How to distribute a DAO governance token

DAO governance tokens are like voting chips you can distribute to members of your organization to make decisions. First you need to mint the governance token, and then it’s time to decide how to distribute it! 

We’ll explore how to distribute DAO governance tokens among your community to balance these four critical factors:

  1. Decentralization
  2. Liquidity
  3. Safety
  4. Engagement

How a token is distributed is only one consideration among many in the complex dynamics of governance. 

Let’s dive into each factor and see what existing DAOs have chosen to do:

Decentralization: how decentralized do you want token holding to be?

Since Bitcoin, decentralization has been the founding principle of web3 and is still our collective destination. However, the composition of DAOs—the internal structure of decentralization—is still a work in progress. 

Web3 organizations are experimenting within a broad spectrum of decentralization, from discrete, on-chain applications that are built and run by a single developer, to giant swarms of activists swapping trading tips on public forums. Between these extremes are workstreams or guilds, where subsets of DAO members assemble within a larger whole to collaborate on specialized tasks like development, marketing or operations. 

What your DAO looks like internally will determine the type of activity you can enable and incentivize. For example, giving everyone an equal number of tokens might sound fair, but without additional mechanisms it could be counterproductive if it ends up swamping the marketing guild with hundreds of unsolicited proposals. In that sense, governance power can be thought of like thermal power: it’s more useful and effective when condensed into a flame rather than evenly distributed.

Liquidity: is the token available to buy on the market?

Liquidity is the ability of a token to find its true value on the market. The concept is closely related to decentralization in that the more people hold the token, the more transactions there can be to estimate true value. 

A caveat to this is that even the broadest distribution needs concentrated pools of tokens to trade in and out of. For this reason, many projects dedicate a percentage of their tokens to provide liquidity on exchanges to ensure adequate liquidity for traders.

Safety: can one entity gain control of your entire DAO?

Another consequence of decentralization is safety. It’s essential to ensure that no single entity can gain a controlling stake of your DAO’s governance power and pass a proposal to drain the treasury. This is commonly known as a 51% attack, but the actual percentage will vary according to the DAO’s threshold for passing a vote. 

Safety involves many factors alongside the distribution of raw governance power, such as the proposal duration, quorum threshold and veto rights, but without a broad distribution, the other factors are much less effective.

Engagement: how many members are voting?

A lack of member engagement - measured by quality proposals and value creation - can be a direct result of poor distribution. If governance token allocation is heavily weighted towards insiders such as the founding team and investors, then the community may feel - at best - unimportant or - at worst - like bag-holders in an exit scam. 

DAO members are sensitive to “decentralization theater” and very unlikely to contribute their time, talent, and effort to an organization if they see that their impact will be negligible.

Legal considerations for token distribution

Before moving to the distribution models themselves, it’s worth reiterating that technology is always several steps ahead of regulations. This is especially so in web3 where the legal landscape for platforms and DAOs is constantly evolving. In principle, legal frameworks in the US and Europe permit everything unless it has been specifically prohibited. In practice, new laws can be applied retroactively and existing laws can be reinterpreted to include recent developments. 

Therefore, it makes sense to make sure that you are up to date with the laws in your jurisdiction and follow a few simple principles:

  1. Consult a legal advisor. Good advice doesn’t need to be prescriptive and will usually provide a range of options that can ground your plans on industry best practices and boundaries that shouldn’t be crossed.
  2. Follow the spirit of the law. Financial regulators are mostly concerned that users are not misled so keep this in mind and be as transparent and informative as possible when planning and communicating your distribution.
  3. Aim for ‘Sufficient Decentralization’. Sufficient decentralization was a concept introduced by the U.S. Securities and Exchange Commission (SEC) in 2018 to describe the point when an organization is too loosely affiliated to be prosecuted as a legal entity. 

Follow the herd. Web3 is a frontier technology, but when it comes to the law, it pays to be a follower and use tried and tested methods that have worked for other DAOs. For specific details on existing legal wrappers, read our guide on How to Choose a Legal Wrapper.

Distribution Models

The Airdrop - Uniswap

Airdrops are the easiest and one of the most common ways to distribute governance tokens, immediately adding potentially thousands of nominal members to your DAO. While this method is great for decentralizing a token holding, it can lead to price speculators holding your governance token rather than engaged DAO members. 

Uniswap did this to great effect in 2020 by gifting early users with 400 or more $UNI tokens and the power to vote on proposals. However, the evidence of its effectiveness is mixed. Despite Uniswap’s $4bn market cap and a healthy 70+ proposals since the airdrop, research by the Dune community has found that 98% of the original 250k $UNI recipients haven’t participated in governance and 93% sold their tokens.

On the one hand, Uniswap’s airdrop took the DAO from zero-to-one overnight, enlisted the collective wisdom of thousands of its users, and increased user loyalty. On the other hand, Uniswap already had a very strong market position and it is clear that most recipients simply took the money and ran. For every $UNI seller, there was a more engaged buyer, and Uniswap has emerged with a distribution of ~343k holders, which might have been more difficult to achieve without the airdrop. Importantly, the distribution was broad enough to prevent a dangerous accumulation of governance power.

Since 2020, airdrops have lost their novelty and can be a nuisance when dozens of them arrive unsolicited and clutter one’s wallet. However, a strong community, combined with a well executed awareness campaign could distinguish your airdrop as one worth holding.

The Liquidity Bootstrapping Pool - KlimaDAO

For smaller DAOs, raising enough $ETH or stablecoin to pair with the DAO token in a liquidity pool can be a barrier to a broad distribution. Even if the capital can be raised, setting the initial price too high can lead to too few holders, whereas a low price leads to ‘gas wars’ and allows whales - aided by trading bots - to buy up the available supply, force up the price, and then either dump it on retail buyers, or wield a large amount of governance power.

To overcome these cold-start problems, KlimaDAO used a solution developed by Balancer, called a Liquidity Bootstrapping Pool (LBP). This technique launches your DAO token with a high price that drops algorithmically over a set duration, disarming whales and enabling genuine candidates to join the DAO at a fair price. KlimaDAO began with a 96:4 $KLIMA / $USDC pool and sold 95% of their tokens in 72 hours, raising over $17m.

With a market cap of $14.5m, $KLIMA currently has 18k holders and 60k stakers, which is an extraordinary 63x more liquid than $UNI, relative to its size.

For DAOs wanting to launch a liquidity bootstrap or standard crowdfund, Aragon has partnered with Prime Launch to make the process as easy as possible. Simply mint your tokens using Aragon Client, then go over to Prime Launch to begin your distribution

The Batch Auction - API3

Route-one for DAOs would be to simply release tokens and sell them to the highest bidder, but as discussed in the Bootstrap section, this can lead to sophisticated front-running exploits. A variation on the LBP is a Batch Auction, where the auction host sets their minimum sale price and bidders submit their maximum bids at any price above it. At the end of the auction, all of the bids are ranked and the tokens are allocated from the highest bid downwards until there are none left.

For their launch, API3 used a variation of the batch auction on the Mesa DEX, an open-source interface to the Gnosis Protocol. Instead of potentially leaving all of their tokens available to the highest bidder, the tokens were available in tranches along a logit-shaped curve with a floor price of $0.30 and a ceiling price of $2.00.

Batch Auction Allocation

At its conclusion, API3’s auction raised $23m. One unexpected consequence of using a relatively new mechanism was that the Gnosis Protocol was exploited during the early stages of the launch, allowing an attacker to buy 1,633,500 $API3 from the four lowest tranches at $0.57 per token, raising the average price for everyone else by about 7%. Thankfully, these events are rare and the specific vulnerability has now been patched, but it is another example of how it pays to follow the crowd and stick to the most battle-tested methods.

$API3 currently has ~19k holders on a market cap of $100m and the DAO has processed 52 proposals at the time of writing.

The Crowdfund - SpiceDAO

A fourth mechanism is the crowdfund, famously used by Constitution DAO in an attempt to buy a copy of the U.S. Constitution. 

Following in the footsteps of Constitution DAO’s, SpiceDAO used the Juicebox platform to raise Ξ2,600 ($3m) from thousands of contributors to bid for a production manual for a failed production of the film Dune. All of the $SPICE tokens were distributed pro-rata according to individual contributions, but in the process the DAO made several strategic and administrative mistakes, which ultimately led to its dissolution.

By the time of the auction, the DAO had raised $700k, but the price climbed well above that number, leading one of the DAO’s multisig members to make the winning bid of $3.01m with his own money (paying around 100x the original estimate for the lot). The DAO eventually raised the $2.3m shortfall but not before realizing that they did not have the intellectual property rights to scan and distribute the book or launch an animated series as they had planned. SpiceDAO has since rebranded to ‘Spice Club’ and are planning to sell their ‘Dune bible’ in Q4 2023 to coincide with the release of Dune: Part II, but they are expected to make a significant loss on the original purchase price.

The SpiceDAO story highlights the need for DAOs not to skip the necessary planning and due diligence before raising money. Although SpiceDAO achieved a broad distribution and generated significant enthusiasm in their DAO, in the end they had not spent the time to build the expertise necessary to successfully execute even their most modest objectives, let alone evolve into a full-service web3 production studio. All of the subsequent problems sprang from this initial naivety.

The Career - DecentDAO

The Career method is when your work directly leads to gaining governance tokens. For example, if you write an article, you’re paid in governance tokens that increase your power. 

DecentDAO is a product accelerator that runs as a simple meritocracy where members contribute work to the DAO in exchange for governance tokens. As members’ vote weight increases, they are naturally assigned more management responsibility by being able to create more proposals and have a greater say on whether proposals are approved or rejected.

The Career DAO model is designed to grow the distribution at a much slower pace than, say, an airdrop, but in doing so it is optimizing for the more intangible qualities of competence, commitment, loyalty, and job satisfaction that have always been critical to the success of any organization.

Conclusion: Be Prepared!

Overall, the method you choose depends on your unique needs as a DAO. For distribution, nothing beats an airdrop, but it requires separate liquidity provision, which the Bootstrap method provides by default. The crowdfund has high engagement because of the excitement it generates, but doesn't have the same safety that others do.

Slow Start can generate hype and get the governance power into the hands of engaged individuals at first, but if price pumps they fall into the same issues of speculation, low engagement, and risk of 51% attacks. The Career method hasn’t been as battle-tested but it will be interesting to see if a meritocratic token distribution works without centralizing power too much. 

Ultimately, these descriptions are only approximations and the success of any distribution will be in its execution. 

A common thread running through all of these methods is preparation. A straightforward airdrop done well can create a lively and productive DAO far better than a more sophisticated strategy done badly.

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