And if complex systems don't evolve, they tend to collapse.

We are here because we're invested in taking positive actions towards avoiding the worst and instead creating a better world that we sense is not only possible but just ahead. So if you are a DAO pioneer or interested in DAOs, what do you need to do to ensure this happens? That's really simple. It's stop thinking of DAOs as a revolution, instead, embrace them as an evolution that will meld with traditional companies. That's what will enable us to use our human superpowers and organize in the new way that DAOs offer us. To do so, we must evolve.

So this is only the beginning of our collective DAO journey. We don't know exactly how it will end up, but we know it's really important. And so, if you'd like to learn more as that journey continues, here's how you can follow me at Mark Lurie on Twitter, and I look forward to sharing all the learnings and reflections around DAOs as they develop.

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