Governance mining will bring a disruptive future: this is liquidity mining of human capital

Written by: Jacob Phillips, Researcher at Polychain Capital
Compiled by: Perry Wang

The idea struck me at 2 AM on Saturday while browsing the COMP forum. It turns out this is not a brand new idea. As far as I know, James Waugh first discussed proposal mining in June 2020, which laid the groundwork for the formal proposal of "governance mining" put forth by Fire Eyes DAO to Balancer in November 2020, but somehow this concept has been overlooked by many.

Governance mining could be a game-changing force; read this article and you'll understand why.

The idea is simple: DAOs need to get things done, but it's hard to motivate people to do those things, so similar to liquidity mining, DAOs should "mine" human capital to kickstart an active governance community.

Current State of DAOs

Understanding the current progress of DAO governance helps to grasp why we need "governance mining." DAOs across the entire crypto ecosystem are facing similar situations:

• Slow product development ------ From a product perspective, the party has just begun. The products that current DAOs are starting to build are at the V1 stage (some are more like V0.5). We know these protocols have not reached their final state. They need improvement, development, and growth to maintain long-term competitiveness. There are many blank areas where protocol regulators may encounter attacks, but very few have been addressed so far.
• Lack of leadership, poor coordination ------ We have seen the teams that built Compound and Uniswap step back, leaving the community to scramble for self-governance. Initially, this led both protocols to near stagnation. Given regulatory pressures, we are almost certain to see this trend continue. More broadly, the community is struggling to coordinate resources to get work done. Protocols rely on individuals who contribute during nights and weekends to lead development plans; very few choose to truly step up, and for those who do, governance work is rarely a priority.
• Organizational structure lacks scalability ------ DAOs should grow as their products are launched, but this has proven difficult in a decentralized environment. Many DAOs do not have a clear development team to serve the protocol. Even if a DAO has a development team, they may not have much else. There are too many sub-teams/positions that need to be filled. If a DAO is to achieve the operational standards of traditional unicorn companies, it cannot rely on distracted part-time contributors. They need full-time developers, product experts, strategic/business development experts, security/QA engineers, customer support staff, etc.
• Few incentives for contribution ------ Given the efficiency of DAOs and the value they unlock, they should be among the highest-earning institutions in the crypto industry, but the reality is quite the opposite; DAOs are stingy, fearing "wasting" money or paying compensation that seems too high compared to market rates, and are hesitant to take action on compensation. It is difficult to find structured full-time roles within a DAO. Most DAO work is compensated through small token stipends for part-time, one-off tasks. Salaries focus more on "work quantity" rather than "work value." As a result, the most capable individuals to solve DAO issues are rarely involved. Additionally, too many DAO contributors engage in relevant work without incentives, including community members contributing through forums, Discord, community calls, etc. These individuals add material value to the protocol but are not compensated for their labor. More broadly, the vast majority of knowledgeable individuals in the crypto space are not actively participating in DAOs. Governance work is very time-consuming, and its incentives often do not adequately compensate for this effort.
• Accumulation of substantial assets in the treasury and the need to distribute tokens ------ DAO treasuries often accumulate excessive assets. There is so much money in the treasury that DAOs sometimes don't even know how to spend it. They beg for someone to spend it for them. The most interesting part is that DAOs structurally need to spend these tokens to ensure that they do not end up with a situation where the team and early investors hold too high a concentration of tokens.

In summary, there is too much that DAOs can build, but no one steps up to lead teams and contribute because the incentives are weak or even non-existent. As a result, DAO product progress is slow, teams do not grow, and existing DAOs risk being replaced by faster-moving new teams. Meanwhile, protocols hold substantial funds that need to be spent.

Let’s break down the last point: protocols have large treasuries and "need" to distribute tokens. Teams typically retain about 20% (rarely exceeding 25%) of the token supply and allocate over 50% of the token supply to their own community. For decentralized protocols, broad token distribution is a mandatory option. Fully decentralized network ownership grants the protocol fundamental characteristics as an underlying decentralized protocol—such as security, neutrality, and community incentive alignment. However, this decentralization process often takes years, which is why we see a significant portion of the token supply residing in the treasury at the launch of the protocol, with the mechanism for accurately distributing tokens over time remaining "to be determined/TBD." This is an area where the community can unleash its creativity. When considering how to achieve decentralized network ownership, the community can use the distribution of its native tokens to cold-start the protocol.

You can imagine that we might want to implement incentives in multiple different areas within the protocol, but currently, liquidity is effectively the only area prioritized. As we have seen, liquidity mining can be a very powerful mechanism, but it is clearly not a panacea for ensuring the success of the protocol. Currently, liquidity mining programs that should allocate tokens to "users" of the protocol have effectively become tools for crypto funds and proprietary trading firms to arbitrage, with the latter two locking in substantial profits through yield farming and token sell-offs. Liquidity is self-bootstrapping, but the community is not.

Compound distributes nearly $1 million in COMP to liquidity providers (LPs) daily, yet making simple and/or necessary improvements to the protocol is a struggle. Liquidity mining has brought short-term success to DAOs, but it is not essential for long-term success. Something is missing here…

Solution: Governance Mining

The importance of protocol governance is systematically underestimated. If you ask experienced developers or investors about the biggest determinants of long-term success for early projects, over 90% will say "the quality of the team." In crypto protocols, the governance community is the "team," so if we want to optimize for long-term success, we should prioritize developing our decentralized team. Issues like "too slow to act," "not evolving quickly enough," and "being outpaced by another protocol" will become the main causes of death for crypto protocols in the coming years—all synonymous with "poor governance."

For DAOs that are gradually decentralizing, incentivizing community contributors is almost certainly the most important form of expenditure. Therefore, DAOs should not only focus on liquidity mining but also on mining for contributors, human capital, and broader governance activities—collectively referred to as: governance mining.

Abstractly summarizing, governance mining works as follows: the protocol commits to allocating a portion of the token supply to governance contributors over a period of time. The distribution of tokens is tied to the quantity of contributions made by each group/individual, weighted by the value of the results of their contributions. The more valuable the contribution, the more rewards the contributor receives. The "value" of contributions will be continuously updated over time to reflect changes in their impact, allowing contributions to have some "preliminary" value that can then be rewarded based on their outcomes, enabling contributors to profit from the long-term value of their work.

"Contributions" can mean any action that adds value to governance (undeniably, the criteria for this judgment are subjective), including but not limited to: highlighting key issues, suggesting and/or implementing protocol improvements, conducting theoretical refinement, and/or designing new products or new versions of the protocol, recommending candidates for vacant positions, providing thoughtful comments on forum posts, conducting technical investigations on proposals, hosting or participating in community calls, etc.

The potential impact of governance mining could be limitless. Imagine the following scenario:

Fast forward to 2023, governance mining is all the rage. A hot new protocol launches, and countless gamblers are all in—but this time, they are betting on governance thinking rather than liquidity. Once the hot protocol is launched, all the best crypto funds, governance mining proprietary firms, and independent contributors rush to "contribute" in various ways, each leveraging their expertise to add value, hoping to earn a share of the token supply. The governance capabilities of the protocol will develop at an astonishing pace—within months, the protocol will have multiple full-time contributors focusing on different needs of the protocol, with almost all existing pain points and technical debts identified and resolved (or solutions birthed), and multiple new products in development, etc.

If governance mining works well (realizing the vision of the previous paragraph), it will yield a series of outstanding outcomes:

• Turbocharging decentralized governance ------ Decentralization is often synonymous with slowing down, but through governance mining, we can actually speed things up. Imagine if governance contributors received substantial airdrops (think five-figure+) every time they helped resolve a governance issue; this would drive people to strive for outstanding contributions to accelerate protocol governance to achieve contributions that generate sufficient impact and returns. When people realize they can get rich working for a DAO, governance work will become a priority. By applying free market economics to the human capital of DAOs, people will fear missing out (FOMO) and rush to capture value, solve problems, and improve the protocol.
• Rapid formation of governance teams ------ The vast majority of full-time DAO contributors start as part-time contributors, so by creating meaningful incentives for people's participation, DAOs can build a deep talent pool to recruit full-time staff. Governance incentives will attract intellectual contributions from developers, product designers, protocol strategists, etc., and help place skilled/expert individuals in specific roles within the DAO to form teams and pod structures early in the network's lifecycle.
• Intelligent distribution of governance tokens ------ Tokens are allocated to those who add the most value to the protocol, rather than those with the most capital. Therefore, large capital pools will no longer have a substantial advantage over independent contributors. The community of active contributors can be said to be the best group to hold governance tokens and the most likely to become long-term active holders.
• Extracting long-term value for the protocol from mining ------ Liquidity contributions are often neither durable nor loyal, but governance contributions have lasting impacts because they lead to permanent protocol improvements that drive sustainable long-term growth. Additionally, human capital may be stickier than liquidity, allowing protocols to lock in some resources attracted by governance mining programs.

Governance Mining in Practice and Associated Challenges

In reality, we have already seen some form of governance mining introduced in Balancer, Index Coop, MakerDAO, Friends with Benefits, and several other protocols. However, so far, the success of these initiatives seems very limited. There are several reasons for this:

1. Insignificant incentives ------ A few thousand dollars in incentive programs will not change contributor behavior; we should invest millions of dollars in governance contributors.

2. Weak heuristics ------ The token distribution we see in governance mining seems to prioritize protocol scalability and decentralization over the accuracy of token allocation, making them good at rewarding long-tail contributions but poor at adequately compensating the most impactful contributors. In contrast, the accuracy of earlier, more centralized distribution mechanisms was better.

3. Insufficient iteration and experimentation in this category ------ This needs to be viewed as a core focus for community leaders and requires reinforcing feedback loops. Governance mining offers a lot of promise, but it takes time and effort to refine.

Based on the existing issues discussed above and extending to potential new issues that may arise, here are some key challenges in the design of governance mining mechanisms:

• Assessing governance participation and creating accurate and scalable heuristics is very challenging ------ Filtering through hundreds of forum posts, hours of community calls, etc., to determine who contributed, how much they contributed, and the impact generated will be very difficult. In the medium to short term, it is unlikely that there will be sufficiently good algorithms to automate this process.
• Assessing the "value" of contributions is inherently subjective ------ One key aspect is the ability for "value" to accumulate over time (suggestions for improvement, if the protocol achieves significant growth from it, then a portion of the created value is collected). While some economics can be strictly defined (e.g., how Yearn incentivizes strategists), much of the other economics may need to be manually defined through human input, which will inevitably become messy.
• "Mining" contributions may dilute the quality of governance activities ------ As it stands, governance is already difficult to fully track. If we start pouring significant funds into governance mining, related activities may increase tenfold, but not all activities will yield results. People may try to flood the system with a lot of junk governance proposals in an attempt to fish for tokens.
• Money may only be part of the solution ------ Protocols have long touted that they will pay meaningful rewards for valuable contributions, even attempting methods such as bounty announcements for products priced above market rates, but few contributors participate. While governance mining focuses on governance incentives, it may also need to address other structural and social issues simultaneously.

Governance Mining Mechanism Design

Here is a simple version 1.0 of what a governance mining mechanism might look like. However, to be honest, this model will start off centralized and may not be particularly scalable, but it could be the safest way to ensure good outcomes early on. Of course, this model can evolve over time.

Version 1.0 Governance Mining

1. Organize a small group of 3-5 people from the community to manage the token distribution in governance mining (perhaps a larger advisory committee is needed). Have this team clarify the priorities and heuristics for token allocation.
2. Set aside a small but sufficient percentage of the token supply to be mined over a period (e.g., 6 months). Ensure it is large enough to attract the best individuals/groups (those with high opportunity costs) and set the right tone for governance value in this network. Create upper and lower limits for the number of tokens to be allocated based on the results achieved during that time period, providing potential contributors with some basic guarantees and sufficient upside if their actions have a significant impact.
3. At a regular increment (possibly monthly), review governance contributions and allocate tokens based on the value of the contributions (which may have some unlocking period restrictions). Incentivize long-term participation by increasing rewards for regular contributors. Maintain a complete historical record of governance contributions to be able to trace and update their value.
4. At the end of the term, evaluate the results, modify priorities and allocation logic, and restart the mining project. This must be an iterative process.

This model looks quite different from existing contributor funding programs: it resembles a gamified stipend program that can freely reward governance participation. The main difference here is that governance mining actively commits to distributing a substantial amount of tokens to contributors—creating a clear incentive that cannot be ignored.

As mentioned earlier, the most challenging part seems to be assessing the value of contributions. In the short term, this will inevitably be very subjective and will largely require qualitative assessments. Over time, we will be able to design a quantification-driven governance mining allocation mechanism that creates higher efficiency and reduces subjectivity compared to the simple version 1.0 model discussed above.

Teams have already been working on this front—since 2018, SourceCred has been improving a PageRank-like algorithm to allocate contributor rewards, while Coordinape was born earlier this year from Yearn DAO, using a decentralized voting mechanism to crowdsource the evaluation of who is contributing in the community. These tools aim to create an automated reward distribution process that allows DAOs to scale rewards to all types of contributors.

In practice, there is currently no perfect model. Different heuristics have varying strengths and weaknesses in rewarding different categories of contributors; therefore, a layered distribution mechanism may make sense to avoid over-reliance on any single heuristic (e.g., using centralized committees, Coordinape, and SourceCred mechanisms simultaneously, each with different weights).

Another important consideration: timing. The earlier governance mining occurs, the greater its potential impact. The most influential contributors will be those who serve as governance leaders for a long time to achieve results for the project, and this type of contributor will need significant rewards to justify the level of investment. Early (pre-deployment; pre-token issuance/project low market cap) projects will offer contributors less existing value and more future value (token appreciation), attracting fewer builders with long-term beliefs in specific projects. Later projects (post-deployment; high market cap), where most of the value has already been realized, have more present value to distribute but less future value, attracting more contributors, but fewer of them will engage long-term. However, the outcomes of later governance mining have less variability. If a project invests a significant amount of cash, it is inevitable that people will get involved, but if a project primarily offers future upside potential (value-uncertain network ownership), more persuasion will be needed to get contributors engaged.

Additionally, just as liquidity mining works best when the fundamental usage dynamics are strong, governance mining serves best as a catalyst for community governance when the community has naturally formed and made progress before crazy incentives are introduced. If the governance community currently lacks organization or contributors (e.g., very few native leaders or no work to be done), governance mining may attract temporary thought-sharing, but without the right leadership and structure, its chances of retaining talent are greatly diminished.

Reflections

The core idea underpinning "governance mining" is that protocols do not place enough emphasis on governance. The community is willing to spend six to seven figures (!!!) daily on liquidity incentives but is shocked when trying to pay contributors a sufficient amount. If we truly value the contributions of those working to improve and advance the protocols we hold tokens in—it's time to put our money where our mouth is.

The operating principle of governance mining is that to attract and retain the best contributors, it is best to pay more in the short term. According to economic principles, governance mining programs (and prevailing contributor compensation programs) are likely to increase the value of the protocol.

Suppose you have a network worth $1 billion, providing 2.5% of the token supply for governance mining in the first year—this means there are rewards of up to $25 million up for grabs. This could mean 25 contributors each taking home $1 million, or 100 contributors each earning $250,000. If the total contributions of those funded by the $25 million governance mining program only increase the network value by 2.5%, the program can break even. In practice, this could mean that even if there is only one governance program investing a significant amount of money, it becomes worthwhile. With so many contributors and so many incentives, we are more likely to see governance mining programs significantly increase network value over the long term.

DeFi found product-market fit in early 2020 and experienced parabolic growth after introducing liquidity mining mechanisms. In 2021, DAOs are searching for product-market fit; now is the time to pour gasoline on the fire, significantly increasing user interest and engagement, and elevating DAOs to a new level. Compound and Uniswap are two key examples of protocols that could benefit from governance mining programs. Emerging protocols about to launch tokens should explore such new initiatives to guide governance communities. Who knows, we might see a new wave of community-driven projects centered around governance mining (if we haven't already). Whatever happens, the game still belongs to experimentation—more attempts will emerge in the future.

Thanks to friends and colleagues who provided insights or feedback on this article: Fire Eyes DAO (esp. James, Cooper), members of the COMP governance team (e.g., Getty, Alex), Reverie (Larry, Derek), GenZ DAO (especially Zach, Mene, Brian, Kaito), Amphiboly, the Polychain team (especially Eli, Niraj), and many others.

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