Chainalysis: DAOs are not as decentralized as they seem

Written by: Chainalysis

Compiled by: Aididiao

Decentralized Autonomous Organizations (DAOs) are the primary organizational operating model in the Web3 era. DAOs, based on internet and blockchain technology, provide a unique democratic management structure for businesses, projects, and communities, where any member can participate in governance by purchasing governance tokens to vote on decisions.

The way DAOs work can be summarized as follows:

1. DAO founders create governance tokens;
2. Governance tokens are distributed to users, supporters, and other stakeholders;
3. Each governance token corresponds to a certain number of voting rights, and governance tokens can be bought and sold on secondary markets.

Although this process is considered a form of decentralization, data indicates that DAO ownership is highly centralized.

Degree of Centralization of Governance Tokens

By analyzing the distribution of governance tokens across ten DAOs, we found that in several major DAOs, less than 1% of holders own 90% of the voting rights.

Proportion of users holding 90% of governance tokens in DAOs

The highly concentrated distribution of governance tokens significantly impacts DAO governance; if only a small portion of the top 1% of holders initiate a vote, theoretically, their decision-making power will exceed that of the remaining 99%. Small investors may be unable to make meaningful contributions to the proposal process.

Impact of High Concentration on DAO Governance

For governance token holders, there are three key governance steps. Voting is straightforward, and any holder can do it, but creating proposals and having proposals passed is not something all holders can do.

According to the proposal requirements of these ten DAOs, we found that:

1. Users must hold 0.1% to 1% of the token supply to create a proposal.
2. Users must hold 1% to 4% of the token supply for a proposal to pass.

By this standard, we found that among the holders of these ten DAOs, only one in a thousand to one in ten thousand have enough tokens to create a proposal.

Number and proportion of holders able to create proposals in DAOs

If too many holders can create proposals, the average quality of proposals may decline, and the DAO may be filled with governance spam. However, if too few people can create proposals, community members may question the authenticity of "decentralized governance."

When it comes to individuals creating proposals, it is reasonable that one in ten thousand to one in three thousand holders have enough tokens to do so.

Excessively concentrated voting power may lead to a decision-making process that contradicts the decentralized principles of building Web3.

For example, in June of this year, the DAO managing the Solana-based lending protocol Solend faced an issue: if the price of Sol dropped further, the largest whale user of the protocol would face a margin call, potentially leading to Solend becoming insolvent, with approximately $20 million worth of Sol tokens being sold off, resulting in a price crash and severely impacting the entire Solana ecosystem. The DAO called for a vote to control the whale user's account, hoping to liquidate their position through OTC trading rather than on the open market.

The proposal easily passed, with over 1.1 million "Yes" votes against 30,000 "No" votes. However, over 1 million of those votes came from a single user holding a large amount of governance tokens. Without the votes of ordinary participants, the proposal would have failed due to a participation rate of less than 1%.

This situation sparked strong opposition from the cryptocurrency community, with many questioning the platform's claim of being decentralized while serving the interests of a few and controlling users' funds against their will. Although the Solend DAO later voted again to reject the proposal, the question of whether a DAO can act in the best collective interest of all participants arises when a small number of holders control a very large share of governance tokens.

How Are DAOs Governed?

Different DAOs have very different actual governance processes. Here, we illustrate with real cases, starting with Uniswap.

Example: Uniswap Governance

Anyone holding Uniswap governance tokens (UNI) is a member of the DAO. They can participate in governance by using their own address or delegating their voting rights to another address, publicly sharing their suggestions or submitting their own proposals. Proposal topics vary widely, such as whether to fund a donation program; whether to integrate a new blockchain; and whether to lower the threshold for submitting governance proposals.

Before submitting an appropriate proposal, two preliminary stages must be passed: willingness check and consensus check.

1. The willingness check clarifies whether the community has sufficient desire to change the status quo. The deadline is two days, with a threshold of 25,000 UNI in favor.
2. The consensus check establishes formal discussions around potential proposals. The deadline is five days, with a threshold of 50,000 UNI in favor.

If both checks are passed, a vote can be held on the official governance proposal. Then, there will be a 7-day deliberation period during which community members can discuss the merits of the proposal on the governance forum. After the deliberation period ends, if there are at least 40 million votes in favor and the opposing votes are in the minority, the proposal passes and will be enacted within the following two days.

Example: Dream DAO Governance

Not all DAOs have the same governance process as Uniswap, but most operate on similar foundations, such as the Snapshot voting system and Discord chat servers. Dream DAO is no exception, although its vision and governance process are unique.

Dream DAO was created by the 501(c)(3) charity Civics Unplugged, aiming to provide training, funding, and community for Gen Z worldwide, helping them use Web3 to change some past habits and mindsets to adapt to the future.

SkywalkerZ holders operate the DAO community, where SkywalkerZ NFTs serve both as governance tokens and fundraising incentives for those who contribute to the program. When donors purchase SkywalkerZ NFTs, they can transfer voting rights to future Gen Z youth, who can gain voting rights in the DAO without purchasing NFTs. NFT purchasers can apply to join the DAO and become voting members, or they can leave it to the Gen Z students they sponsor; in either case, the NFTs belong to the purchasers.

By gifting NFT voting rights, financial barriers to Gen Z's participation in the DAO governance process can be eliminated, allowing them to immerse themselves in Web3 and actively use blockchain technology.

Where Are DAOs Most Common and Well-Funded?

DAOs are set to become an important organizational operating model for Web3, managing:

• DeFi protocols: such as Uniswap ($UNI) and Sushi ($SUSHI).
• Social clubs: such as Friends With Benefits ($FWB) and Bored Ape Yacht Club ($APE).
• Funding organizations: such as Gitcoin ($GTC) and Seed Club ($CLUB).
• Gaming guilds: such as Good Games Guild ($GGG) and Yield Guild Games ($YGG).
• NFT generators: Nouns (1 NFT = 1 vote).
• Venture capital funds: such as MetaCartel and Orange DAO.
• Charities: such as Big Green DAO and DreamDAO (1 SkywalkerZ = 1 vote).
• Blockchain games: such as Decentraland ($MANA) and Sandbox ($SAND).
• And more.

However, in terms of user numbers and funding scale, DeFi-type DAOs account for 83% of the total treasury value of all DAOs and 33% of the total number of DAOs, holding a significant lead.

Asset proportion and number proportion of various DAOs

DAOs focused on venture capital, infrastructure, and NFTs also hold a significant share, indicating that DAOs are attractive to investors, developers, and artists. However, their on-chain asset values are relatively small.

The boundaries between different types of DAOs are blurred. Gaming DAOs are often related to NFTs, venture capital fund DAOs typically fund DeFi, and infrastructure DAOs support all of the above categories.

Asset Management: What Assets Do DAOs Hold?

Although the types and scales of DAOs vary, most on-chain treasuries hold similar cryptocurrencies. The most commonly held cryptocurrency is the stablecoin USDC; among the 197 DAOs analyzed, over half hold USDC stablecoin.

Most commonly held cryptocurrencies by DAOs

Stablecoins held by DAO treasuries rarely account for the majority of treasury value, averaging only 23% of assets being stablecoins. In the DAOs we studied, 85% of DAO treasuries consist of a single asset.

Distribution of the number of DAOs with different proportions of stablecoins in their treasuries

The volatility of on-chain treasury values is roughly similar to that of Bitcoin. Assuming the assets currently held by DAOs are their historical portfolios over the past year, we found that:

• DAOs with assets exceeding $1 million have an average annualized volatility of 82%, while Bitcoin's is 69%.
• DAOs with assets exceeding $1 million had an average maximum drawdown of 51% over the past year, while Bitcoin's drawdown was 72%.

The value of DAO treasuries is also closely related to Bitcoin price trends. 38% of on-chain DAO treasuries have a correlation with Bitcoin between 0.5 and 1.0.

Correlation distribution between DAO treasuries and BTC prices

One of the most interesting areas of fund management for smaller DAOs is mergers and acquisitions (M&A). M&A allows DAOs to enter other related fields without needing to develop internal tools. As the DAO model matures, DAO acquisitions will become more common.

So far, the financial tools and related legal regulations available to DAOs are quite limited. For example, very few DAOs use loans or credit, possibly due to their uncertain legal status. As the DAO model matures, we may see more standardized regulations, management strategies, and practical outcomes.

Who Contributes to DAOs?

While we have not collected statistics on DAO participants, we can glean some information about DAO contributors through on-chain data.

Token smart contracts = project-specific ERC-20 or Layer 1 token contracts

As expected, DAO participants are advanced users of cryptocurrency services. Only 17.9% of DAO treasury funds come from centralized services, while the remaining 82.1% come from decentralized services. This indicates that most DAO contributors also use DeFi platforms to host their cryptocurrencies.

The Future of DAOs

As DAOs continue to evolve, specialized tools and teams to help DAOs grow and govern have emerged. Superdao simplifies the creation of DAOs; Snapshot simplifies governance; Coin Center advocates for the development of DAOs in Congress. We look forward to what DAOs can achieve in the future, what they will become, and to what extent they will realize decentralization.