Incentivizing Web3 delegates, the driving force behind decentra…

Incentivizing Web3 delegates, the driving force behind decentralized governance

May 9th, 2023

As web3 ecosystems mature, the importance of effective governance structures cannot be overstated. At the heart of these systems are Web3 delegates, who represent token holders and play a crucial role in decision-making processes. This article will explore how incentives can be structured to attract and retain qualified delegates, fostering a thriving environment for decentralized governance and ensuring the long-term success of Web3 projects.

Web3 has revolutionized how we work, taking mechanisms that worked in traditional systems and applying them to the forward-thinking approaches founded on decentralization. At the core of web3's success lies a group of key players known as delegates, who play a crucial role in ensuring the smooth operation, security, and development of these decentralized networks via governance. But who are these delegates, and what motivates them to take on such a significant responsibility?

In this article, we will explore the concept of delegates in the web3 ecosystem, their roles and responsibilities, and the incentives that drive them to participate actively in the governance and maintenance of web3 platforms. From understanding the delegate governance model to examining the rewards and risks associated with being a delegate, we aim to provide a comprehensive overview of these individuals’ vital roles in shaping the future of decentralized finance.

Tally is excited to present Delegation Week from May 22-26, a 5-day event dedicated to exploring the power and potential of voter delegation in the DAO ecosystem. We’re running Twitter Spaces on every topic covered in this article and beyond. Get excited.

The ABC of the Delegate Governance

What is delegate governance?

Delegate governance is the decision-making process where token holders assign their voting power to chosen representatives, known as delegates. These delegates participate in protocol governance, proposing and voting on changes or improvements to the platform. This model fosters scalability and inclusivity while incentivizing delegates to act in the protocol's best interest. However, potential drawbacks include centralization and voter apathy, which can impact the ecosystem’s overall health. We’ll dive deeper into that later.

This model of governance, sometimes referred to as "liquid democracy," combines elements of both direct and representative democracy. It allows token holders to participate indirectly in the decision-making process by nominating delegates who are more knowledgeable or have more time to dedicate to the project. This approach aims to ensure that the project's direction is guided by informed individuals while still giving every token holder a voice. Typically, delegates serve as an alternative to direct governance, allowing token holders to either delegate their tokens or retain their voting rights and participate alongside delegates in the decision-making process.

Here's how the process typically works:

First, token holders nominate delegates. Users who own tokens but may not have the expertise or time to make informed decisions can assign their voting power to someone they trust to represent their interests. This could be a developer, industry expert, or any individual with a deeper understanding of the project and its goals.

Then, delegates represent token holders. Delegates, now holding the voting power of those who nominated them, participate in the project's governance. They may propose changes, vote on proposals, or contribute to the project's development in various ways. Ideally, these delegates are knowledgeable and dedicated to the project's success, ensuring that decisions are made in the best interest of the token holders and the overall ecosystem.

Voting on proposals: When proposals are made, delegates vote on behalf of the token holders who nominated them. Their votes are typically weighted according to the voting power they hold from their nominators.
Decision implementation: Once a proposal is approved, the changes are implemented in the project. This can include protocol upgrades, funding for development, or any other decisions that may impact the project's direction.
Reassignment of voting power: Token holders can reassign their voting power at any time, either to a different delegate or to themselves. This fluid nature of delegation allows for continuous adjustment and ensures that token holders can maintain control over their influence in the project's governance.

This approach to web3 governance can be an effective way to balance the need for expert input with broad-based community participation. By allowing token holders to delegate their voting power, projects can potentially achieve a more decentralized and democratic decision-making process while still benefiting from the expertise of knowledgeable delegates.

Most Tier 1 DeFi protocols—including Optimism, Aave, Compound, and Uniswap—employ delegate governance systems. Recently, Arbitrum introduced its DAO, featuring a comprehensive delegate governance framework to bolster its decentralized decision-making process further.

Benefits and Drawbacks of Delegate Governance

As with any governance model, delegate governance has drawbacks that must be carefully considered and addressed to ensure a robust and inclusive decision-making process.

Benefits of Delegate Governance:

Scalability: One of the primary advantages of delegate governance is its ability to facilitate faster and more efficient decision-making. By limiting the number of delegates involved in the consensus process, transactions can be validated more quickly. The network can handle a higher throughput, which is crucial for the growth and scalability of web3 platforms.
Inclusivity: Delegate governance enables token holders who may not have the technical expertise or resources to actively participate in the protocol’s maintenance to contribute by delegating their voting power to trusted representatives. This model ensures that a broader range of stakeholders can have a say in the governance process, fostering a more inclusive and diverse ecosystem.
Security and Accountability: Delegates are incentivized to act in the best interest of the network, as their reputation and stake are on the line. Misbehaving delegates can be voted out and replaced by the community, promoting accountability and encouraging delegates to work towards the network's long-term success.

Drawbacks of Delegate Governance:

Centralization: Concentrating power in a small group of delegates can lead to centralization, which can make the network more vulnerable to attacks or collusion. This centralization goes against the fundamental principles of decentralization that underpin web3 and can compromise the platform's integrity and security.
Voter Apathy: Token holders may not actively participate in the election process, leading to a small number of delegates dominating the protocol's governance. This lack of participation can reduce accountability and transparency, potentially undermining the democratic nature of decentralized governance.
Limited Diversity: The delegate governance model can result in a limited diversity of opinions and perspectives during the decision-making process. When decision-making authority is concentrated among a few representatives, it may lead to suboptimal outcomes that only partially represent the broader community’s interests. A diverse range of perspectives is essential to ensure that governance decisions are balanced and consider various aspects of the web3 ecosystem.

What are the types of delegates?

Delegates can be broadly categorized into three types based on their background, expertise, and organizational structure:

Professional delegates: These are individuals or organizations with a proven track record in web3 (or, occasionally, TradFi). They usually possess extensive technical knowledge, experience in web3, DeFi or blockchain, and a strong reputation for acting in the best interest of the community. Professional delegates may include developers, industry experts, and analysts who actively participate in governance discussions, propose changes, and vote on behalf of their delegators.
- Examples: Blockworks Research, Stablenode, GFX
Individual delegates: Individual delegates are regular users of the web3 platform who possess a strong understanding of the protocol and actively participate in the governance process. They may not have the same level of professional expertise as professional delegates, but they bring their perspectives and insights as community members. Individual delegates often have a personal stake in the platform's success and are motivated by their commitment to the project's vision and goals.
- Examples: Matthew Graham, Linda Xie, Hasu, ChainLinkGod
DAO delegates: A different (and somewhat new) category, DAO delegates are specialized DAOs with direct experience and expertise in their advising field, DAO governance itself. This unique background equips them to provide valuable insights from their firsthand management of other DAOs. Each DAO delegate may employ a different internal system to determine how to utilize their delegated voting power during decision-making processes. Additionally, these delegates often possess extensive ecosystem connections, enabling them to facilitate not only the initial establishment of new DAOs but also the long-term growth and success of protocols.
- Examples: Layer2DAO, Treasure, PlutusDAO
Service provider delegates: These are organizations or companies, such as venture capital firms, asset management companies, or crypto research firms, that have a significant stake in the web3 project and participate in the governance process. Delegate institutions often bring substantial resources and expertise to the table, enabling them to contribute meaningfully to the platform's growth and development. They may also have access to a network of industry professionals, which can be beneficial for driving strategic partnerships and fostering broader adoption of the protocol.
- Examples: Gauntlet, Llama, Flipside, Reverie

Token holders can choose to delegate their voting power to any of these types of delegates based on their trust, expertise, and alignment with their own interests and values. By leveraging the strengths of different delegate types, the web3 ecosystem can foster a balanced and inclusive decision-making process.

Rewards and Compensation for Delegates

As DAOs and Internet-native organizations create new ways to exist and work, they also create new ways to contribute, new relations, and new incentives. Some might look similar to previous ones. Nonetheless, we are redefining what rewards and compensation can be for the new relationships between organizations and contributors.

Although compensation and rewards come from the exact word origin, “mede,” today, we use the words differently. Rewards stand for recognition for the work done and intrinsic and external incentives. Compensation, on the other hand, refers to the primarily monetary rewards in exchange for work.

How about the new stakeholders: the delegates? Why are they doing it, and why would they continue doing it? Let's look at their incentives in the form of rewards and compensation.

We will tackle all extrinsic and intrinsic rewards for the delegates. Compensation and rewards have two parts of primitives in their language. The takeback is the value given back to the value creator, and the accounting measures the value created by the contribution. We will also look at the considerations when designing your reward and compensation systems .

The Takeback

In rewards and compensation, the "takeback" refers to the value returned to delegates and can be presented in various forms, as outlined below. Factors such as affordability, availability, delegate needs, and overall appeal can all influence the structure of these incentives.

Cash is a central part of the compensation, the liquid monetary value in stable or other currencies, sometimes a bundle of different ones. Most of the DAOs compensating their delegates have a component of this. Examples are Aave in their currency, MakerDAO has been compensating up until now in DAI, Illivium in USDT, and Nouncil in Eth.

Ownership: This can still denote monetary value represented by less liquid tokens, giving ownership and governance. It resembles startup equity however does not need to be classified so from the regulatory point of view. Some of the liquid tokens can also have ownership utility.

Governance Power: As in most DeFi-related governance models, the tokens that give monetary value can also have a monetary value. Hop protocol compensates with HOP and AAVE in their token, which holds both utilities. MakerDAO will be compensating soon with the MKR at the time of writing this article.

Reputation: Delegation runs hand-in-hand with reputation. First of all, it is a tremendous reputation-building event when elected and recognised as a delegate. We also see passive reputation-building for delegates as they are monitored and rated for their activities through Karma. Karma monitors the governance activity of the delegates across DAOs. Gitcoin introduced Steward Health Cards which integrated Karma as well.

Personal gain: Fictional or not, the personal gain has been voiced as a potential reward that could happen. This has been a concern not only relevant to delegates but whenever there is resource concentration and voting skew and capture is possible. However, it is preventable and can remain hypothetical with measures.

The Accounting

Accounting is how we measure the value created and an aid in determining how to reward and compensate.

Retroactive: Retroactive rewards are not a foreign concept to DAOs and refer to deferring the estimation of the value till after it is created. Although it is not guaranteed or deterministic, it can also be used in delegation rewards and compensation. An example is the Nouncil, the Nouns DAO releasing an amount for the council retrospectively. In the same vein, Optimism awarded their delegates retroactively for past seasons.

Performance Quality: Performance-based rewards and compensation become crucial in delegate compensation. The reason is voting is nothing without justification and engagement. Most DAOs incorporate measures of how active, engaged and informed voting is. For example, MakerDAO delegate compensation includes a formula that factors in participation and communication. Some other performance parameters we have seen are the duration of how long delegates have been active and the amount of governance power the delegates hold.

In some DAOs like Illivium, although performance is factored in, it is more black and white, removing non-performant delegates from the council.

When delegation becomes specialty based rather than just voting, performance metrics become more prominent, as in treasury management and yield-based compensation, see the Yield section.

Time-based: Time-based, monthly or hourly, is a simple accounting for work committed and might not need to be connected to the value created . The examples we see are monthly to Illivium and Aave, where delegates are compensated at monthly intervals.

Bounty/Grants: In some DAOs, the choice is through a grant and proposal, like in Buttery Money x Aave's recent grant.

Yield: Not to be confused with yield farming, delegates can be incentivized with staking rewards. The applicable delegates for this differ from those mentioned in this article, as they are only appropriate in proof of stake networks with delegated PoS. Some examples are Tezos, Solana, Cardano, and Polygon Supernets. In this model, the reward for the delegates is the yield, the staking rewards. Generally, it is shared among the delegator and delegate.

Basis Point - Used in assets-based models, implies a one-hundredth of a percentage tied to the assets under management(AUM). For example, in the case of DxDAO, We observe that a part of the fee Karpatkey gets for treasury management delegation is based on the delegated AUM.

Considerations for Designing Your Rewards and Compensation

The DAOs have been optimizing when choosing their rewards, and the compensation model is varied. However, we see some common traits. Here is a bird's eye view.

Motivation to Govern: The number of proposals can be overwhelming, and a full-time job. The primary task for DAOs is to consider incentives for delegates to respond to the proposals accepted or defeated at the right time while safely decentralizing decision-making. From the delegate's perspective, although the motivation to govern can be implicit, like contributing to something larger than oneself, DAOs need to secure continuity.

Performance: Voting alone might not be meaningful enough for governance, and the need to set the incentives for meaningful voting arises. What is meaningful can vary; however, we see some common traits that are baked into the formulas for compensation and rewards. For MakerDAO, voter performance is tied to communication and engagement. Specifically ensures that delegates explain the reasoning behind their choices frequently and timely while engaging with the rest of the community.

Risk aversion: Risk bears opportunities too, and delegates could develop risk aversion to build trust and be performant. A factor to think of when setting rewards and compensation rather than pushing for success is focusing on calculated risk and communicating effectively.

Encouraging new entrants: Some incentives that nudge on reputation also need counterbalancing. Talking to the experts in the field, Getty Hill from GFX labs emphasizes that new entrants are one of the critical factors for a healthy delegates ecosystem. We agree and think incentive mechanisms that favor the tenure of the delegate or aggregate votes delegated can block the new entrants.

Personal gain: This is not touted as an incentive but a hypothetical situation, a hidden one when the personal gain conflicts with the overall DAO gain. It does not sound fictional in financial decisions and can only be aggregated lack of other explicit incentives.

Future Signals

Where are we headed? It seems delegates will not disappear and will only increase in adoption as more DAOs create their delegate models and introduce compensation. We sought some future signals from the experts in the field:

Kohei Nagata from Senate Labs is excited about the amplifying trend of specialized delegates rather than generalized ones such as risk management and treasury management. This makes sense to us and brings the potential of more compensation models focused on different performance factors.

Getty Hill from GFX labs adds that the grants for delegates and measurement on the quality and scoping are becoming more mature with time and that there are signals it will only get better.

Frisson from Tally.xyz points out the new entrants, such as Buttery Money, providing tools that enable measurement and services to delegates which is a signal of a maturing market. He thinks of the importance of reducing the end-user gas costs associated with delegation through L2s and taxing-relaying services that enable the DAO to cover the costs of delegation like those offered by Tally.

What are the rewards and compensation models you have seen?