As VC Money Pours In, Many ‘Decentralized’ Projects Are Anything But

A lot of people lately have been asking questions about just how decentralized DeFi actually is.

Most notably, regulators and central bankers see decentralized finance (DeFi) projects raking in billions while claiming to have no executives, no board, and no central authority whatsoever. Instead, they are run by decentralized autonomous organizations (DAOs), which resolve disputes and set policies by token-based voting.

Some, including the Financial Action Task Force (FATF) and the Bank for International Settlement (BIS), have concluded that DeFi projects and the DAOs that run them are not nearly as decentralized as they seem, citing a variety of way of finding someone on whom to pin any charges.

See also: Bank for International Settlements Calls DeFi’s Decentralization an Illusion

But many DAOs have a bigger problem: They’re far too centralized to really deserve the moniker. Not only that, but DAOs form the building blocks of the blockchain-based Web3 that many in the crypto community believe will be the next generation of the web — a decentralized, privacy-focused version free from the controls of Big Tech.

Read more: Web3: Is There Any ‘There’ There? And if so, Where Is It?

That’s what a Twitter conversation between Elon Musk and Jack Dorsey this past December pointed to. When Musk asked Twitter where Web3 is, then-Twitter CEO Dorsey responded, “It’s somewhere between a and z” — a reference to venture capital giant Andreessen Horowitz’s blockchain and crypto arm, a16z.

See also: Musk, Dorsey Hint VC Money Puts Web3 Vision at Risk

The point being made was that venture capital would end up controlling the “decentralized” web because it would hold so much voting power. With that wealth comes the ability to pay people to pay attention when votes are called.

Decentralized-washing

Take the dispute that broke into the open this week between a pair of DAO-controlled, pay-to-earn game development projects, Merit Circle and Yield Guild Games (YGG).

The problem, as Coindesk explained, is that a pair of prominent Merit Circle DAO members — a group that includes anyone who holds an MC governance token — has proposed a vote on canceling a contract with YGG, which invested $175,000 in Merit Circle.

Also read: PYMNTS DeFi Series: Unpacking DeFi and DAO

Merit Circle members had expected YGG to bring in more investors and provide social media marketing that hasn’t materialized. Saying YGG has brought in too little “value-add,” they wanted to hold a vote to cancel the contract.

Among cancellation advocates is Sad Cat Capital, which calls itself “an activist-investment firm which specializes in innovative and disruptive blockchain technologies.”

Saying, “we take pride in the activism we do for projects that we love,” Sad Cat Capital said in a discussion forum that it was “disappointed” with YGG.

But the contract was signed by Merit Circle, the firm that developed the game, and it is unclear, CoinDesk said, if the voters have any actual authority or ability to cancel the contract — even if it is legal to do so. The company and its directors are, needless to say, major token holders.

This is a problem most DAO projects have, even with the best of intentions. In many cases, developers or early investors like VC firms have large governance token holdings, and thus outsize control, as most DAO proposals are decided by majority vote of a generally small quorum. Then there’s the reality that those votes are largely discussed on dedicated chat channels such as Discord, where relatively few casual token holders — particularly small investors or players — spend much time.

See here: PYMNTS DeFi Series: Unpacking DeFi and DAODeFi’s Achilles’ Heel on Display: Vote Could Take $100M in Crypto from an Investor

All that doesn’t take into account whether majority voting is actually a good way to run a business.

Down the Road

Another aspect is that many projects are started with the intention of becoming DAOs but aren’t there yet.

LinksDAO, created this year, is fairly open about that. Formed to buy a “world class” golf course and operate it as a member-run DAO, the project raised more than $10 million in 48 hours — thanks to some highly respected founders — by selling NFTs that allow the holder to buy a membership, CNBC reported in January.

Most of that money, however, was earmarked for the costs of forming the DAO and launching the search for a club to buy. Another funding round will be necessary to buy it.

Meanwhile, the NFT buyers will get governance rights after the DAO is formed.