Gov-Acc Pipeline.

DAO Governance: Decentralized But Not So Disorganized ∗ † Ian Appel Jillian Grennan Abstract Decentralized autonomous organizations (DAOs) promise a new model of collective governance, replacing managerial hierarchies with token-holder participation. Yet de- centralization alone does not guarantee effective decision-making. This chapter ex- amines how real-world DAOs structure governance to balance openness, security, and accountability. Drawing on evidence from leading DAOs, we show that successful gov- ernance hinges on thoughtful design rather than maximal decentralization. Inclusive participation,well-calibratedconstraints,andsecuritymechanismscanreinforcerather than undermine collective decision-making. We translate these insights into practical guidance for DAO builders, contributors, and policymakers, highlighting governance features that foster engagement, mitigate agency problems, and support sustainable growth in decentralized organizations. JEL:G3, G34, L17, M13, M21 Keywords: decentralized autonomous organizations, blockchain, decentralized governance, cryptocurrency, wisdom of crowds ∗Ian Appel, University of Virginia, Darden School of Business, appeli@darden.virginia.edu †Emory University, Economics Department, jillian.grennan@emory.edu Introduction How do decentralized autonomous organizations (DAOs) operate efficiently while addressing theiruniquegovernancechallenges? Unliketraditionalorganizationsthatrelyonhierarchical structures and centralized decision-making, DAOs offer a radically different model: direct participation by token holders in governance via blockchain-based voting mechanisms. This approach aims to harness crowd-sourced wisdom, even from pseudonymous users, while safeguarding against persistent security threats. The stakes are significant. One of the main applications of DAOs is in decentralized finance (DeFi). As of November 2024, DeFi projects control over $300 billion in assets, including $190 billion in stablecoins. For many leading DeFi applications, this capital is not overseen by traditional management teams, but by DAOs composed of decentralized token holders, raising critical questions regarding governance best practices for such organizations. Yet, DAOs face complex challenges. Beyond issues stemming from pseudonymous users and security threats, DAOs grapple with principal-agent problems common to other orga- nizational forms. For example, core team members may face personal incentives that are misaligned with those of the broader community. Such challenges are particularly acute for early-stage projects, which often lack effective mechanisms to mitigate such conflicts. Moreover, simply labeling an organization as “decentralized” is insufficient – without careful design, DAOs can replicate issues related to centralized control that they were intended to solve (Appel and Grennan, 2023) In “Decentralized Governance and Digital Asset Prices,” we examine the governance structures employed by more than 200 prominent DAOs (Appel and Grennan, 2024). By analyzing voting processes and mechanisms, we investigate governance token performance andreal outcomesfor DAOs likeDEX volume growth. Our researchoffers importantinsights into governance best practices for this emerging organizational form. 1 Empirical framework and data Our work on DAO governance builds on foundational concepts from corporate governance, particularly the question of the optimal balance of power between the shareholders and man- agers of corporations. Gompers et al. (2003) pioneered an influential approach to answering this question by developing indices of governance features to classify firms as democratic (i.e., high shareholder rights) or dictatorial (i.e., low shareholder rights). Their analysis found that corporations with relatively democratic governance profiles outperformed their more dictatorial counterparts along multiple dimensions, including equity returns, profitabil- ity, and sales growth. This seminal paper has inspired a rich body of research examining the link between governance structures and corporate outcomes, though some later studies have contested its findings. DAOs present a unique laboratory for revisiting fundamental questions in governance. Unlike traditional corporations bound by centuries of legal precedent and standardized char- ters, DAOs can experiment freely with new ways to aggregate the preferences of their token holders. In addition, while corporate governance changes typically require years to imple- mentandevaluate, DAOgovernancefeaturescanbemodifiedquicklythroughcrowd-sourced improvement proposals. These factors combine to create a dynamic environment in which DAOs have innovated in areas such as voting mechanisms, decision-making processes, and incentive alignment. To study the governance of DAOs, we collect novel data on their gov- ernance structures from white papers, governance forums, and data aggregators such as Messari.io, Boardroom, Snapshot, and Tally. Consolidating data from these sources has allowed us to create one of the most comprehensive databases on DAO governance and im- provement proposals. To conduct our empirical analysis, we categorize DAO governance structures along three key dimensions: 1. Inclusive features: These are features that promote broad participation, similar to shareholder rights in traditional corporate governance but with greater scope given the wide variety of improvements DAO token holders must consider. 2 2. Restrictive features: These are features that constrain decision-making, anal- ogous to management entrenchment provisions in traditional firms. These are the features that help mitigate agency costs. 3. Security features: Thesearenovelfeaturesuniquetoblockchain-basedgovernance systems that aim to deter malicious activity. Our sample spans DAO improvement proposals from 2020 to 2024, including over 17,000 proposals across more than 200 DAOs, operating in a variety of verticals inducing DeFi (61% of sample), Web3 (32%), and infrastructure projects (7%). We document significant variation in the governance structures employed by DAOs. We find that DAOs employ a wide range of mechanisms intended to promote inclusive decision making, the most common being off-chain gasless vote for signaling (e.g., via Snapshot) and offering uniform, transparent templates for proposals. However, a relatively small number of DAOs offer direct incentives to vote (e.g., in the form of increased rewards or proof of attendance badges). DAOs similarly use a wide range of restrictive governance mechanisms intended to constrain decision-making, with some of the most common being requirements to create a formal proposal (e.g., hold a minimum number of tokens) and the use of quorum requirements (e.g., a percentage of the outstanding token supply). More complex voting mechanisms that may also constrain decision-making (e.g., supermajority requirements) are considerably rarer. Finally, DAOs also use a variety of mechanism to enhance security, such as requiring a multi-sig before implementation or allowing the core/developer team to override a proposal. Implications for Practitioners Our findings offer several insights for those developing and managing DAOs. Our research suggests that successful DAO governance requires careful attention to both structure and incentives, with particular emphasis on fostering inclusive participation while mitigating security risks. We highlight some of our key takeaways below. 3 1. Harness collective intelligence: Our research highlights the benefits of broad participation in decision-making. This finding aligns with research on the “wisdom of crowds,” which shows that diverse groups often make better decisions than individual experts. InDAOs, thiscollectivewisdommanifeststhroughseveralmechanisms. When governance processes are more inclusive, they attract diverse perspectives from techni- cal experts, users, and stakeholders across different geographies and backgrounds. This diversity helps avoid the “groupthink” that often plagues traditional corporate gover- nance. To tap into this collective wisdom, DAOs may benefit from implementing some specific features. First, off-chain voting through platforms like Snapshot eliminates transaction costs associated with on-chain voting, thus removing financial barriers to participation. Second, standardized proposal templates can serve as a tool to guide users to provide comprehensive information about their proposals, including imple- mentation details, expected benefits, and potential risks. This standardization serves two purposes: it makes proposals easier to evaluate and compare, while also making it less intimidating for new participants to submit proposals. 2. Building community through recognition: A variety of mechanisms can be used to promote community involvement in the decision-making process. One low- cost option is the use of Proof of Attendance Protocol (POAP) badges and similar recognition systems. These digital badges, which verify participation in votes and discussions, create a reputation system that encourages sustained engagement. POAPs serve multiple functions: they provide a verifiable record of participation, create a sense of community belonging, and help identify experienced members who can mentor newcomers. DAOs using such recognition systems may show a higher retention of active participants. Of course, it is important to ensure these credentials cannot be transferred to others (i.e., “soulbound”). 4 3. Security without centralization: Ourresearchresolvesakeytensionbetweense- curityanddecentralization. Ratherthantradingoffagainsteachother, certainsecurity featuresactuallyenhancedecentralizedgovernancewhenproperlyimplemented. Multi- sig requirements, which require multiple parties to approve major changes, provide protection against malicious actions without creating excessive friction. Time-delay mechanisms, which build in waiting periods between proposal approval and implemen- tation, allow for community review without significantly slowing decision-making. 4. Toward standardization: For DAO developers, our findings point toward the benefits of standardizing certain governance features. While DAOs serve diverse pur- poses, certain governance mechanisms prove effective in a variety of contexts. More- over, a growing number of DAOs are joining organizations such as DAOstar. This is beneficial as it reduces the costs for DAO tokenholders to learn about and participate in governance when it becomes more standardized. Some basic governance features that constitute best practices would likely benefit from standardization across most DAOs: – Off-chain voting capabilities through established platforms – Standardized proposal templates with required fields for impact analysis – Time-delay mechanisms (24-72 hours) for implementation – POAP or similar recognition systems for participation – Delegation capabilities for token holders – Clear documentation of governance processes This standardization can reduce the learning curve for new DAO members while maintain- ing flexibility for DAO-specific customization. We anticipate that DAOs that adopt these features in the future would see faster growth in active participants compared to those with highly-customized governance systems. 5 Future Considerations As DAOs evolve, we anticipate growing sophistication in their governance. For example, emerging technologies like zero-knowledge proofs (ZKPs) could enable anonymous voting while maintaining accountability. In addition, AI might help summarize proposals and pre- dict their impacts on performance, enabling users—regardless of their technological exper- tise—to better evaluate their strategies. AI could also pave the way for advanced reputation systems, further incentivizing thoughtful and informed decision-making. Despite these tech- nological advancements, core principles such as inclusive participation, robust security mea- sures, and standardized processes are likely to remain central to effective DAO governance as the ecosystem matures. For regulators and policymakers, our findings suggest that principles-based approaches emphasizing transparency and participant protection are likely to be more effective than rigid, prescriptive rules for DAO governance. Additionally, requiring DAOs to conform to corporate-like structures may be counterproductive. As DAOs continue to mature, their governance will likely evolve to align in accordance with their objectives. Such objectives may differ considerably from those of corporations. Regulatory resources, therefore, would be better directed toward addressing harmful behaviors, such as insider trading and other actionsthatthreatenmarketintegrity,ratherthanimposingone-size-fits-allgovernancerules. Conclusion Our research indicates that effective DAO governance hinges on striking the right balance rather than pursuing maximal decentralization. The most successful DAOs achieve this by fostering broad participation, implementing robust security measures, and minimizing exces- sive privileges or entrenchment for core developers. As DAOs continue to evolve, prioritizing this balance will be crucial for sustaining long-term success. 6 References Appel, I., Grennan, J., 2023. Control of decentralized autonomous organizations. AEA Pa- pers and Proceedings 113, 182–185. Appel, I., Grennan, J., 2024. Decentralized governance and digital asset prices. Darden Business School Working Paper No. 4367209 . Gompers, P., Ishii, J., Metrick, A., 2003. Corporate governance and equity prices. Quarterly Journal of Economics 118, 107–156. 7