THE CONSTITUTION – THE CORNERSTONE OF GOVERNANCE
In our previous article, we concluded that governance – in the context of mostDAOs – is to enable democratic decision making over a common pool of assets by interested participants. If we agree that many DAOs can be described as a global association of often anonymous individuals which pursues a common purpose and is untethered to any one location and ideally, reliant on no one person – what are the rules by which this association operates?
These rules are enshrined in what is often referred to as a ‘constitution’. The constitution – be it of a nation state, a company or a DAO – contain the fundamental principles and rules which determine how decisions are to be made by individuals belonging to that association.
But the term ‘constitution’ as used in many DAOs is often somewhat of a misnomer. I have advised on the incorporation of several DAOs, analysed quite a number more and sat in the peanut gallery commenting on governance failures of even more.When DAO founders draft a ‘constitution’, it is sometimes simply a broad statement of the DAOs objects and principles. Some are better – and seek to enshrine a governance structure – often some sort of ‘Council’ – where initially appointed and then later democratically elected individuals maintain either operational or defensive oversight over the objectives and undertakings of the DAO.
It is the super minority which create a comprehensive ‘living’ document which is carefully crafted to further the objectives of the DAO – that is clear enough in its decision-making procedures yet provide sufficient flexibility for theDAO to evolve with the times. This is no easy task – and I do not profess to be the expert in what nation states still struggle with. But that doesn’t mean we shouldn’t strive for higher standards of governance – beginning with how DAO constitutions are drafted.
Through good drafting of a DAO’s constitution – I would aver that many DAO crises, often arising from ‘governance attacks’ can be averted. So what is good drafting? I find it helpful in these cases to refer to centuries of corporation and constitutional law in designing an appropriate constitution for a DAO.
Defining Voting Parameters
Perhaps the most apparent way in which a constitution can be drafted more carefully is in defining the voting parameters – not just for all decisions but for specific categories of decisions.
This is where DAO founders could do well learning from how company laws and shareholder agreements are drafted. It is incredibly primitive governance to allow a simple majority of token holders by value (often the preferred voting mechanism) to pass major proposals which concern core tenets or even the existence of the DAO.
Take for instance the opportunity to collapse a DAO and return the treasury to token holders pro rata. Far too many DAOs allow something like this with a simple majority in value – and founders become upset when the ‘RFV’ hunters start buying tokens in a DAO to vote through a dissolution. Conventional company law wisdom provides that a decision as integral at this cannot be carried out without a super majority of shareholders voting – with shareholder agreements often fixing such a decision as requiring a voting threshold of 75%or more.
Following conventional wisdom – perhaps a reasonable voting mechanism for different categories of decisions for a DAO could look like this.
The above is of course – simply an illustration and each DAO will have its own dynamics and categories of decisions which its founders deem to be weightier than others. Additionally, the draftsmen must be wary of introducing more uncertainty – if a constitution differentiates between ‘significant’ and ‘non-significant’ contract upgrades, there should be a mechanism for determining what constitutes a ‘significant’ and ‘non-significant’ upgrade!
Additionally, there should be certain decisions which are completely ultra vires(which is pretentious speak for ‘beyond the powers’ of the DAO). That is, decisions which simply cannot be passed or implemented.
To put it quite simply, if a person can transfer 100% of your DAO treasury to a single wallet by acquiring a majority vote, the criminal is not the activist tokenholder but the draftsman.
Governance Structure and Delegation of Authority
The other key issue for an aspiring DAO founder is to determine how and for what purposes can authority be delegated to one or more persons. As much as some participants might be direct democracy maximalists – the fact of the matter is that no organisation can function effectively if even the most basic of administrative or operational decisions have to be passed as a DAO resolution by democratic vote.
It is thus – integral that any well drafted constitution outlines the governance structure and controls how authority is delegated. Again borrowing from traditional corporate governance structures – most companies consist of a board of directors which is responsible for the day-to-day management of the company comprising of individuals who are voted into office by shareholders. Most DAOs model on this – and sensibly so.
However, it is often unclear if the DAO ‘Council’ – as such bodies are often called –fulfils an active role or a defensive role, and the scope of their powers and the extent of their responsibilities is often undefined. Does the Council have responsibility for day-to-day governance? If so – what decisions can they undertake on their own and what has to be put to the tokenholders for a vote?
If the Council is purely defensive and supervisory in nature, then who should be responsible for the day-to-day management of the DAO’s affairs?
These are all questions which should be clearly addressed within a DAO’s constitution and should be carefully drafted to ensure that there is sufficient control and oversight on the extent and exercise of delegated powers while still retaining enough flexibility and efficiency for day-to-day administration of the DAO.
The third issue that a constitution should address – one that could grind another wise successful DAO’s operations to a halt is perhaps an extension of the two issues we have discussed above. What happens if there is a deadlock in theDAO’s decision-making process?
Imagine you have a DAO with USD 100m in treasury and it has clear voting parameters and delegation of authority to a ‘Council’ which handles its day-to-day affairs.Now one day, the DAO finds itself in a position where it has to make a significant smart contract upgrade, without which the protocol which the DAO is in charge of running will no longer be effective. Per the voting parameters and delegation of authority, the tokenholders are to pass a DAO proposal with a 66%majority and 20% quorum, following which the Council will implement the upgrade.
Except a tokenholder puts out a proposal and the DAO fails to get the requisite quorum because for example, an active whale has entered into a bankruptcy process and another has lost his ledger. The DAO grinds to a stop. Now what?
A well drafted constitution should forestall an issue like this by having a well-drafted deadlock mechanism in place. This could take the form of lowering the threshold of future votes on the same issue, trigger a constitutional amendment with a lower voting threshold if certain conditions are met or delegating ‘emergency powers’ to a supervisory board. Although this would allow a DAO to avoid an existential crisis in the event of unforeseen externalities affecting the governance process, much care must again be given to the drafting of such a deadlock provision in order to avoid the deadlock mechanism itself manifesting as a weak link in the governance structure.
The cornerstone of a DAO is its constitution from which governance flows. A thoughtfully drafted constitution sets a DAO up for long-term success whilst a poorly drafted one sets it on the road to governance hell. Founders interested in the longevity of the DAOs they create should accord the constitution the same level of care and thought as they would in designing a DAOs tokenomics.
In our next article, we discuss DAO proposals and the best practices in drafting such proposals in order to ensure that efficient and transparent implementation of the will of the tokenholders.
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