In our previous articles, we've explored the stages of decentralization and the journey that decentralized applications (dApps) and Decentralized Autonomous Organizations (DAOs) undertake. In this piece, we'll delve into the regulatory landscape and the strategic path a project should choose at each stage of decentralization.

Stage 1: Not real DAOs, just companies in disguise

At this stage, DAOs are more like companies than DAOs. The development team has near-complete control over the project with little to no checks and balances. If a project has a token at this stage, it serves more as a fan club ticket than a governance instrument. Token holders have limited influence over decision-making and primarily serve as supporters of the project.

However, issuing tokens at this stage can present potential risks. Regulatory scrutiny and the risk of being classified as a security are significant considerations. Therefore, it might be advisable for Stage 1 DAOs to issue non-transferable tokens. These tokens can't be speculated upon and can be attributed to users or governance participants via Liquidity Mining (LM), Staking, or contribution. This approach can align the interests of the community with the project's success. This is the approach chosen by Morpho, a young Stage 1 DAO with some form of success.

Don’t do this…

Don’t do this…

Transition to Stage 2

The transition to Stage 2 should ideally occur when there's some form of product-market fit. At this stage, the influence of early investors and other stakeholders begins to dilute the development team's authority. Token holders start to gain more power in governance, but it can be challenging to overcome the influence of venture capital firms and early investors.

At Stage 2, protocol revenue might better stay in the treasury and start compensating delegates and service providers. This approach ensures that the DAO's resources are used to further its goals and incentivize active participation in governance. AAVE is a successful example of a Stage 2 DAO that has effectively balanced the interests of various stakeholders and made significant strides towards decentralization.

However, a DAO that is effectively controlled by 2-3 VCs or the team can be considered a failed Stage 2. Such a DAO may struggle to achieve true decentralization as a small group of powerful entities hard to replace or balance out can dominate decision-making.

Transition to Stage 3

The shift to Stage 3 marks a significant milestone in a DAO's journey towards achieving full decentralization. This stage requires a strong and reliable governance framework to organize the DAO effectively. The "O" in DAO stands for "organization," and without a robust framework, a DAO can quickly devolve into chaos.

A strong and independent network of delegates platforms is also crucial at this stage. Delegates act as checks and balances to service providers and work for the interest of the DAO itself. In a late Stage 2 DAO, delegates are nominated, as they receive their voting power via delegation from a few large entities, such as the team and VCs.

A real Stage 3 DAO has delegates elected and not nominated, with many delegations from many actors, large and small, making them truly independent.

300+ delegations, 0 from genesis team, 0 from VCs, 0 from other protocols, true Independence

300+ delegations, 0 from genesis team, 0 from VCs, 0 from other protocols, true Independence

In the Aave DAO, for now, only the Aave-Chan Initiative (ACI) with 300 delegations has reached this stage. Aave DAO will be considered a Stage 3 DAO when there are half a dozen elected “ACIs”.

But to have professional and independent delegate platforms, you need to have skilled people doing this full-time. But without compensation, how can you attract these people and how can you retain them? This is a chicken and egg problem. That's why ACI launched the Orbit program & gas rebate program to find a path to sustainability for delegates and pay them directly via the DAO and not by third-party subsidies to allow independence.

To fund these programs, protocols require real activity revenue and not token subsidies. A real Stage 3 DAO can only be achieved with a profitable protocol. This approach ensures that the DAO is sustainable in the long term and is not reliant on external funding or token price appreciation.

The Protocol pays the bills and have a surplus

The Protocol pays the bills and have a surplus

to obtain diverse delegations, you need token holders that have some interest in the governance of the protocol. it can be achieved by UX design (a call to delegate when user stake) and more importantly, by keeping the governance accessible for this, reducing legalese and overcomplexities is necessary to avoid gatekeeping.