Almost everyone involved in Ethereum is familiar with the dark experiment of MolochDAO. Named by a post by Scott Alexander on his blog SlateStarCodex, MolochDAO is a novel way to provide funding to the Ethereum ecosystem. Its organizational structure is derived from the neoreactionary idea of “All Exit, No Voice” with only two mechanisms for token holders: voting to issue new tokens, and the continuous option to exit, destroying the token holders’ equity in exchange for their percentage of MolochDAO’s capital stock.
Ethereum has suffered from the deep funding woes all too familiar to followers of the open source ecosystem (Red Hat, anyone?). MolochDAO has helped somewhat alleviate the problems. While its first grant was only for $3000, today it has distributed over $120,000 to 17 projects and has a current guild bank of almost $1m. Given its success, what can blockchain investors, founders, and outsiders learn from the MolochDAO experiment?
MolochDAO was just launched in February of 2019. In the space of 8 months, the treasury went from $0 to $1m. Most startups would struggle to raise so much capital on just a highly experimental organizational structure. MolochDAO’s success shows that in the current global low interest environment, many investors are looking for high growth opportunities to deploy their capital. Projects that combine simplicity with innovation and a massive upside can quickly scale, despite the overall cryptocurrency bear market.
Blockchain founders and early stage investors should take note. Be bold with the types of projects you are willing to start. Don’t hold back, be innovative, and don’t be afraid to be a little bit crazy.
Traditionally, organizations tend to think of manager’s exits in terms of risks instead of opportunities. Traditional corporate organizations invest substantial funds into contingency plans in case their executives are injured, retire, or otherwise unable to continue their duties. Transition planning for CEOs has its own field of study within business management with empirically based research on what works and what doesn’t.
MolochDAO opened up a new way to think about exit. Instead of exit as a liability, exit is a mechanism to maintain a highly collaborative environment. While for MolochDAO the mechanism is quite blunt, more sophisticated systems, like in the SwiftDao standard, can use simple but effective rules to not just maintain but improve an organization’s cooperation through exit. In the case of SwiftDao, inactive members automatically get their percentage of the capital returned or auctioned to the highest bidder, whichever is a better return for the member. Not only does this “exit as feature” improve coordination by removing freeloaders who don’t contribute, it also prevents SwftDao tokens from qualifying as securities under US law, meaning fewer organizational costs.
In your own research and blockchain projects, think about how you can use exit as a feature rather than a liability. With the success of MolochDAO’s new approach, the powerful organizations of the future will likely be built around pro-exit functionality as older organizations which treat exit as a liability are outcompeted and eliminated from the market.
Many blockchain project founders, including MolochDAO’s, overlook the cost of locking up capital. For traditional organizations, unused capital is allocated to money market funds and other low risk investments. For most traditional organizations, $1m of capital could earn the organization upwards of $50,000 a year if it was invested instead of locked up. Locking up capital in this way is an opportunity cost. Opportunity costs are real costs that result from not taking the strongest alternative. Put simply, of two firms, one of which earns interest on its liquid capital and one that does not, the one that invests will outcompete the other.
For MolochDAO, the cost of capital is even higher. Investors in high-risk, high-growth projects expect a high return for their investment. Calculating the exact cost of MolochDAO is difficult but for other high-risk investments the cost of capital can range from 10-20%. The guild funds are thus a massive inefficiency. While MolochDAO promotes itself as lower in operational costs, the cost of locked up expensive capital easily outweighs the organization expenses as, depending on how it is measure, the cost from capital inefficiency might be as much as $200,000 just for 2019.
Blockchain projects must consider cost of capital when designing their organizations. DAOs should be designs to be as capital efficient as possible. MolochDAO clearly showed that capital costs can easily outweigh other benefits of poorly designed DAOs. Of course, in the case of MolochDAO, the goal was to create a functioning experiment not a perfectly designed system. It is a valuable experiment with many excellent features but locking up huge amounts of capital was a big though perhaps inevitable mistake.
MolochDAO’s decision to lock up capital was not made without reason, flawed though that decision may have been, and blockchain builders who ignore the MolochDAO’s reasoning may fall into a bigger problem than capital costs.
Over 92% of blockchain projects fail, and in many of these cases the original developers and early stage investors scammed late comers, taking off with their investment and spending it on personal luxuries in cheap third world countries. Of course, this is more difficult in the case of a DAO where the investors and the managers are the same people. However, it is still possible as several members of the DAO can collude to make decisions that are in their best interest while damaging the interests of the organization as a whole and the remaining investors. Accordingly, DAOs should be designed with an exit mechanism that allows members to retrieve their percentage of the capital.
In MolochDAO’s case, the reason for the large amount of capital locked into the contract is to provide an assurance to its current group of investors that they can easily retrieve their investment from the DAO should they disagree with the actions of the other members. While there may be more capital efficient ways to accomplish this goal, it is a vital one that must not be ignored. For instance, with SwiftDaos, members can retrieve their percentage of the current tokens held by the DAO at any time – or sell their tokens in an auction, whichever provides a higher return. Since member’s tokens can also be sold in auction, it prevents the need for high levels of capital to be locked into the contract as an assurance. At the same time, other members cannot abuse tokens owned by the SwiftDao as dissenting members can simply withdraw their portion of the capital. This is just one solution to the problem of providing capital protection and capital efficiency simultaneously.
As Ameen Soleimani, one of the key founders of MolochDao noted, “Ethereum is only now starting to shrug off its PTSDAO.” By PTSDAO, he is referring to the horror show of the original DAO, name “The DAO” which lost $60m of investors money in a hack, forced Ethereum into a controversial fork creating Ethereum Classic, and sparked an investigation in the SEC which found that “The DAO” violated securities regulation. However, all of these issues have now been addressed and the Ethereum community is slowly coming to the realization that DAOs have far more potential than is currently being exploited.
For instance, on the SEC’s statement, OpenLAO believes that DAOs can be structured as LLC’s without violating any security laws in the US. SwiftDaos are designed with the ability to take any legal form they wish, but since inactive members are automatically removed SwiftDao tokens also do not qualify as securities. The potential for DAO investment without legal ramifications has opened up the playing field.
Better Ethereum contract auditing and DAO design has mitigated the other issues of “The DAO.” In this space, new DAOs have been rapidly forming in 2019. So much so that there is now a DAOincubator which has connected with 13 DAOs each performing a different function in the ecosystem. AragonOS has created an easy to use system to create new DAOs and modify them to have any feature imaginable through its network of apps. Tools by OpenZeppelin have given developers the tools to make secure smart contract projects, including DAOs, quickly and easily.
While a lot of experimentation has been occurring in the space, it has created its own problem; lack of standardization. That is the primary reason SwiftDao formed – to create a platform for investors to easily and quickly compare a wide variety of DAOs that all have implemented the best practices as learned from decentralized projects like MolochDAO as well as traditional corporate governance.
MolochDAO shows that Ethereum has moved past the stage of early experimentation and is ready to bring to prime time DAOs that can compete on the global stage with traditional corporations. No matter what your involvement in the space is, just by being here and reading this article you’re at the leading edge of the curve. Get ready for a wild ride. The markets may be down but the technology is booming.