4. An Introduction to DeFi
DAOs and Governance
Since the goal of DeFi is to maintain as much decentralization as possible to avoid any one person or group having control, the governance of DeFi protocols reflects that belief. Decentralized governance is meant to create a collective decision making process, where everyone that’s involved in a project can get a say about which direction it should go in. This ensures that a protocol will continue to reflect the values of its users and developers as it grows.
Decentralized Autonomous Organizations, or DAOs, are set up to be an effective system of offering decentralized governance over a protocol. They operate fully on-chain, with all actions revolving around governance being done through smart contracts that do not require any third party interaction.
The goal of a DAO is always to continuously improve the protocol by applying any improvements necessary. These improvements are proposed to and voted on by the community and include items such as bug fixes, treasury allocation, new feature implementation, and any other items that a DeFi protocol may need.
Source: ChatGPT
As already discussed with Aave and Pendle, most DAOs operate with a token governance system, where members hold the protocol’s token and use it as voting power to suggest and vote on improvement proposals. Different projects have different rules regarding voting power and token allocation, so it’s important to know the rules of a DAO when becoming a member. Voting is always done on-chain to ensure fair practice, since votes are calculated by a smart contract that can’t be manipulated due to its transparency - if a protocol created a rigged smart contract for counting votes, members would be able to audit the contract themselves on-chain and call out the protocol.
The main business benefit of a DAO is its fluidity; it allows for much faster decision making and actions to occur since there are far less bureaucratic delays. Traditional businesses often have multiple layers of management that need to sign off on any action, whereas a DAO can put out a proposal at anytime and have its members all vote on it.
This also gives the DAO a much more diverse input, since it’s not just a small group at the top of the business making decisions but rather the entire group itself. Anyone can suggest improvements to make the DAO more streamlined and efficient, since no one will know issues better than the developers who building the product and its users who interact with it.
Voting and quick decision making lets DAOs remain competitive in the market and pivot at any point to better respond to market demands.
Because of this fair system of governance, DAOs offer unparalleled community engagement that most businesses lack. While a traditional business may have a small percentage of truly devoted customers, a DAO will generally have a much higher percentage of devoted users because those users have a direct say in the governance of the protocol and can therefore propose and vote on improvements that will benefit them.
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