Forewarning, this will be a long article. It is not meant to be a final proposal, but to get individuals thinking about some of the current issues. But before I get into the proposal, a bit of background is needed to understand why Polkadot was setup the way it was.
The majority (over 50%) of the holders of the DOT token are the following entities: 1) founders, 2) Web3 foundation, 3) Parity, and 4) Over 30 venture capital (VC) firms. Many folks are quick to criticize the number of VCs that hold DOT; however, I would counter that argument that it was a necessity. The current security laws within the US would have absolutely considered the initial sale of the token as a security; therefore, Polkadot had no choice but to raise funds using KYC and accredited investor status (or the equivalents). They could have taken the easy way out like Solana and raised funds using a small number of VCs, but they did not. They distributed the initial sale across many parties to ensure the most amount of decentralization as possible. Also, to be fair, you probably want at least 50% of the tokens in the hands of highly sophisticated entities. Further, based on my understanding, no individual or entity owns more than 20%, which is important because the SEC starts to consider an amount over 20% as “significant influence” thereby creating additional regulatory requirements.
The design of governance is quite ingenious. The significant problem with cryptocurrency today from a regulatory perspective are the disclosures, NOT the financials. The financials can in essence be seen on-chain. Polkadot’s governance solves this problem by requiring every Treasury spend or code update go through a governance vote (disclosure) that is on-chain (verifiable) where the code of the proposal is included (accuracy of the proposal can be confirmed based on code) using software that is open source (trusted) and autonomously executes (no reliance on humans). This in essence solves the disclosure requirements issue that would normally be provided within 10Ks (annual financial reports) and 10Qs (quarterly financial reports).
The majority of folks don’t really understand why the conviction vote (i.e., lock DOT for a more powerful vote) was designed the way it was. Why conviction voting is touted as a person with long term interest can have more voting power is often described (which is the truth), it is not the whole truth. Conviction voting was designed as a defense mechanism against the accumulation of customer funds for voting (think about what Blackrock and Vanguard do with your stock votes as you give them money to invest in index funds). Let’s take a look at two examples. Example One: A crypto exchange tries to vote to influence the network with customer funds. In this example, even if they had a significant amount of DOT, they would not be able to run a conviction vote with customer funds because those funds would need to remain liquid if the customer asked for them back. Example Two: Blackrock issues an index or ETF. In this example, they have to hold the underlying asset and regulations in most countries require those assets to be available to trade (which can’t happen if they are locked for conviction). So even if an exchange or ETF held 95% of the DOT Token, if the other 5% voted using a 60x conviction, the other 5% could outvote the exchange’s or ETF’s 95% 3 to 1.
The Problem Statement with Governance
Governance participation is low and Treasury spend is ineffective at best. Let’s address the whales in the room. Whale voting is a significant issue. Should they have more say because they have more at stake, sure. But at the same time, a whale is likely wealthy as a whole and may actually have less at stake in percentage terms than a small investor. Also, something can be said for one vote for one person; however, this is not a realistic solution in the near term. When a whale votes, it discourages everyone else from voting because there is literally no point. Further, it ostracizes people because it reminds them generally how poor they are (which I would argue is part of the problem we are trying to solve). Lastly, most wonder what the whale was even thinking because usually there was no explanation in the post. I would argue that a whale has a responsibility to the community to provide commentary on aye or nay votes. While the whale might bring dollar value, the other holders bring people and adoption through word of mouth. Both are needed for an ecosystem to do well. Without the people, the whales value will dwindle.
The other issue is that there is no direct economic reason to vote. We are not talking about political elections where folks cast a vote once every few years. You are asking folks to read entire proposals on a significant scale for free. This would be equivalent to a board of director role or a proposal reviewer at a VC firm (both are paid positions). Now, I do understand some of the philosophical arguments against paying people to vote and realize that it may not result in the best outcome if folks are voting to vote just to get paid. I will propose a solution here shortly.
Size of the Treasury
Currently, over 44M DOT sits in the Treasury, which as we speak is north of $160M in value. Most folks worry that the Polkadot Treasury will become like the Kusama Treasury and run out of money. I would argue the EXACT opposite. My goal is not to talk about price, but assuming DOT re-establishes itself at its all time high at some point in the future, the total Treasury amount will be north of $2.4B in value. Burning the tokens would NOT be logical. We would want to fund operations given Polkadot is still in its start up phase and to keep tokens available in case of a risk event. Further, burning DOT does not increase value of an individual token if the burned DOT is not in circulation to begin with. Lastly, Polkadot’s total raise was north of $300M. While we are in the early phases of Web3 development, I do not reasonably believe that DOT is in need of $2.4B in funding for the short term. So I will not propose a different solution.
The Solution Statement
Now, keep an open mind . Polkadot should start to use its Treasury to partially become a decentralized VC provider and I think there are game theoretical and regulatory ways to do this correctly. See steps below:
- We would set aside a small amount of Treasury funds to try this concept (let’s say 5%). This would not break Polkadot’s Treasury or cause any long term damage.
- The teams requesting funds would do the following:
- a. Perform Know Your Business (KYB) to ensure funds are being appropriated to non-restricted individuals and countries. Further, this helps reduce scams. This could be done through something like KILT.
- b. The team would be asking for a 0% loan in $ terms paid in DOT. By making a loan instead of it being free, the Treasury would re-cover at least some of its funds (assuming not a 100% failure rate). Further, we would set at 0% interest because we would not want to turn this into a “profit” venture for what are hopefully obvious reasons.
- c. The team would be required to lock the entire teams holding, as well as provide collateral through their token in a multi-sig. This could be done through something like Invarch.
- d. Open source their code and provide a permissive license so others in the Polkadot community could leverage their code. Polkadot does not want to be in a position where we pick winners and losers.
- e. The team would provide an airdrop to the individuals who voted on the proposal (whether aye or nay if it passes). They would decide how much. Voters now receive compensation for their own efforts.
- Voters would require to lock their DOT for two years and it would not be eligible for staking. However, they could use that locked DOT to vote on other funding programs. This way, voters get paid for their services, but they must vote wisely because there is an opportunity cost to not being able to stake, a limited amount of funds to be disbursed (like I noted above, it would be 5% starting off), and they must consider airdrop rewards/project quality versus staking benefits.
This solution would reduce the supply of DOT, increase existing staking rewards, create funding programs for developers, encourage more governance participation, create exciting airdrops, and prevents whales from blowing up proposals unless they are willing to lock their DOT and forgo staking rewards. Further, there is limited risk given we would initially keep the amount available for disbursement to 5% of the Treasury. This would be a separate governance track solely used for providing startup funding for projects. It would not impact any other governance features. Would want a lawyer’s opinion as well .