DAOs tend to asymmetrically reward early contributors. These early contributor take on more risk, and ultimately impact whether a DAO succeeds. However, the downside of this is that later members are less-incentivized to contribute.
They key to sustainable governance is a fair reallocation of power over time. The historical method for reallocating power has been inflation. Inflation creates a constant pressure to contribute. But normal inflation has a negative side-effect – it compounds.
Elastic Governance Tokens (EGTs) allow for a slow reallocation of governance power based on active participation without the negative price impact of inflation.
Inflation creates a constant pressure to contribute. If we look at USD as an example, inflation reduces the buying power of each dollar slowly over-time. By contributing value to the economic system (investing, producing goods, etc.) the influx of new dollars counteracts the negative price impact of inflation. Doing nothing in an inflationary economy results in the loss of power.
Traditional inflation has one very detrimental side effect. It compounds.
Let’s put this in the context of a DAO that pays contributors with an inflationary governance token.
As the DAO reallocates power to contributors through inflation, the price-per-token decreases, meaning that the DAO must increase the number of tokens issued as compensation. Very quickly this leads to a compounding effect forcing ever-increasing inflation. We already see this with the US economy, and the minimum wage.
In an ideal world, reallocation of power occurs at a constant and predictable rate.
Hierarchies explain why disproportionately awarding early DAO contributors can be harmful. There are two general forms of hierarchies – steep and shallow.
Steep hierarchies are detrimental to collaboration because lower members in the hierarchy are faced with uncertainty. In short, contributors are put in a position where they are unsure whether contributing to the DAO will result in upside for them versus the members at the top of the hierarchy.
Meanwhile shallow hierarchies tend to encourage collaboration because the upside between individuals is relatively similar.
Elastic governance tokens attempt to solve this by slowly changing the hierarchical structure of power to the people that contribute the most value to the organization.
Elastic governance issues new tokens at a constant and predictable rate, but elastically reduces the balances of every token holder by the same percentage to maintain a fixed total supply.
Inflation hides dilution from contributors. Elastic token balances directly debits the token holder balances which is clear and transparent (just check your wallet to see how many tokens you are holding).
Unlike traditional token balances, the balance for these governance tokens is computed on the fly. The math is pretty simple. A balance is multiplied by some coefficient that is set at the smart contract level.
The coefficient is calculated by adjusting the inflated supply by the total supply.
Let’s run through an example.
There is a total supply 1000 tokens. The DAO reallocates 1% to active contributors each month.
1% of 1000 tokens = 10 new tokens per month.
The balance of every token holder is multiplied by ~ 0.9900990099 which decreases the balance of each holder slightly while maintaining a fixed total supply.
The balance coefficient is updated each inflation event to maintain a fixed total supply, or could occur at a block rate so that reallocation is streamed in real-time.
Elastic Governance Tokens are an experimental new way to think about continuously reallocating power in DAOs. The goal of this mechanism is to be incredibly transparent about how power is redistributed over time, while isolating token price from the impacts of inflation.