The problem with decentralization

Decentralized autonomous organizations (DAOs) are gradually gaining popularity in the Web3 communities as many are beginning to explore possible ways of creating or investing in one. The concept is being marketed as “a collectively-owned, blockchain-governed organization which allows us to work with like-minded folks around the globe without trusting a benevolent leader to manage the funds or operations”. Basically, it means that people form a group to make decisions in a digital world. A DAO is collectively owned by its members, with rules set and executed through code. The main values are stated as transparency and democracy. At the same time, the concept of DAO has been largely supported by questionable big-name investors like Peter Thiel (the founder of Palantir), Mark Cuban (Broadcast.com), Paradigm (Web3 venture capital firm), and others. It is worth to explore the challenges we might face while dealing with decentralized organizations in their current state.

To examine the concept of a DAO we need to look at a tangible use case – Ethereum’s first-ever DAO, “the DAO”. Launched in 2016 and presented as a revolutionary project, it started with a token sale for future investors and quickly raised $150 million USD worth of ether (ETH), becoming one of the biggest high-profile projects on the Ethereum blockchain. Three months after its launch, the organization was hacked and $60 million USD worth of ether was stolen. As a result, to blacklist the attacker, Ethereum had to divide the blockchain into two parts: Ethereum Classic and Ethereum. Thus, the first-ever DAO has raised one of the major issues of the emerging technology – security.

Despite being perceived as more safe than fiat operations, the blockchain still leaves room for hacking, fraud, and laundering, mainly because there is no legal framework for blockchain-operated organizations. With a totally decentralized subject, which makes decisions through code, the concept of personal responsibility ceases to exist. However, DAOs could potentially benefit from having a clear protocol to solve legal challenges to gain ground in the physical world.

Some believe that a totally transparent system can save us from the problems stated above. At the same time, when dealing with personal data used in DAO’s smart contracts, it can bring forward bigger problems with security. Imagine everyone’s medical records being publicly available in the form of smart contracts on the ledger, for example. Because of poor coding, the information can potentially be obtained and used for questionable reasons. It’s shown in a study done by a few researchers in 2018, called “Finding The Greedy, Prodigal, and Suicidal Contracts at Scale”. By the results of the study, around one in twenty smart contracts is at risk for hacking.

The second example case is BuildFinance DAO, which got into a scandal in February 2022. In true democratic fashion, the DAO’s decisions were made by votes. Usage of the typical voting system for this type of organization, 1 token = 1 vote, created a situation in which one user collected enough governance tokens to have a majority, then manipulated the vote to gain full control of the DAO. After that, they began minting and selling the project's native token, draining the treasury of about $470,000, turning a decentralized idea into a perfectly centralized one. This situation brings us to the next problem – the lack of real democracy and the uneven spread of power.

So, the blockchain can be manipulated by a single user, going against the intentions of the project founders and most of its community. This process can be amplified to understand the bigger problem with crypto itself. Cryptocurrency was mostly decentralized back when it started, with the early adopters running operations via graphic cards in their houses. It took a few years for just a few mining pools to gain control over more than half of the network, which, by the 51% rule, means they almost own the network itself. This is how most systems tend to centralize as they scale. By the same principle, with the proof-of-stake mechanisms in the future, we can see DAOs becoming the same globalized companies they fought against.

Contrary to existing disadvantages, there must be a strong upside of using DAOs for organization management. The advantage usually used as an example is usability: the system may be relatively well-designed and available to the general masses, encouraging engagement and incorporating decision-making. However, a network can’t be 100% user-friendly and productive while maintaining strong security and relying on democracy. Thus, existing problems in the crypto community might actually exist to reinforce usability of the system.

Existing technological structures mostly operate on the decisions of those who designed them. Depending on the priorities of the creator, a system might suffer from various disadvantages and gain various benefits at the same time. That’s why many of the “bugs” we can notice in a technological object are actually deliberately placed features, designed for the benefit of certain groups. In the case of DAOs, existing gains and disadvantages may be presented as a trilemma, in which usability comes at the expense of security and democracy.

The concept of a decentralized autonomous organization seems like a libertarian dream, in which the government is deprived of any monetary policy and decision-making. However, decentralization in this case is tied to a plethora of problems, which may have been purposefully designed to be features, not bugs, so that some people could have more ability to benefit. Eventually, that manifests as a range of financial scandals in the real world. I believe that for the idea of DAO to work, we have to address those issues instead of trying to subvert the system while being subverted by it at the same time.