Weekly Gauge #39 : Governance Wars and Regulation, Part 1
Weekly Gauge #39 : Governance Wars and Regulation, Part 1
The emergence of DeFi and the widespread adoption of cryptocurrencies have disrupted traditional financial systems and challenged existing regulatory frameworks. The decentralized nature of DeFi protocols, the pseudonymity (and sometimes even privacy) of cryptocurrencies and the functioning of the different applications will require a paradigm shift to get an adapted regulatory landscape, with legal and philosophical questions surrounding the governance of these markets.
On the one hand, proponents of DeFi argue that on-chain governance is necessary to preserve its privacy and protect the sovereignty of its participants. On the other hand, critics argue that DeFi governance is prone to manipulation and plutocracy and that regulation is necessary to protect retails from insiders and greedy market makers.
This article seeks to explore the philosophical discourse and social considerations surrounding DeFi governance wars.
In general, whales or entities holding a significant amount of any cryptocurrency, play a critical role in the governance of the underlying DAO or protocol. These actors often have high stakes and a substantial economic interest in the success or failure of specific protocols.
Whales are often early adopters of DeFi protocols which can confer significant advantages in governance, moreover, they generally have a better understanding of the protocol's strengths and weaknesses, giving them an advantage in shaping governance structures.
Two recent events support the theory that the classical model of DeFi governance, granting each token a vote without conditions of commitment and alignment with the protocol, is subject to a strong centralization of executive power.
Following the misalignment of interests between the management team and ROOK governance token holders, the community raised itself and proposed the dissolution of the DAO and the distribution of the treasury funds as an RFV of the ROOK token.
Note that several comments of the Discourse draft for the DAO dissolution proposal highlights the potential legal concerns behind such action. Indeed, part of the community explains their willingness to go through a more consensual solution; given the risk that such a dissolution raises regarding the securities regulation in the U.S., while others consider that it is necessary to assume such a risk in the sector in which we operate.
An order of magnitude above, the first proposal of Arbitrum DAO using its freshly launched $ARB token also turned out in an unfortunate sequence of miscommunication.
Some community members are saying that the vote is worthless if Arbitrum decides what happens to ARB and executes it before a vote. Arbitrum's response was that AIP-1 was a ratification, not a proposal. A presentation [to the community] of what was already decided in tokenomics.
The vote escrowed tokenomics incentivize participation in governance by giving committed holders the control over a native token’s emissions. On top of that, it opened the process of voting to a whole new level of composability, resulting in new types of interactions between retail users and protocols such as voting incentives.
Note that, since the qualification and legal categorization of DeFi markets relies also on the interpretation of the textual expression of the nature of the processes and interactions that take place within a protocol, thanks to the products and services it makes available in an open source manner, it is then essential to describe it with an appropriate vocabulary. In the same way that liquidity protocols such as AAVE are clumsily qualified as lending markets, the use of the word "bribe" should be reconsidered when talking about vote escrowed incentives.
While this model has proven effective in increasing participation compared to classic DeFi governance, it raises questions about the legal sustainability of governance wars. As DeFi and crypto markets become more mainstream, policymakers may look to regulate these markets more closely, potentially limiting the use of governance markets and other incentivization models.
The second part of this article, which will be released next week, will take the form of an interview with H.B, the legal man of Paladin and Adan - the leading European professional crypto association-, a notable figure in the DeFi regulatory landscape who will help us to better understand the outstanding issues as well as the short and medium term perspectives of governance wars regulation.
