Why DAOs Fail – Masternodes.buzz

Decentralized autonomous organizations, aka DAOs, appear to be the hottest kid in the crypto space. But a lot like the ICO era of late 2017, many of these organizations are already a shadow of themselves.

DAOs represent a new model of internet-native entities collectively owned and governed by participants. However, many DAOs end up stagnating or collapsing entirely after the initial hype. In this article, we will explore some of the root causes behind DAO failures and draw some lessons on how to structure more enduring and successful organizations.

But first, DAOs in Brief…

DAOs are communities coordinated through decentralized governance typically built on blockchain technology. Some key attributes:

DAOs issue governance tokens that give holders voting power over decisions.
Rules and automation are structured transparently on a blockchain through smart contracts.
Major choices are made through member proposals and majority votes rather than top-down hierarchies.
Operations, incentives, and funding are directed democratically by engaged participants.

When well-structured, DAOs offer a new paradigm for decentralized yet effective collaboration and resource management.

So, Why Do DAOs Fail?

There are a number of reasons why DAOs fail. Some of these include:

Lack of Strong Shared Purpose

Without a compelling mission that motivates and aligns members, interest fades over time. To prove this point, think of the top five decentralized organizations that made headlines nearly a year ago. How many of them are still very much active? While they may still be functional, most of the initial hype has died down.
DAOs without concrete goals or outputs struggle to coordinate members productively.

Poor Token Economic Design

Tokens unrelated to tangible utility fail to gain sustained value and engagement. You’d have to agree that this is the case for many DAOs – NFTs and tokens that have no real worth.
Mismatched incentive designs enable profit-seeking rather than collective action.

Unbalanced Stakeholder Incentives

Failing to reward all key roles like contributors, governance participants, and core developers through appropriate incentives. In most cases, whale holders and executive members have all the power, leaving retail players uninterested.

Inadequate Funding Mechanisms

Undercapitalization prevents the DAO from funding impactful initiatives long-term. In addition to undercapitalization, the treasury of many DAOs is stored in their native token, which is often worthless. With the ongoing crypto winter, many DAOs have been forced to close shop.
Overreliance on volatile external revenue like donations without stable internal capital flows.

Low Barriers to Exit

Lack of vesting periods and cliffing enables short-term opportunists rather than committed members.
When participation is easy to exit, engagement languishes through apathy and attrition.

Poor Technical Execution

Buggy smart contracts, failed integrations, scaling limitations, and weak security practices result in the loss of assets or capabilities.
Inadequate auditing and testing fail to identify weaknesses.

Legal and Regulatory Noncompliance

Failure to understand and adhere to relevant regulations opens legal liabilities and existential regulatory risks.

Thoughtfully structuring purpose, incentives, funding, technology, and compliance is key to a sustainable DAO lifespan.

Symptoms of DAO Decline

Some common symptoms associated with stagnating or failing DAOs:

Declining proposal volume as members stop actively participating.
Treasury funds slowly depleting without sufficient revenue and contributions to replenish.
Key contributors like developers drifting away to pursue other projects.
Liquid governance tokens consistently trading at a heavy discount to raise price.
Discussions filling with complaints rather than constructive solutions.
Leadership voids with a lack of accountability are left unaddressed.
Members resentfully referring to the DAO solely for speculative profit-seeking.
Public disputes and infighting rather than healthy debate and cohesion.

Intervening to correct course before issues escalate can help prevent collapse.

Case Study: The DAO Hack

One of the most famous DAO failures was The DAO hack in 2016. The DAO was a pioneer DAO built on Ethereum that reached over $150 million in crowdfunded assets. However, hackers exploited vulnerabilities in The DAO’s code to siphon $50 million of assets into their control. The failure highlighted dangers like:

Rushing complex smart contract development without adequate auditing.
Not designing proper access controls and accounting validations.
Lacking emergency controls and freezes to contain issues.
Having no recourse after contracts were deployed live with issues.

The debacle triggered years of research into best practices and standards for smart contract development and security. Costly lessons about prudent engineering were learned.

Avoiding DAO Stagnation

To sustain an engaging, lively DAO, experts suggest:

Establish working groups and councils to involve members beyond just voting.
Facilitate social interaction and community building to strengthen relationships.
Monitor metrics like proposal volume to catch declining activity early.
Plan initiatives on a roadmap to maintain momentum through execution stages.
Incentivize high-quality proposals with grants and recognition.
Phase participation privileges to elevate engaged members to greater responsibilities.
Advertise opportunities and ideas to stimulate participation across channels.

An active, energized community comes from thoughtful engagement nurturing.

Righting Declining DAOs

Some turnaround measures for struggling DAOs include:

Pause underperforming programs siphoning funds to reassess alignment with goals.
Consolidate activity to high-impact projects rather than spread efforts thin.
Evaluate all incentives and eliminate those encouraging rent-seeking over value creation.
Institute vesting and cliffing on token rewards to align member time horizons.
Buy back and reduce token supply if it has substantially outpaced real usage and activity.
Replace indifferent leadership with elected representatives committed to restoring the DAO.
Rally community spirit by reconnecting to founding purposes and principles.

With proper corrective measures, struggling DAOs can regain member engagement and purpose.

Decommissioning Defunct DAOs

If turnaround seems hopeless, options exist for properly sunsetting a DAO:

Make a governance proposal to formally shut down and distribute the remaining assets.
Liquidate any treasury assets and holdings into base cryptocurrency.
Calculate member shares proportional to token holdings and distribute.
Transfer any assigned roles and infrastructure like domains to caretakers.
Freeze and shut down smart contracts to reduce attack surfaces.
Publicly document learnings and analysis to benefit future projects.

Following an orderly wind down process avoids abandoning the DAO into neglect.

Conclusion

Sustaining a thriving DAO long-term rests on thoughtful community design, incentives, technology, and execution. Failure to properly structure these foundationals opens risks of stagnation, decline, and collapse over time as member energy fades. But lessons from struggling DAOs offer guideposts on patterns to avoid and best practices to implement. With careful planning and adaptable governance, DAOs can evolve into lasting organizations and communities far into the future.