How to truly decentralize DeFi?

Currently, one of the main criticisms of decentralized finance (DeFi) is how decentralized it is?

Critics assert that if the Maker, 0x, Compound, etc. agreement is to control the smart contract of the agreement through a centralized company, and can close or terminate the contract at any time, then these agreements can not be labeled as "decentralized" s Mark. They believe that these agreements should at best be described as unmanaged financial services.

Although the argument is reasonable, there are many strong arguments to justify these “controls.” The most reasonable argument is to consider the time dimension: The DeFi protocol is not 100% decentralized from day 1. But it will become more and more decentralized over time. At the same time, there should be mechanisms, such as the ability to start a self-destruct switch in an emergency to stop the operation of the protocol, thereby protecting the user's funds.

Another strong argument for defense is that all of these DeFi protocols are open source and auditable . If the development company of an agreement decides to close/terminate the project, other companies/individuals may use the code for that agreement.

Regardless of which camp you belong to, you need to admit that DeFi still has room for improvement in decentralization. And DAO (Decentralized Autonomous Organization) may be the best tool to further improve the decentralization of DeFi products. DAO allows DeFi users to make decisions about major decision making, such as adding features to the DeFi protocol, or deploying a new version of the DeFi protocol.

In addition, users can vote on who will launch the emergency self-destruct switch, and even vote to create a "child DAO" (sub-DAO) to handle this important task.

In this article, I will discuss why the DeFi protocol will ultimately need to decide whether to delegate control of the agreement to DAO for true decentralization or to become a centralized enterprise that provides unmanaged financial services on the public chain. . Both options can be a sustainable and effective model with different goals and compromises.


Although the concept of DAO is the cornerstone of the decentralization of DeFi projects, this does not mean that projects such as Maker and Uniswap are 100% decentralized. On the contrary, although these DAO projects have already set the road towards complete decentralization, there is still a long way to go to achieve this goal.

Why is DAO important for DeFi decentralization?

First, we need to explain the definition of DAO:

1. The membership of DAO is open and is not limited to only certain groups/individuals;

2. DAO members/investors can propose decisions/vote for decisions, and no decision can be blocked or modified by a central authority;

3. DAO members obtain economic incentives directly or indirectly through participation, thus ensuring consistency of incentives.

These features of DAO are critical to achieving truly effective decentralization. In this sense, we can think of Bitcoin as the most successful DAO. In the Bitcoin network, anyone can participate by running a node or just holding a BTC. Anyone can propose, support or criticize a Bitcoin Improvement Offer (BIP), and eventually all those involved can (at least Inter-ground) Benefit from participating in and keeping the system running according to the rules.

As such, these features make DAO a great governance mechanism for truly decentralizing DeFi products.

Another benefit of using the DAO governance mechanism in the DeFi protocol is that if this mechanism is used properly, it will help developers of the DeFi protocol mitigate some of the regulatory risks. In fact, this is a complex and subtle topic involving the legal level, and it is worthwhile to write a separate article to elaborate. While many developers believe that if they don't have full control over smart contracts, they should not be responsible for how they are used, but regulators such as the SEC (the US Securities and Exchange Commission) disagree.

Decentralized autonomous organization MakerDAO

MakerDAO was one of the earliest DeFi projects that recognized the need to manage many of the key parameters required to run a Maker project through DAO.

The most notable of these is the stability fee, which is the interest charge on CDP (guaranteed mortgage debt). In March and April of this year, MKR token holders continued to increase the stability fee by voting. In this way, the price of DAI was stabilized at US$1, because the transaction price of DAI was lower than the anchor price. 4%.


Another important decision that MKR token holders need to make by voting is for the multi-mortgage guarantee DAI (MCD), which ERC20 tokens users can choose to use as collateral. According to the official blog of MakerDAO on June 27th, the Maker community will vote in REP, BAT, DGD, 0x, GNT, OMG and other tokens to become the first candidate assets that can be used as collateral.

Although Maker's DAO structure is based on many of the governance rights of MKR token holders, Maker's DAO structure is not perfect:

In theory, although almost all decisions related to Maker can be decided as a governance proposal by voting, many decisions are not made by voting, such as the employment of Maker team management members and the use of project funds.

Another limitation of MakerDAO is that the current distribution of MKR tokens makes it possible for a large number of entities holding the most MKR tokens to vote.

Decentralized Exchange & DAO

The Decentralized Exchange (DEX) is one of the first products in the DeFi field. While the goal of DEX is to enable users to trade and exchange tokens in an unmanaged and decentralized manner, DEX is the most difficult system to achieve decentralization without sacrificing critical functionality and performance . We can explain this through the core operations of DEX. The core operations of DEX include:

1. Decide which tokens to put on the shelves;

2. Organize order books to speed up transaction execution and order matching;

3. Obtain transaction fees as income from DEX.

Among the above three core operations, the second one is the most difficult to achieve decentralization . Although it is possible to create an order book by generating a limit order by means of a chain transaction, this method is costly and has a large performance bottleneck. And even in this case, a centralized server and website are needed to read the blockchain data and display the order book to the user. Improving performance usually means using a centralized chain order book and a transaction matching engine, which increases the degree of centralization of the system.

And DAO has always been considered a mechanism to solve this centralization problem , as we have seen in decentralized exchanges such as IDEX, 0x, and Uniswap.

Uniswap's stealth DAO structure

Although the Uniswap project team did not label itself as a DAO structure, a careful study of how Uniswap works can be found to be fully compliant with the DAO definition.

In the three core operations of DEX mentioned above, Uniswap implements the second most difficult decentralized operation in an automated manner and implements 1st and 3rd in a DAO-like manner. Operations.

The most difficult part of DEX, market making and order matching, Uniswap solves this problem by using an automated market-making technique and creating a transaction price that is automatically determined by smart contracts.


In terms of which tokens are placed on the decision, Uniswap allows any participant to create a pool of liquidity for the tokens of the ETH or DAI or any other token for the tokens that need to be put on the shelves. On the shelves "any ERC20 tokens are used for trading . By providing liquidity to the liquidity pool, participants can share a portion of the revenue of the liquidity pool.

Participants can also “ off the shelf ” by retrieving liquidity and destroying the share in the liquidity pool.

Through this process, Uniswap participants have the right to put on/off any ERC20 tokens.

In addition, all Uniswap transaction fee income (a fee of 3% per transaction) is returned to the provider of the liquidity pool. In this way, Uniswap participants can earn revenue directly by running the system.

Given this structure, Uniswap is fully compliant with the DAO definition ; 1) it is an open organization where anyone can provide liquidity to generate revenue; 2) Participants can decide by allocating funds to their chosen pool of liquidity On the shelf or off the token, the Uniswap team cannot organize the decisions of the participants; 3) Participants can directly benefit by holding the share of the organization.

In addition, Uniswap can manage and benefit from a formal DAO organization, such as decentralized decisions such as changing the fee structure, upgrading automated market-making techniques, and increasing the features of Uniswap DEX.

Why are some DeFi projects not DAO?

Many interesting DeFi projects and agreements implement some elements of DAO, such as voting or gaining revenue through participation in agreements. However, if these projects/protocols do not meet the three main characteristics of the DAOs listed above, they cannot be classified as DAOs.

For example, the loan agreement Compound runs anyone involved, and the participants in the agreement can benefit from the interest earned, and the platform operator can vote to decide which tokens to offer as loans or collateral, just as the previous Compound community voted. The way is to place the WBTC token on the platform as a loanable asset. However, this type of voting is not binding and the Compound team can ignore the voting results, so the Compound protocol is not a DAO.

Compound's vote is in stark contrast to the way MakerDAO votes through smart contracts because the voting results of the MakerDAO system cannot be overturned by the project team.

Similarly, decentralized exchange IDEX is decentralizing the platform by adopting a gradual approach, ie IDEX allows users to run the project's infrastructure by staking the tokens of the project. Users who assist in participating in the infrastructure node of the platform will be able to obtain a certain percentage of platform transaction fees (currently 25% of the platform's transaction fees). However, IDEX does not conform to the definition of DAO because users do not have the right to decide which tokens can be placed on the exchange, and therefore are not DAOs.

What aspects of DAO can benefit from DeFi?

In addition to improving the decentralization of current Ethereum-based DeFi products, DAO can also play an important role in bringing DeFi into Bitcoin.

Many of the possible ways to use Bitcoin in DeFi rely on creating a sidechain (such as the bitcoin sidechain Liquid created by Blokstream), which can be converted to the native currency L-BTC of the Liquid network by the sender and in the Liquid network. Complete the fast transaction, after the transaction is completed, the receiver will convert the L-BTC into BTC), or create an area (such as WBTC and Cosmos) that anchors bitcoin on other blockchains such as Ethereum.

The basic problem with this solution is to choose whether the verifier of the maintenance anchoring process is decentralized enough.

For example, Blockstream selected 35 trusted entities for the Liquid sidechain as members of Liquid Federation (including some exchanges and financial institutions) to monitor the anchoring process with the Bitcoin blockchain. The problem with this approach is that the verifier's choice is central .

But this problem can be significantly improved by adopting the DAO structure, that is, the participants decide who can act as a verifier . DAO participants can also earn a transaction fee generated in the anchor area as a reward to motivate the verifier to run the platform honestly.

Author | Mohamed Fouda

Compile | Jhonny