Token Economy: DAOs & Purpose-Driven Tokens

By Shermin Voshmgir

This third edition of Token Economy is published as a series of three books: "Money, NFTs & DeFi," "DAOs & Purpose-Driven Tokens," and "Web3 Infrastructure." The purpose of this book - DAOs & Purpose-Driven Tokens - is to explain the institutional impact of blockchain networks and tokenization - both from a theoretical and a practica

• Language: English
• Publisher: Token Kitchen
• Release date: Feb 8, 2024
• ISBN: 9789899157125

Book preview

Imprint

Token Economy: DAOs & Purpose-Driven Tokens

Third edition, 2024

The first edition was published in June 2019 under the title Token Economy: How Blockchain & Smart Contracts revolutionize the Economy and had two amended editions. A second revised edition with four additional chapters was published in June 2020 with a modified subtitle Token Economy: How the Web3 reinvents the Internet. This third edition has expanded in scope and depth compared to previous editions and is being published as three separate books that constitute the Token Economy Series. The other books in this series are titled Money, NFTs & DeFi and Web3 Infrastructure.

Author: Shermin Voshmgir

Publisher: Token Kitchen, operated by Labirinto Eclético Unipessoal, Lda. Estrada do Garro 1649 Varche, 7350-123 Elvas, Portugal

https://token.kitchen

Design: Justyna Zubrycka

Production: Caroline Helbing

Copy edit: Constanze Huther

Cover & layout: Carmen Fuchs

eBook ISBN: 978-989-9157-12-5

Paperback ISBN: 978-989-9157-08-8

Hardcover ISBN: 978-989-9157-09-5

Audiobook ISBN: 978-989-9157-11-8

An open access version is available on: https://token.kitchen/token-economy/third-edition

Copyleft 2024, Shermin Voshmgir: Creative Commons - CC BY-NC-SA: This license allows reusers to distribute, remix, adapt, and build upon the material in any medium or format for noncommercial purposes only, and only so long as attribution is given to the creator. If you remix, adapt, or build upon the material, you must license the modified material under identical terms. For commercial permissions contact: [e-mail]

Table of Contents

Imprint

Table of Contents

About the Author

Acknowledgements

Other Books in the Token Economy Series

Preface

Part 1: Theory

Decentralized Autonomous Organizations

History of DAOs

Origins of the Term

Rule of Law & Rule of Code

DAOs as Internet-based Institutions

DAOs as Complex Socioeconomic Systems

DAOs as Public Goods

DAOs as Non-State Actors

DAO Governance

DAO Economics

Challenges of DAOs

References & Further Reading

Purpose-Driven Tokens

Token Engineering, Token Economics, Cryptoeconomics & Cryptogovernance

Political & Ethical Engineering

Economic Engineering

Legal Engineering

Technical Engineering

Emergent Power Structures

References & Further Reading

DAO Design Thinking Framework

Purpose of a DAO

Political Principles

Positioning

Stakeholders

Functions

Stakeholder Roles, Function, Rights & Rewards

Number & Types of Tokens

Economic Design

Legal Design

Technical Design

Token Distribution & Power Structures

Team Composition

References & Further Reading

Part 2: Use Cases

Bitcoin: P2P Money & Payment Network

Political Principles

Functional Design

Stakeholders

Token Types & Token Properties

Economic Mechanisms

Governance, Protocol Upgrades & Network Splits

Power Structures

Purpose & Reality

References & Further Reading

DAI & MakerDAO: P2P Stable Token

History of DAI in a Nutshell

Purpose & Political Principles

Functional Design

Protocol Upgrades & Protocol Funding

Stakeholders

Token Types & Token Properties

Economic Mechanisms

Economic Parameters

Policymaking & Execution

Power Structures

Purpose & Reality

Outlook: Endgame Roadmap

References & Further Reading

Steemit, Hive, Friend.tech & Co: P2P Social Networks

History of Steemit in a Nutshell

Purpose & Political Principles

Functional Design

Token Types & Token Properties

Economic Policies

Stakeholders

Power Structures

Steemit Hard Fork: Hive Network

Purpose & Reality

Reddit: Tokenizing Web2 Platforms

Friend.tech

References & Further Reading

Helium: P2P Telco Network

Purpose & Political Principles

Functional Design

Stakeholders

Token Types & Token Properties

Power Structures

Purpose & Reality

References & Further Reading

Ocean Protocol: P2P Data Exchange

Purpose & Political Principals

Functional Design

Ocean Market & Third-Party Marketplaces

Ocean Predictoor

Token Types & Token Properties

Economic Policies

Stakeholders

Power Structures

Purpose & Reality

References & Further Reading

Rebalance Earth: Biodiversity Tokens

Forest Elephant Use Case in a Nutshell

Purpose & Political Principles

Functional Design

ReFi Terminologies

Funding, Governance & Protocol

Token Types & Token Properties

Stakeholders

Power Structures

Challenges & Outlook

References & Further Reading

About the Author

~

Apart from regularly publishing about Web3 related topics, Shermin is the founder of Token Kitchen, a research company dedicated to investigating how to tokenize agricultural assets and sustainable ecosystem services – such as biodiversity protection, soil quality, water retention or CO2 capture – with the support of hardware wallets and sensor technology. In the past, she was the director of the Research Institute for Cryptoeconomics at the Vienna University of Economics, which she also co-founded. Before that, she founded BlockchainHub in Berlin and was a curator of the infamous project TheDAO. Shermin studied Information Systems Management at the Vienna University of Economics and film-making in Madrid. Under her alter ego KAMIKAT.SE she has also created a series of audiovisual works. She is Austrian, with Iranian roots, and now lives in Portugal where she works on the intersection of technology, agriculture, art & social science.

Acknowledgements

~

I would like to express my deepest gratitude to my partner Tom Fuerstner for encouraging me from the very first edition to write this book, and also for his continuous input and feedback along the various iterations of this book.

For this specific volume, I would furthermore like to thank Jakob Hackel, Quentin Botha, Michael Zargham, Valentin Kalinov, Kelsie Nabben, Jeff Emmet, Esen Esener, Walid Al Saqqaf, Tony Vernall, Trent McConaghy and Tom Fuerstner, for all the input and feedback – without them, this book would not have the same level of quality and depth. Valentin Kalinov merits special gratitude for their ongoing contributions since the first edition and all previous activities that influenced this book.

I would also like to mention the people who have inspired or supported me from the very beginning of the crypto journey and who have contributed with input and feedback to previous iterations of what has now become the Token Economy Series: Peter Kaas, Valentin Kalinov, Jakob Hackel, Alfred Taudes, Michael Zargham, Justyna Zubrycka, Caroline Helbing, Kris Paruch, Susanne Guth, Guido Schäfer, Sofie Schock, Katja Nettesheim, Nina Siedler, Robert Krimmer, Markus Sabadello and all the advisors and collaborators of BlockchainHub, including my dear friends from Lunar Ventures. I am also grateful for all the people who supported the creation of the Cryptoeconomics Research Lab at the Vienna University of Economics, and who believed in the necessity of dedicated interdisciplinary research on this topic.

I am especially grateful for the hospitality and open environment of the Ethereum Office in Berlin, which offered us shelter in their coworking space when setting up the BlockchainHub, and the open mind of all the people involved in post- TheDAO hack activities, working 24/7 to find a solution to recover depleted funds, which taught me a great deal about open-source software development and bug fixing in decentralized networks.

Last but not least I would like to thank all the voluntary contributors who – in the course of 2021 – collectively translated the book into nine languages, all of which are accessible for free on GitHub.

~

Shermin Voshmgir

January 2024

Other Books in the Token Economy Series

~

Token Economy: Money, NFTs & DeFi

The aim of this book is to introduce the core concepts of tokenization, before delving into the question of what constitutes money and credit. Both chapters provide an important foundation from which we can then analyze various use cases for fungible and non-fungible tokens that represent different types of assets. Later chapters will introduce the concepts of financial markets and analyze how asset tokens can be used as collateral in a growing ecosystem of tokenized financial applications – ranging from DeFi (Decentralized Finance) to CeFi (Centralized Finance) and discuss, what impact this might have on our future definitions of money, finance and the real economy.

The chapters in this volume cover the following topics:

* Tokens

* Money & Credit

* Stable Tokens: Money with a Stable Value

* Asset Tokens & NFTs: Money with Attributes

* Decentralized Finance (DeFi)

* Token Sales

* Token Exchanges & NFT Marketplaces

* Tokenized Credit & Lending

* Tokenized Derivatives, Synthetics & Insurances

* How to Design a Token System

Token Economy: Web3 Infrastructure

The purpose of this book is to explain the paradigm shift between Web2 and Web3 on an infrastructure level of the Web and how this will affect the application landscape that builds on it. It gives an introduction to the basic principles of Web3, explains why the emergence of the Bitcoin network was a game changer, and outlines the fundamental building blocks of Web3 from a technical, economic and political perspective. The book caters to a general audience with a non-tech background and aims to give an overview without going into all the technical details. The chapters in this book cover the following topics:

* Tokenized Networks: Web3, the Stateful Web

* Token Management: Bitcoin & Its Origins

* Token Management: Other Blockchain Networks

* Token Security: Cryptography & Wallets

* Token Privacy: Privacy by Design for Web3

* Who Controls The Tokens? User-Centric Identity-Systems

* Token Contracts & Token Types

Preface

This third edition of Token Economy is published as a series of three books: Money, NFTs & DeFi, DAOs & Purpose-Driven Tokens, and Web3 Infrastructure. The history of money and finance, and the impact of Web3 and tokenization on money, real-world assets and financial markets are discussed in the book Money, NFTs & DeFi. The technical and political aspects of blockchain networks and core Web3 infrastructure will be discussed in the book Web3 Infrastructure. The purpose of this book is to explain the institutional impact of blockchain networks and tokenization – both from a theoretical and a practical perspective – with the goal of providing a common understanding of the concept and practice of Web3-based institutions.

At the time of writing this book, the term Decentralized Autonomous Organizations (DAO) is often used to refer to Web3-based institutions. However, the term DAO is still quite under-defined and there is no common understanding of what constitutes a DAO, or how a DAO should be designed. The lowest common denominator of the term seems to be that it is a new type of Internet-based institution that can be more or less decentralized and in which network participants can have various degrees of autonomy – depending on the purpose of the organization and the design of its purpose-driven network tokens.

The unclear nature of the term might be one of the reasons why many authors over the past decade have come up with alternative words to describe the same phenomenon, such as Decentralized Autonomous Corporation (DAC), Decentralized Organization (DO), Decentralized Cooperative, Coordi-Nation, or Network State. Another reason for the ambiguity of the term might be that Web3 is an institutional infrastructure upon which we can build any type of organization, which can have elements of traditional institutions – such as nation states, companies, cooperatives, or public infrastructure networks, etc. However, these decentralized organizations are rarely pure representatives of these traditional institutions. Instead, we find new and hybrid forms, sometimes with completely novel types of organizational structures and institutional dynamics which introduce completely new possibilities and pitfalls.

The goal of this book is to critically reflect the concept of DAOs, starting with its first real-world example – the Bitcoin network. I will explain why the Bitcoin network can be considered the first practical instance of a DAO, and how the groundbreaking cryptoeconomic mechanism behind Proof-of-Work paved the way for a novel type of organization that is steered by purpose-driven tokens and relies on trust by math rather than trust by legal contract. The first two chapters of this book will explain the concept of Web3-based decentralized organizations – its origins and impact from various perspectives: history, cybernetics, organizational science, political science, economics and complex systems.

Since there is no one-size-fits-all solution for the design of DAOs, theory alone will not do justice to the complex nature of this topic. Any meaningful organizational design, including that of the purpose-driven tokens which steer Web3-based institutions, will always depend on the purpose and political principles of said organization/network/Internet community/cooperative. To provide a more tangible approach to the best practices and pitfalls of DAOs, I selected a range of DAO use cases, and based the analysis of each use case on a DAO design thinking framework, which I developed specifically for this book. I hope that this combination will give readers a basis from which they can derive common interaction patterns, and understand the different requirements on token design, depending on the purpose and the principles upon which the DAO is being designed.

One challenge I faced when selecting my use cases was that best practices for designing DAOs and the purpose-driven tokens that steer them are still underdeveloped. Many early use cases lack a sustainable token design to achieve their self-declared purpose. I therefore decided to display a wide range of purposes that a DAO can achieve or aim to achieve, even though some of the use cases selected have considerable design flaws. My assumption is that the reader will also benefit from learning the don’ts of token design, not just the dos. While all use cases have compelling value propositions, and in some cases even considerable traction, they sometimes display unintended design flaws that contradict the purpose and political principles upon which they were designed. The use cases selected are: P2P money & payment network (Bitcoin), P2P stable token (DAI & MarkerDAO), P2P social networks such as Steemit.com or friends.tech, P2P Telco Network (Helium), P2P Data Exchange (Ocean Protocol), and biodiversity tokens (Rebalance Earth). Except for Rebalance Earth, all use cases have a long track record of protocol evolution. They provide historical data to correlate token design choices to their effects, i.e. power structures that emerged over time, and the long-term success of the protocol/network/organization in question.

I am convinced that the design of purpose-driven tokens which steer DAOs requires as much rigorous research as the development of Bitcoin’s Proof-of-Work consensus mechanism – which was a result of decades of theoretical and applied research. Yet, many newer DAOs were designed with a trial and error mentality, conceptualized within a relatively short period of time by only a handful of people, which is why many of them had to conduct fundamental protocol changes, sometimes even repeatedly. A P2P payment network such as Bitcoin requires market mechanisms and brings institutional complexities that differ from, for example, a data exchange DAO such as Ocean Protocol, a telecommunication DAO such as Helium, or a stable token DAO such as MakerDAO. Depending on the purpose of a DAO, there will be different stakeholder types with different preferences, areas of know-how and other constraints, including all the downstream differences that become relevant when creating the market design for their protocols. Creating sustainable token governance rules for a DAO is an optimization problem that aims to maximize the personal goals of all network participants – such as their revenue or reputation – under a set of internal and external constraints. Use cases that require reliable data from the outside world, such as hardware oracles and software oracles, create additional complexities for the token mechanism design.

I worked on this book for almost 3 years and the greatest challenges that I had were research- and scope-related. Except for Bitcoin, the governance rules of all other use cases changed often, and when they did, the changes were significant. It was not easy to keep up with the changes. To make things worse, the exact political and economic governance rules and token distribution policies were often under-documented – which is quite remarkable for Web3-based organizations that claim to be publicly accountable by default. Furthermore, each ecosystem seems to use its own special-purpose vocabulary to describe the same thing with other playful words, which makes research and documentation even harder. In order to increase the readability of this book, I tried to harmonize the special set of vocabularies that each DAO uses, but at the same time I had to maintain the terminologies used by the founders, which was quite a conundrum. The second challenge was trying to provide a wide overview, while not getting lost in too many details. Each one of the use cases presented would merit a book of its own, and could be analyzed in even greater detail than done here. As the saying goes, the devil very often lies in the details. Unfortunately, too many details can be overwhelming for first-time readers of these use cases.

At this point, I would like to mention that the analysis of the use cases in the second part of the book is mostly qualitative. Additional quantitative analysis could be carried out as well, but that is not the purpose of this book. Quantitative analysis only makes sense once one understands what needs to be analyzed, and in which context the data should be interpreted. A metric such as a market cap or gross network value of a token is not significant on its own, if one does not first consider the purpose of the token design, the industry in which the DAO operates, the stakeholder structure, and many other qualitative aspects relevant to different types of DAOs.

Last but not least, I would like to mention which parts of this book are new and which ones have been rehashed from previous editions. The theoretical chapters of this book build on the body of work that has been published in the first and second edition of Token Economy and some other publications on the topic that I wrote together with Michael Zargham from Blockscience. The chapter describing the DAO design thinking framework is completely new, as are the six use cases analyzed in the last part of the book – with the exception of the chapters on Bitcoin and Steemit. However, while both Bitcoin and Steemit were covered in the previous editions, my analysis here is more systematic.

Part 1: Theory

~

This first part of the book will analyze the history of DAOs, the origin of the term, and the different social, political and economic perspectives from which one can gain a better understanding of this novel type of institution. I will explain why Bitcoin can be considered the first practical instance of a DAO, and how the groundbreaking cryptoeconomic mechanism behind Proof-of-Work paved the way for a novel type of organization that is steered by purpose-driven tokens and relies on trust by math rather than trust by legal contract. Since there is no one-size-fits-all solution for the design of DAOs, the third chapter will introduce a DAO design thinking framework.

Decentralized Autonomous Organizations

¹

Since the emergence of the Internet, many distributed Internet communities have formed around specific goals, such as social media, e-commerce or knowledge sharing. These communities can be described as new forms of internet based tribes who coordinate with the increasing help of computer algorithms around special purposes and values. In Web2, these tribes have been predominantly privately managed, with the exception of selected community governed networks - such as Wikipedia or free and open source software development (FOSS). In many cases, the operators of Web2-based platforms have disproportionate power over the fate of the communities contributing to and using their platforms. Web3 networks introduce a new type of Internet-based institutional infrastructure that can be collectively governed, allowing distributed internet tribes to self-organize and coordinate in a more autonomous way. These networks are commonly referred to as Decentralized Autonomous Organizations (DAOs), and they are steered by purpose-driven tokens.

~

Blockchain networks provide a new type of Internet-based operating system that allows for non-territorial coordination between people and institutions who might not know or trust each other. As such, blockchain networks are considered the backbone of what many refer to as Web3. They can enable the collaborative maintenance of a public infrastructure in the absence of trusted intermediaries and bilateral agreements. Instead of humans enforcing all property rights, access rights, execution rights or voting rights in person – via management structures and the legal system – the core coordination mechanisms are computationally enforced via semi-automated mechanisms in a publicly verifiable way.

The main difference between Web2-based and Web3-based networks is that the latter are collectively managed, with very different ownership structures than traditional organizations. Individual contributions to the upkeep and maintenance of a Web3 network are incentivized through one or several purpose-driven tokens which are designed to steer the collective action within these networks.

Since the emergence of the Bitcoin network, the concept of distributed organization that are executed by blockchain networks has been described with various terms: Digital Nations, Decentralized Corporations, Decentralized Autonomous Organizations, Decentralized Organizations, Network States, Coordi-Nations, Digital Cooperatives, Infrastructure Networks, etc. For the sake of consistency, and because it has been the predominant term for many years, I will refer to this new type of organizational structure as a Decentralized Autonomous Organization (DAO) throughout this book. As we will see later on, the level of individual autonomy often varies to such a degree that the term Decentralized Organization (DO) might be more appropriate.

In theory, DAOs can replace the hierarchical structures of state-of-the-art institutions with more distributed and autonomous institutional structures. The blockchain protocol and/or the smart contract code formalizes the governance rules of a decentralized organization, regulating the action space of all network participants. As a result, more fluid decentralized Internet-based organizations can emerge around a specific economic, political, or social purpose. Web3 networks provide more institutional transparency regarding the flow of funds, the appropriation of funds, or governance process than traditional organizations. Many claim that this can reduce the risk of corruption and information asymmetries that often result in the so-called "principal-agent dilemma of organizations. The principal-agent dilemma occurs when the agent of an organization, network or country has the power to make decisions on behalf of, or impacting, the principal. The principal is usually another person or group of people in the organization, network or country. Agents could be managers that act on behalf of shareholders, or politicians that act on behalf of citizens. In such setups, so-called moral hazard" occurs when the agent takes more risks than they normally would, because the principal(s) bear the cost of those risks. In more general terms, we speak of moral hazard when agents act in their own interest rather than the interest of the principal, because the principal cannot fully control the agent’s actions. This dilemma usually increases whenever there are information asymmetries at play.

Due to the publicly verifiable nature of blockchain networks, decentralized organizations that build on top of them reduce many information asymmetries and – as a result – provide more institutional transparency over how, for example, tokenized funds have been appropriated, almost in real time. All transactions of the organization are recorded and maintained by a blockchain network. Web3 networks can also provide (almost) real-time information about tokenized credentials and attestations, which are relevant to rights management in organizations. Proposals to change the network rules can be usually made by any network participant, and are voted upon by eligible network actors. The exact majority rules of the voting process and the question of who is allowed to participate in the decision-making can vary from DAO to DAO. DAOs can also live on other DAOs.

Once deployed, a fully decentralized and autonomous organization becomes independent of its creator and cannot be controlled by one single person or institution, only by majority consensus of the organization’s participants.² Since DAOs operate on a decentralized infrastructure that is collectively maintained, DAO protocols are often referred to as unstoppable code. In their most autonomous form, DAOs require a minimum of human intervention for governance purposes. They may still rely on individuals or organizations to perform certain management tasks that cannot be replaced through automation. As will be discussed in later chapters, a certain degree of human intervention will always be necessary – especially when it comes to conflict resolution, unforeseen events and protocol evolution.

Unfortunately, the term DAO is often used in a fuzzy way to describe a wide range of organizations, tribes, communities, networks or cooperatives - or whatever one might choose to call them. The use cases presented in the later chapters of this book will show that the application scope, the level of autonomy of its stakeholders, and the grade of decentralization of self-proclaimed DAOs can vary greatly – depending on the purpose of the community/network/cooperative/organization and the political principles it is designed upon. Before our deep-dive into use cases, this introductory chapter will define the history of the term DAO, explain the terms decentralized or autonomous, describe DAOs from different perspectives, and outline the general challenges that DAOs face today.

History of DAOs

The Bitcoin network can be considered the first DAO, though this term had not yet been coined in 2009. The Bitcoin network provides a collectively maintained operating system for financial transactions without traditional banks and bank managers. The governance³ rules are tied to the network token (Bitcoin), which is minted upon and used to reward contributors upon Proof-of-Work. No central entity controls the network. Anyone can opt into or out of the Bitcoin network at any time – without permission of a centralized entity, both as a contributor and a user.

The open-source nature of the Bitcoin protocol allowed anyone to take the code, copy and modify the governance rules, and issue their own decentralized network, which many did. But to do so, they always had to create their own blockchain infrastructure. With the emergence of the Ethereum network, the concept of decentralized organizations moved up the technology stack from the protocol level to the application level. Whereas before, one needed a special-purpose blockchain network with an attack-resistant consensus protocol to create a decentralized and autonomous organization, Ethereum smart contracts made the creation of decentralized organizations easily programmable, often with just a few lines of code, and without the need of setting up one’s own blockchain infrastructure. While any type of purpose could be incentivized and modeled with a few lines of code, the question of how to sustainably design the DAOs and the tokens that steered them – from an economic, political, ethical and legal perspective – was and still is the subject of many discussions as well as trial and error.

In 2016, TheDAO was a very early example of a complex smart contract on the Ethereum network. It was created with the purpose of providing an autonomous vehicle for fund management without traditional fund managers. During a four-week token sale, TheDAO issued DAO tokens against ETH, collecting an equivalent of 150 million USD, resulting in the biggest token sale at the time. The idea was that every DAO token holder would be a co-owner of the decentralized investment fund and could participate in investment decisions with voting rights proportional to the number of tokens held. TheDAO token holders could vote upon governance decisions such as hiring subcontractors for specialized services which would be necessary for TheDAO. However, due to a programming error in the software, this vision of TheDAO never became reality. The project was drained of roughly a third of its funds before it became operational, by the people who took advantage of this programming error. This led to a controversial hard fork of the Ethereum network.⁴ Apart from this bug in the smart contract, another shortcoming of protocol was that the governance rules of TheDAO did not account for decision-making processes in the case of unforeseen events – such as the exploit of this programming error. This early social experiment showed that what the Bitcoin network resolved with a complex consensus protocol, building on decades of applied and theoretical research, could not be simply replicated with a few lines of smart contract code that was not sufficiently thought through.

Since the purpose of TheDAO was very different from the Bitcoin network, the governance mechanisms tied to the network token required a new type of attack-resistant steering mechanism. But the governance rules of TheDAO were developed over the span of a few months, mostly by engineers with no governance expertise at all. Furthermore, the system was not tested before it was deployed, and the token governance rules were based on oversimplified assumptions of how token holders would behave. For example, the protocol designers did not sufficiently account for psychological phenomena such as the "free-rider problem⁵ or bounded rationality."⁶ These phenomena fall under the field of behavioral science, and behavioral economics in particular. As we will see in the next chapters, they are very relevant when designing the token governance rules. The rules also did not account for the fact that the voting process involved personal intervention, but since the wallet usability at the time was difficult for lay people (and sometimes even for pros), many smaller and technically less adept token holders were practically excluded from participating in voting processes.

The protocol designers of TheDAO had based the token governance rules on the assumption that small token holders would mimic the behavior of big token holders, who were assumed to take the time for sensible decision-making as they had more skin in the game. In reality, most small token holders did not participate in any voting processes at all, probably hoping that other token