The Digital Financial Services and Cross-Organisational Digital Transformations (FINATRAX) research group at SnT, led by Prof. Gilbert Fridgen, conducted a study this year on the governance of DeFi projects. The research paper, entitled “DeFi, Not So Decentralised: The Measured Distribution of Voting Rights” will be presented at the 55th Hawaii International Conference on System Sciences (HICSS) in January 2022. The research was conducted by a team of Prof. Fridgen’s current and former doctoral candidates at SnT: Tom Barbereau, Alexander Rieger, Reilly Smethurst, Orestis Papageorgiou and Johannes Sedlmeir. A more advanced version of the paper is already available as a pre-print “Decentralised Finance’s Unregulated Governance: Minority Rule in the Digital Wild West”. The study shines a light on DeFi’s shadowy and unfair governance, as well as unregistered voting rights – the opposite of registered shareholders’ voting rights from the world of traditional finance. The paper focuses on voting rights issued by five DeFi projects from the new Bloomberg Galaxy DeFi Index: Uniswap, Maker, SushiSwap, Yearn Finance and Universal Market Access (UMA).
DeFi services range from peer-to-peer loans and payments to the exchange of derivative, an instrument whose value is derived from the value of one or more underlying assets. From 2020 to 2021, DeFi experienced spectacular growth; the Galaxy DeFi Index, for instance, represents $65 billion. DeFi projects allow for the distribution of voting rights in the form of tradable tokens – also known as voting right tokens or governance tokens. Tokens define how many individuals can govern a project, and what voting rights are allocated to them. Instead of being majority-owned and controlled by banks, projects are governed by holders of these tokens. But how does it work in practice?
DeFi’s enthusiasts criticise “fat cats” from banks and financial institutions, while their own field breeds a new species of majority shareholders – more commonly called “whales”. Whales can be, for example, a DeFi project’s developers, advisors and early investors, who sometimes accumulate governance tokens before anyone else is able to purchase them via crypto exchanges. The research uncovers this major gap between reality and DeFi’s promotional rhetoric. Although DeFi’s governance is promoted as open, fair and democratic, its voting rights are in fact highly concentrated.
To measure the concentration of DeFi’s voting power, the study employs conventional measures of inequality like the Gini coefficient, which is used to measure inequalities in the distribution of voting right tokens among individuals of the DeFi community. The authors argue in their research that re-centralised is a better fit for DeFi’s governance system than decentralised. They rehash a 19th-century saying from Alexis de Tocqueville, French historian and philosopher: “When a nation abolishes aristocracy, centralisation follows as a matter of course.” History seems to repeat itself.