Voter coalitions and democracy in Decentralized Finance Evidence from MakerDAO1 Xiaotong Sun1

2025-05-06 2 0 1.14MB 29 页 10玖币

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Voter coalitions and democracy in Decentralized Finance: Evidence from

MakerDAO

Xiaotong Sun1

Xi Chen2

Charalampos Stasinakis3

Georgios Sermpinis4

1Adam Smith Business School, University of Glasgow, Gilbert Scott Building, Glasgow G12 8QQ,

United Kingdom. Email: Xiaotong.Sun@glasgow.ac.uk.

2Leonard N. Stern School of Business, New York University, Kaufman Management Center, New

York, NY 10012, United States. Email: xc13@stern.nyu.edu

3Adam Smith Business School, University of Glasgow, Gilbert Scott Building, Glasgow G12 8QQ,

United Kingdom. Email: Charalampos.Stasinakis@glasgow.ac.uk,

4Adam Smith Business School University of Glasgow, Gilbert Scott Building, Glasgow G12 8QQ,

United Kingdom. Email: Georgios.Sermpinis@glasgow.ac.uk.

Abstract

Decentralized Autonomous Organization (DAO) provides a decentralized governance solution

through blockchain, where decision-making process relies on on-chain voting and follows majority

rule. This paper focuses on MakerDAO, and we find three voter coalitions after applying clustering

algorithm to voting history. The emergence of a dominant voter coalition is a signal of governance

centralization in DAO, and voter coalitions have complicated influence on Maker protocol, which is

governed by MakerDAO. This paper presents empirical evidence of multicoalition democracy in

DAO and further contributes to the contemporary debate on whether decentralized governance is

possible.

Keywords: governance; Decentralized Autonomous Organization (DAO); voting

The online appendices can be accessed:

https://drive.google.com/file/d/1Xbgq7S73sV3B2Gv_vfLzb2bzAWmiHWZ7/view?usp=sharing

1.Introduction

Decentralized Finance (DeFi) encodes the logic of traditional financial systems and benefits from

characteristics inherited from the underlying blockchain infrastructure. However, decentralization, as

the most controversial virtue of DeFi, is often questioned. Recently, Carapella et al. (2022) argue that

DeFi is not immune from centralized governance, and associate problems may arise.

The most popular mode of governance in DeFi is Decentralized Autonomous Organization (DAO),

proposed by Jentzsch (2016). In DAO, there is no centralized coalition, and any suggested changes to

DAO should be jointly decided by DAO members. To distribute decision-making power, DAO will

usually issue governance token, which are tradable cryptocurrency. Voters’ decision-making power

relies on the amount of governance token, and the proposal that gets most voting power will be

implemented. Benefiting from the transparency and accuracy of blockchain, voting results are

publicly visible and hard to be tampered, and DAO has been the most widely adopted choice for on-

chain governance.

Unfortunately, governance centralization is an inevitable problem for DAO. First, blockchain itself

is not safe haven for decentralization. Buterin (2021), as the co-founder of Ethereum blockchain,

proposes that complete decentralization is impossible if blockchain pursues scalability and securities

at the same time. In fact, a few key developers propose most changes to blockchain (Hsieh et al., 2017;

Yermack, 2017), implying that these developers have more control. Furthermore, DAO is not immune

from governance centralization. By investigating voting history of several leading DAO, DAO

governance is controlled by several dominant voters, and their centralized power has complicated

influence (Sun, Stasinakis and Sermpinis, 2022; Fritsch, Müller and Wattenhofer, 2022;). For example,

Carter and Jeng (2021) contend that key decision-makers, especially administrative teams can abuse

their governance power. Using Decentraland as a case study, Goldberg and Schär (2023) prove that

centralized governance may result in rent extraction behavior and other problems. Moreover, Nadler

and Schär (2020) show that some DAO participants may conceal their centralized decision-making

power by creating multiple on-chain identities.

The previous studies mainly focus on centralization problems at individual level, however, DAO

governance is likely to be battlefield of voter coalitions with different interests. Given the fact that

voting is all about social choice functions (Arrow, Sen and Suzumura, 2011; Kelly, 1988; Plott, 1976;

Schwartz, 1986), voters with similar interests and characteristics can form coalitions (Downs, 1957;

Black, 1990; Enelow and Hinich, 1994; Tajfel and Turner, 2004), while voters with different beliefs

will vote against each other (Adams, Merrill and Grofman, 2005; Abramson et al., 2009). In corporate

finance, voting rights are distributed among shareholders, and both small shareholders and large

shareholders can form their own coalitions. Smaller shareholders collaborate in order to protect their

own rights (Bennedsen and Wolfenzon, 2000; Zwiebel, 1995), while large shareholders attempt to

extract private benefits by seizing more control (Bennedsen and Wolfenzon, 2000; Dyck and Zingales,

2004). In DAO, we expect to detect voter coalitions since both dominant voters and minority voters

exist, and the interlinks between voters can help to depict DAO governance better.

This paper attempts to answer two key research questions: (1) if voter coalitions exist in DAO; (2)

how voter coalitions influence DAO. We choose the most influential DAO, namely MakerDAO, as a

case study. MakerDAO is probably the most successful DAO in blockchain because it sets industry

standards, e.g., ‘one token – one vote’ principle and a combination of on-chain governance and off-

chain discussion. The main role of MakerDAO is to manage Maker protocol, which is a leading

financial system on Ethereum blockchain. Maker protocol issues Dai (DAI) stablecoin, which is soft-

pegged to US dollar, and any agents can borrow DAI by locking collateral. In other words, Maker

protocol is a multi-collateral DAI system, where MakerDAO decides how this system develops.

To study MakerDAO, we retrieve voting history of governance polls from 15th August 2019 to

deployed on 25th July 2022, where all voters’ choices and voting power are available. After applying

K-means clustering algorithm to MakerDAO dataset, we identify three distinguished voter coalitions

(i.e., coalitions 1-3), and the largest coalition, mentioned as coalition 1, has the most voters and

contribute to most total votes. Though the other four coalitions have only a few voters, they can win

governance polls of Maker protocol, implying that MakerDAO governance is battlefield for these

coalitions.

By applying a series of factor analysis, we show that the voter coalitions have dissimilar effects on

Maker protocol. The first sub-section of empirical results centers on the coalitions’ voting share in

every governance poll. Here, three factors specific to Maker protocol are studied, including DAI

volatility, daily revenue and new users of Maker protocol. When voting share of the largest coalition

is higher, DAI will be more volatile, and daily revenue of Maker protocol will decrease. However,

smaller voter coalitions have the opposite effects. Previous literature (e.g., Sah and Stiglitz, 1988; Sah

and Stiglitz, 1991) mainly discuss how (de)centralization affects firm performance, however, they

ignore that coalitions may affect the underlying financial system very differently.

Beside voting share, we are interested in if group cohesion also matters for voter coalitions, since

previous studies point out that cohesive teams can contribute to better firm performance (Hogg, 1992;

Pepitone and Reichling, 1955; Schachter et al., 1951). We adopt a measurement named Agreement

Index (AI) (Hix, Noury and Roland, 2005), which is widely used in political science. A higher AI

means that group members tend to choose the same option, while AI will be close to 0 if voting power

of a group is equally distributed among all options. Again, the largest coalition has different effects

compared to the smaller coalitions. For example, more new users will be attracted to Maker protocol

when the largest coalition is more cohesive, while cohesive smaller coalitions can decrease the

number of daily new users.

We also consider the interlinks between Maker protocol and crypto market. DAI, as a primary

stablecoin, can be traded in various blockchain-based platforms. Here we choose five destinations of

financial flows of DAI, including Centralized Finance (CeFi), Decentralized Exchanges (DEXes),

Lending Protocols (LPs), External Owned Address (EOA), and bridges

. Our findings show that voter

coalitions can drive DAI flows in differently ways. For example, the voting share of a small voter

coalition can increase the number of DAI transferred to CeFi. The findings imply that voters

coalitions have certain similar preference, e.g., where to transfer DAI.

The remainder of our paper is organized as follows. Section 2 provides necessary background

knowledge and related work. The dataset for MakerDAO, clustering algorithm, and measurements of

group cohesion are defined in section 3. The main empirical results are presented in section 4, and

section 5 concludes.

2. Background

2.1 Decentralized Finance (DeFi) and Decentralized Autonomous Organization (DAO)

where the third coalition is not necessary component. Simply, Decentralized Finance (DeFi) refers to

blockchain-based financial applications without any centralized intermediaries. DeFi can replicate

most traditional financial systems, such as trading platforms and borrowing and lending marketplaces,

and the rapid growth of DeFi brings forward both opportunities and challenges. For more details of

DeFi and its potential risks, we refer readers to Werner et al. (2021), Makarov and Schoar (2022), and

Carapella et al. (2022).

Beside financial risks inherently existed in DeFi, another inevitable plain point is: how to govern

DeFi? Without relying on any third coalition, DeFi naturally tends to expand such decentralization to

its governance. Among all novel solutions to decentralized governance, the most widely adopted

organizational form is Decentralized Autonomous Organization (DAO), which is first proposed by

Jentzsch (2016). Formally, DAO is an entity structure lead by community instead of centralized

authority. In a DAO, decision-making power is distributed among all DAO members, and decisions

about the future of the DAO will be jointly made by members via voting. In other words, DAO is

owned and managed by their members.

In practice, most DeFi protocols are governed by DAO (e.g., Maker protocol is governed by

MakerDAO), and DAO will usually issue their own governance token, which resembles shares in

corporate finance. If there are any suggested changes to the DeFi protocol, governance token holders

can state their opinions via voting, and their voting power relies on the amount of governance token.

Benefiting from underlying blockchain, voting records can be documented on blockchain, and on-

chain voting is more precise and transparent than decision-making process in corporations (Hsieh,

Vergne and Wang, 2017).

DAO governance relies on voting. Among all voting procedures, most DAO chooses Plurality

In the context of blockchain, bridges refer to tools that connect two blockchains and allow agents to transfer

on-chain assets from one blockchain to the other.

voting procedure, meaning that only the candidate who gets votes more than any other

countercoalition will be elected (Arrow, Sen and Suzumura, 2011). In DAO, given a proposal, only

the option that get the most votes will be deployed. As for voting principle, though quadratic voting

exists, most DAOs adopts ‘one token – one vote’. However, Burkart and Lee (2008) argue that such a

voting mechanism will be optimal only when several agents compete.

2.2 MakerDAO and Maker protocol

Created in 2014, MakerDAO has grown up to the most successful DAO (MakerDAO, 2020).

Governed by MakerDAO, Maker protocol has adopted large market share in on-chain lending. Maker

protocol issues two native cryptocurrencies, namely Dai (DAI) and Maker (MKR). DAI is a

stablecoin soft-pegged to the US dollar, and people can borrow DAI by locking collaterals (usually

cryptocurrencies accepted by Maker protocol). In a way, Maker protocol is a Multi-Collateral Dai

(MCD) system. MKR is the governance token, and any MKR holders can participate in on-chain

voting in Maker protocol. For more details of the governance structure in MakerDAO, we refer

readers to Sun, Stasinakis and Sermpinis (2022).

Currently, Maker protocol applies ‘one token – one vote’ rule, therefore, voters with more MKR

will have more decision-making power. Empirically, a small group of voters control most voting

power in MakerDAO, and governance centralization can be witnessed in other DAOs as well (Fritsch,

Müller and Wattenhofer, 2022). Surprisingly, though governance centralization is not intention of

DAO believers, centralized decision-making power can have positive effects on the underlying DeFi

protocol (Sun, Stasinakis and Sermpinis, 2022). In this paper, we dive more deeply into the voting

history of MakerDAO, and beside individual level of governance centralization, more information can

be revealed by considering potential coalitions of voters.

2.3 Governance centralization

In traditional finance, governance centralization is regarded as a double-edge sword. A well-

studied example is banks. Iannotta et al. (2007) prove that higher ownership concentration can

contribute to better loan quality and lower insolvency risks. However, bank managers’ dominant

decision-making power can lead to more risk-taking decisions, and unacceptable outcomes can

happen (Mollah and Liljeblom, 2016; Dbouk et al, 2020). Since Maker protocol resembles a bank in

crypto markets, we suspect similar complex findings should be observed.

In corporate finance, governance centralization also attracts discussion (e.g., Shleifer and Vishny,

1997). Centralized ownership facilitates interest alignments (Shleifer and Vishny, 1997), but

blockholders can have self-serving actions (Burkart and Lee, 2008). Adding to the problem, small

stakeholders lack incentives to participate in corporate governance (Burkart and Lee, 2008). Currently,

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VotercoalitionsanddemocracyinDecentralizedFinance:EvidencefromMakerDAO1XiaotongSun1XiChen2CharalamposStasinakis3GeorgiosSermpinis41AdamSmithBusinessSchool,UniversityofGlasgow,GilbertScottBuilding,GlasgowG128QQ,UnitedKingdom.Email:Xiaotong.Sun@glasgow.ac.uk.2LeonardN.SternSchoolofBusiness,NewYorkUniv...

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