Decentralized Autonomous Organizations (DAOs) and the protocols they govern have revolutionized how blockchain-based businesses approach decision-making, most notably in the Decentralized Finance (DeFi) sector. These DAOs are disrupting the traditional financial system by enabling transparent and decentralized products that operate without intermediaries to ensure that financial services can be accessed in a decentralized manner.
To achieve this, DeFi protocols often use ‘Governance Contracts’, which are a type of smart contract that embeds rules and decisions onchain. These contracts enable a trustless and decentralized decision-making system, allowing DAO token holders and community members to have a say in the direction of the organization. Overall, this technology has revolutionized countless DAOs and propelled them toward full decentralization.
While DeFi protocols can operate without governance contracts, a DAO cannot exist without one. Protocols choose to use these contracts to enable collective decision-making by DAO token holders, contributors, and community members in a trustless and verifiable manner. Governance contracts have proven to be an essential part of the democratic principles that DAOs uphold.
In this article, we’ll explore governance contracts, how they work, the different types, their current limitations, and the innovations that have been made to these primitives.
How Governance Contracts Work
At the core of every Governance Contract lies the Core Voting Contract, where essential parameters are established by the contract’s creator. These initial parameters typically encompass voting power, proposal monitoring, and voting power calculations. Over time, fueled by various industry innovations, governance contracts have evolved to include features beyond the Core Voting Contract. This evolution has enabled greater adaptability and modularity in contract parameters, broadening the ways in which a governance contract can be tailored to meet the specific governance needs of a particular DAO. A prime example of a Governance Contract that boasts adaptable and upgradable features to cater to a DAO's unique requirements is the Council Governance Contract.
To better understand how governance contracts operate, it is crucial to examine their historical development.
Compound Finance, a decentralized lending and borrowing platform, is renowned for its pioneering efforts in creating and implementing Compound Governor Alpha and Bravo. These two contracts are considered among the most significant in the realm of decentralized governance.
Notable Bravo contract functions include:
propose() — allows anyone with enough votes to propose changes to the protocol.
castVote() — any token holder can cast a token-weighted vote on a proposal
delegate() on the ERC20 contract — This gives token holders the right to give their governance power to another token holder; the token holder can go on to vote on their behalf.
cancel() — any token holder can cancel a proposal if the against votes outweigh the votes in its favor.
queue() — anyone can begin the queueing process of a proposal after it passes.
execute() — allows anyone to execute a queued proposal after the timelock delay has passed.
How Bravo Improved Alpha
On March 30th, 2021, Governor Bravo was released as an upgrade to Alpha and brought with it new optionality and upgradability compared to its predecessor.
Built-in Upgradeability: Regardless of any adjustments or upgrades to the governance contract or its execution, Governor Bravo has a set contract address and proposal numbering system which will not change when an upgrade occurs.
Parameter Changes: Governor Bravo introduced the ability to easily adjust certain parameters such as quorum, submission threshold, voting period, and time lock period. This adjustability helps improve governance risk management, something Alpha lacked.
Other Governance Contract Types
As previously mentioned, governance contracts come in many shapes and sizes. Building on the foundations established by Governor Bravo, novel governance contracts have emerged, offering innovative solutions to governance challenges. In this section, we explore two prominent governance contracts in the space.
Similar to Governor Bravo, the Open Zeppelin (OZ) governance contract enables DAOs to perform on-chain governance with customizable parameters to meet the unique needs of each DAO. Notably, the OZ contract is fully open-sourced, unlike Governor Bravo which has to be forked in order to implement.
The OZ contract offers a wide range of options for governance customization. For example, it supports ERC721's voting power, allowing NFT owners to participate in governance. Additionally, it can distribute voting power to multiple ERC20 tokens, among other possibilities that create more inclusive governance.
Overall, the Open Zeppelin Governance Contract offers a higher level of optionality than other governance contracts, and its open-source nature allows for greater collaboration and innovation from day one.
Council by DELV
The Council Governance Framework, developed by DELV (formerly known as Element Finance), is a cutting-edge innovation in the field of governance contracts. Unlike traditional governance contracts, DELV's Council Governance Framework offers a modular approach that allows for greater flexibility in meeting the diverse needs of today's and future governance requirements.
Although the Governor Bravo and OpenZeppelin contracts are upgradeable, they fail to give DAOs the optionality of switching voting strategies to cater to the different kinds of votes that a DAO may have, this has led DAOs to operate a hybrid governance system where proposals that do not require on-chain implementation are done on Snapshot and proposals with onchain implementations are executed with native onchain governance.
This is where Council comes in with various governance strategies for different circumstances. For example, the variety of techniques that can be accepted as voting power is a major constraint for most onchain governance contracts. Token-weighted governance is the standard in most DAOs, but it has drawbacks that have been well-documented in one of our previous posts. By enabling protocols to switch between voting strategies easily, voting vaults provide a more tailored solution for DAOs. As the vaults are upgradeable and detachable via the core voting contract, protocols can then combine various voting vaults across multiple use cases.
Voting vaults enable governance to scale alongside a DAO and its protocol; as new token primitives and voting strategies are developed, new vaults can emerge to accommodate those use cases. This flexibility opens the door to whole new on-chain governance processes, approaches, and power structures.
Limitations of Governance Contracts
Similar to other smart contracts, there are certain limitations to governance contracts.
Sacrificing Yield for Voting Power: When a governance token is deposited into a liquidity pool or staked to earn yield, the token holder in most cases has to sacrifice the governance power in that token for yield. This forces token holders to choose between yield or governance power. As a result of this tradeoff, a number of tokens are not represented in governance and instead are used to generate yield.
Lack of Partial Delegation: When it comes to delegating governance power, most contracts today allow a token holder to delegate their governance power to one delegate, an optimal system would be a situation where a token holder can delegate to more than one person. A tokenholder should be able to fractionalize their support between multiple delegates.
Exploitation: A common fault within smart contracts is they’re exploitable, meaning because they run with code they can be manipulated and changed by bad actors. Below are a couple of examples of these.
Low Price Attack: If the price of a governance token is low enough and there is a large incentive to attack the governance of a DAO, an attacker might seek to amass enough tokens to execute a malicious proposal. To accomplish this, an attacker would be able to execute this attack if the price of the governance token is low and there is a lack of governance communication within the DAO. An example of this occurred against True Seniorage Dollar, where the attacker voted to mint billions of dollars worth of stablecoins to then be transferred to their personal wallet, after which the attacker sold the stablecoins on a decentralized exchange.
Flash Loan Attack: According to ChainLink, a Flash Loan is “a type of uncollateralized loan that lets users borrow assets with no upfront collateral as long as the borrowed assets are paid back within the same blockchain transaction”. This kind of attack is designed to get around the time delay in case a last-minute request needed to be approved. An attacker would take advantage of this by obtaining a flash loan to have enough voting power to go around the timelocks and issue a command that would deplete the protocol's treasury.
Innovations in Governance Contracts
The world of governance contracts has been largely built on the foundation of Compound Governor Alpha and Bravo and Open Zeppelin. These contracts have played a crucial role in the development of crypto governance. However, as the ecosystem continues to evolve, we can expect to see new innovations and upgrades to these and new contract primitives.
Below are some interesting and notable developments.
Council: This governance framework from the DELV team is the latest in governance contract innovation. Council aims to serve as the foundation for future governance developments that address tomorrow’s needs.
Butter: The Butter Protocol aims to solve a unique governance problem via an onchain delegation mechanism that makes governance tokens reusable, thereby creating an additional layer of utility for governance tokens.
Gas Rebates: With the ever-increasing cost of participation in on-chain governance due to gas prices, Gas Rebates would cover the costs of on-chain voting for involved stakeholders by refunding them the “gas” cost to participate. This lowers the barrier to entry for participation and helps eliminate any potential financial burden.
Cross-Chain Governance: As DAOs continue to expand across different chains, it’s important for these organizations to run and execute governance votes on different networks. For example, Aave V3 Polygon parameter changes are voted on Ethereum mainnet instead of where the protocol version is deployed. Aave Service Provider BGD Labs has begun dedicating its efforts to enabling cross-chain governance.
Shielded On-Chain Voting: DAOs should offer the choice to enable shielded voting for on-chain proposals. This enhancement would be crucial in addressing the bias that can arise from voters viewing the outcomes of a proposal in progress. It is often underestimated how psychological factors can impact tokenholders when they have access to real-time governance vote results. By adopting shielded voting, the voting behavior of individuals can be monitored without any external influence, thereby promoting independent thinking rather than groupthink. Overall, implementing shielded voting would help to ensure fair and transparent decision-making within DAOs.
The world of on-chain governance is constantly evolving, with new innovations and upgrades constantly being introduced to governance contracts. However, there are still limitations, such as the tradeoff between sacrificing yield for voting power and the lack of partial delegation. Exploitation is also a common fault within smart contracts, and there have been instances of attacks, such as the low price attack and flash loan attack. Despite these limitations, new developments, such as Council and Butter, along with gas rebates, cross-chain governance, and shielded on-chain voting, offer exciting solutions for future governance needs.
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