The Futarchy Experiment
Deep dive in to the concept of Futarchy, with MetaDAO's radical governance experiment at the center.
META’s price increased from just $40 to a whopping $1600 in a matter of a few days.
META is a token of MetaDAO, a project that was undercover for months and nobody had any idea about has taken over Crypto Twitter. The reason? Proposal by Panterra, one of the biggest VCs in Crypto. MetaDAO is a futarchy-based market on Solana. Simply speaking, in this case, the proposals are passed or failed based on the price of the META token decided by the prediction market(s).
To find the correlation with the causation, we must take a step into what MetaDAO is trying to achieve through its unique approach to solving human governance and decision-making. The face value of futarchy might seem very logical which it is, but it's more than that. It's about basic human psychology, how we feel about any information, and our actions based on that in society. It is an experiment to solve the human coordination problem.
As the creator of Meta-DAO Proph3t states, "The goal of the DAO is to make the number go up". But how? Let's find out in this deep dive. We will explore what and how’s of Futarchy, real-world case studies based on Futarchy, and if it’s sensible to use in a crypto-based system.
A primer on decision-making
Meta-DAO's rapid growth has attracted the interest of venture investors, including Pantera Capital. The large cryptocurrency investment company had an active proposal to purchase $50,000 worth of META tokens from the DAO at a price well below the current market value. Though the proposal failed and the deal didn’t go through, but it made Meta-DAO a talking point throughout Crypto Twitter.
This is not the first example where we are seeing futarchy. It is simply a form of a prediction market to bet on a certain outcome based on what information you have and their interpretation. As infamously said, “Vote on values, bet on beliefs.” It is a paper from Economics professor Robin Hanson who introduced Futarchy in a 2007 paper.
The idea behind this concept is that speculative markets might be better at making decisions than pure democracies. In speculative markets like the stock and betting markets, participants are motivated to conduct thorough research to understand the best outcome that aligns with their interests. They will then buy or sell based on that knowledge. This belief is rooted in the notion that numbers possess information that is not directly visible to us.
Futarchy reduces irrational social influences in governance. Taller presidential candidates were likelier to win elections in the 20th century, while voters picked George Bush because he seemed "like a guy you could have a beer with". Futarchy encourages focusing on proposals, not personalities, through introverted activities like poring over models, statistics, and trading charts.
Futarchy is a nuanced implementation of Robin Hanson’s other brainchild prediction markets, where traders bet on the outcome of verifiable events within a time frame. e.g. “Presidential Election Winner 2024”
While traditional general elections are not considered prediction markets, alternative methods like the Iowa Electronics Market (IEM) have emerged as intriguing tools for gauging public opinion. Launched in 1988, the IEM, involving universities like Harvard and MIT, has often shown greater accuracy than mainstream media polls in predicting election outcomes.
Beyond elections, prediction markets like PredictIt and Kalshi are gaining traction in various domains. Kalshi, for instance, facilitates prediction markets on diverse topics ranging from economic indicators (inflation, unemployment) to political events (government shutdowns) and even entertainment (Oscar winners).
Here's how these markets work:
Participants predict the outcome of an event by purchasing shares representing specific possibilities.
Prices fluctuate based on supply and demand, reflecting the collective sentiment of the market.
Payouts are determined by the actual outcome, rewarding participants who accurately predicted the event.
Some big companies like Google and HP have successfully utilized prediction markets to forecast launch dates, printer sales, and office opening dates
Prediction Markets + Governance = Futrachy
Those who know they are not relevant experts shut up, and those who do not know this eventually lose their money, and then shut up. — Robin Hanson
This is how Futarchy is supposed to work. Everything boils down to making sure people are trying to act in the best interest of their surroundings. But most of the time humans make their decisions based on either Self-interest (what’s in it for them) or conformity bias (following the crowd without any evaluation).
A system where:
You vote on desired outcomes for your community.
Experts propose different ways to achieve those outcomes.
Prediction markets determine the most effective approach, based on collective wisdom and potential impact.
Futarchy combines traditional voting for goals with prediction markets to choose the most effective paths, aiming for smarter, more informed, and community-aligned policies.
In futarchy, democracy would continue to say what we want, but betting markets would now say how to get it. That is, elected representatives would formally define and manage an after-the-fact measurement of national welfare, while market speculators would say which policies they expect to raise national welfare.
The basic rule of government would be: When a betting market clearly estimates that a proposed policy would increase expected national welfare, that proposal becomes law.
Vote on Values:
Imagine voting on metrics that represent your priorities.
Instead of directly electing officials, you vote on what matters most, like environmental sustainability or economic growth.
These metrics become the guiding principles for the system.
Bet on Beliefs:
Once core values are established, prediction markets come into play.
People can bet on the future outcomes of various policies based on their beliefs about how they will impact the chosen metrics.
These bets collectively signal which policies are believed to be most effective in achieving desired outcomes.
Politicians set the goals, but the markets pick the path. This is the core idea of Futarchy.
With this system in check, Futarchy can:
Align decision-making with shared priorities as defined by the community.
Leverage collective intelligence through prediction markets to identify potentially effective policies.
In an ideal scenario, one should pick the choice in which global benefits will outweigh the action’s global costs. But in the real world, it's far from real. People are greedy and often think about their benefits first.
In practical terms, leaders may sometimes prioritize their self-interest over the well-being of the group they represent.
we are yet to find a proper solution to these theories, but there have been many efforts to solve these human co-ordination problems. Starting from democracy to the decentralized governance models and DAOs.
DAOs
DAOs face the similar fundamental challenge of expressing the will of their members while navigating technical hurdles. A core question is whether to adhere to the "one person, one vote" principle. However, creating multiple wallets to bypass this system is technically straightforward.
To bypass this many DAOs address this with quorum token-based voting combined with expiry dates:
A threshold of tokens (e.g., 30% of total supply) must participate for a proposal to pass.
Votes are cast by committing tokens to a proposal, indicating support or opposition.
If the threshold is reached within a set expiry date, the proposal passes with a majority vote within the participating tokens.
This approach tackles several issues:
Voter Apathy: Not all token holders want to actively participate in governance actively, often viewing their tokens as financial investments rather than governance tools. This is very important to understand while considering people's motivation in a governance system.
An example here can be Elastic DAO, where “Active participants are rewarded while bad actors are penalized if their inaction leads to an inability to reach quorum.”
Limited Incentive: While token price and project success are linked, the incentive to vote for major changes is often weak, and even less so for smaller matters.
While DAOs excel at making decisions collaboratively through futarchy, the challenge lies in execution. This necessitates focusing on efficient implementation strategies to translate decisions into real-world actions.
Futarchy has been attempted before in the crypto space. In 2020, Gnosis DAO committed to utilizing futarchy through prediction markets to govern their decision-making.
Recently Zeitgeist, a project built on Polkadot SDK proposes integrating prediction markets into Polkadot to boost voter participation and explore their deeper implementation with their ecosystem.
Before delving into the core assumptions of Futarchy, let's establish the context:
The Information Bottleneck: Democracies rely on elections to make decisions, but the vast amount of information can overwhelm these systems, leading to potential biases and inefficiencies.
The Desire for Measurable Progress: To evaluate success, objective metrics like wealth and happiness can provide insights into societal progress.
The Power of Collective Prediction: Humans, individually and collectively, possess a remarkable capacity to anticipate future outcomes. However, harnessing this collective intelligence effectively remains a challenge.
While traditional democratic systems might be valuable, they have limitations in dealing with the complexities of the modern world and are easier to manipulate. In this context, Futarchy presents a novel approach that aims to leverage collective intelligence and prediction markets to overcome some of these challenges.
Meta-DAO implementing Futarchy
MetaDAO presents a novel approach to organizational governance by proposing decentralized control through executable code. Instead of relying on traditional human leadership, MetaDAO utilizes instructions stored on the Solana blockchain to automate decision-making.
The process is simple, you first submit a proposal with a clear idea of what the choices are and the instructions clearly outlined. Once the proposal is launched, two separate markets will be created. A pass-and-a-fail market is simply a prediction market. Market participants trade in these markets with the DAO’s native token META, based on what they want to support. The decision is based on which market has the highest price of META (more than 5%).
TL;DR: People trade on the market based on how much “$META” the token would be worth if the proposal passes vs how much it would be if it failed.
The TWAP (Time-Weighted Average Price) is an important part of this system. It executes the SVM (Solana Virtual Machine) instruction if and only if TWAP (pass) > TWAP (fail).
Meta-DAO is composed of 3 open-source programs:
A conditional vault program,
A time-weighted average price (TWAP) program,
It is built on top of the OpenBook V2’s central limit order book.
The autocrat program that orchestrates futarchy.
Conditional Vault Program
Traditional financial markets allow for trade reversals in specific scenarios. Blockchains, however, lack this functionality, creating a hurdle for implementing futarchy. Conditional tokens address this challenge by:
Representing Claims on Underlying Assets: These tokens are pegged to specific underlying assets (e.g., META, USDC) and contingent upon the outcome of a designated event (e.g., proposal passage/failure).
Enabling Conditional Redemption: Two types of conditional tokens are issued:
Conditional-on-Pass: Redeemable for the underlying asset if the event occurs (e.g., the proposal passes).
Conditional-on-Fail: Redeemable for the underlying asset if the event does not occur (e.g., the proposal fails).
Mechanism:
Conditional Vault Creation: A designated entity (e.g., MetaDAO) establishes a vault linked to a specific underlying asset and itself as the settlement authority.
Underlying Asset Deposit: Users deposit underlying assets into the vault in exchange for both conditional token types, effectively splitting their claims into two contingent outcomes.
Settlement: Upon event resolution (e.g., proposal outcome), the settlement authority finalizes or reverts the vault, enabling holders of the corresponding conditional tokens to redeem their underlying assets.
Example:
A user deposits 10 USDC into a vault associated with a proposal. They receive:
10 conditional-on-pass USDC or pUSDC (redeemable for 10 USDC if the proposal passes)
10 conditional-on-fail USDC or fUSDC (redeemable for 10 USDC if the proposal fails)
For each proposal, two markets are established:
Conditional-on-Pass META (pMETA) traded for Conditional-on-Pass USDC (predicting proposal passage)
Conditional-on-Fail META (fMETA) traded for Conditional-on-Fail USDC (predicting proposal failure)
These markets allow participants to express their convictions regarding token value based on anticipated proposal outcomes. Conditional tokens are designed to mitigate losses from incorrect predictions by allowing you to redeem your tokens based on the outcome. However, they don't eliminate all risks.
The TWAP program
All Meta-DAO markets are on OpenBook v2. There didn’t exist a TWAP oracle for OpenBook or any other Solana AMM or CLOB, so Meta-DAO built one for themselves. It is based on the same design as Uniswap V2 and uses some mechanisms for manipulation-resistance
The Autocrat: Orchestrating Futarchy in MetaDAO
The autocrat program serves as the central engine of MetaDAO's futarchy system, helping proposal creation, execution, and market settlement.
Key Functionalities:
Proposal Creation: Anyone can submit proposals through the autocrat, specifying details like:
Proposal number
Proposal descriptive link
Executable Solana Virtual Machine (SVM) instruction outlining the intended action (e.g., transferring 100 USDC to X address from Y address)
Upon proposal creation, corresponding conditional vaults and markets are automatically established. After a predefined timeframe (currently 10 days), anyone can initiate the finalization process.
TWAP-Based Outcome Determination: The autocrat compares the Time-Weighted Average Price (TWAP) of the "pass" market (predicting proposal success) with the TWAP of the "fail" market (predicting proposal failure).
Execution and Settlement:
If the "pass" market TWAP is higher:
The SVM instruction is executed.
The "pass" market finalizes.
The "fail" market reverts.
Otherwise:
The proposal is marked as failed.
The "fail" market finalizes.
The "pass" market reverts.
By “finalize” it means, that one of the two markets, either "pass" or "fail," is ultimately "realized." Those who have the relevant conditional tokens associated with the winning market (pUSDC and pMETA for "pass," fUSDC, and fMETA for "fail") into their underlying REAL assets (USDC and META).
Conversely, market “reverts” simply means conditional tokens from the losing market (fUSDC and fMETA for "pass," pUSDC and pMETA for "fail") are rendered invalid and cease to have any value and are burned.
As you can see, like prediction markets, it’s a zero-sum game!
Participating in the Market and Valuation
As only one market becomes "real" upon finalization, converting its tokens (pUSDC/pMETA for "pass" or fUSDC/fMETA for "fail") to the underlying asset (USDC or META). Tokens in the losing market become worthless.
Trading Considerations:
While both markets experience trading activity, the outcome is unknown until finalization. This means:
It's uncertain which tokens will receive value (become backed by the underlying asset).
Both markets experience "real" trades, but only one set of trades translates to actual value capture.
Proposal 10 — Meta-DAO As you can see here in this proposal, the passing market TWAP is higher than the fail market and people are trading based on either of the markets according to their belief.
Your Role as a Participant:
Evaluate proposal value impact on MetaDAO: Consider the potential impact of the proposal on the price of META.
Form an opinion on META's price: Is it undervalued or overpriced based on your perspective?
Align your trading with your price assessment:
Buy META if undervalued: You believe it's a good investment at the current price.
Sell META if overpriced: You believe the current price is too high.
Contribute to price discovery: Your reasoning and actions, along with others, collectively influence the market price through buy and sell pressure.
Financial Model Analysis:
Scrutinize provided financial models: Most proposals will present a breakdown of potential revenues, even if speculative.
Distinguish short-term gains vs. long-term value creation: Differentiate between proposals offering immediate benefits and those building lasting revenue streams. And analyze how the proposal might impact the value of META in different timeframes.
Valuation Methods:
Comparable Valuations: Compare the Meta-DAO with similar projects (e.g., DeFi projects, web3 start-ups) based on market capitalisation or conversion cap. META token link
Venture Capital Method: Estimate the current valuation based on a potential future exit value and your desired return rate.
In the end, it comes back to
People trade on the market based on how much “$META” the token would be worth if the proposal passes vs how much it would be if failed. The market with a higher value will get finalized.
Meta-DAO’s Structure and Operations
Members:
Single-product, profit-seeking entities: Similar to sub-DAOs in Helium, each member manages its own treasury, token, and operations (grants, payroll, suppliers).
Collective: A group of members forms a Meta-DAO, focusing on a specific area like DeFi. For example, a DeFi Meta-DAO could have members managing an AMM and a yield vault.
MetaDAO doesn’t have any hierarchy, but we can classify the members into a few categories. And someone can also wear multiple hats we all do at times.
Analysts: Thinkers, analyze markets to guide resource allocation. Emotionally detached, data-driven, potentially high earners.
Entrepreneurs: Mobilizers, identifying projects, rallying support, and building teams. Multi-skilled, risk-taking visionaries.
Cyber-Agents: Implementers, coding, designing, marketing, and managing partnerships. The backbone of execution.
Proposals for Action
Proposals drive everything in MetaDAO. They fall into four categories:
Business: Focused on creating and managing revenue-generating products.
Projects: Launching new products or significantly revamping existing ones.
Direct Actions: Fine-tuning existing products (e.g., changing prices, marketing strategies).
Operations: Supporting the MetaDAO's infrastructure and resources.
Projects: Setting up new teams, upgrading software, establishing partnerships.
Direct Actions: Hiring new staff, allocating funds for specific tasks, making minor system adjustments.
Anyone can submit direct action proposals, while project proposals typically come from responsible entrepreneurs. Use any document app (e.g., Hackmd, Google Docs) to draft your proposal and choose the appropriate template based on its category.
Funding and Incentives
Projects: Entrepreneurs set budgets and allocate funds for execution (team size, compensation).
Cyber-agents: They paid immediately upon completing tasks (e.g., bounties for GitHub issues).
Entrepreneurs: Earn long-term, performance-based compensation (e.g., options, vesting contracts, performance metrics).
Operations: Retroactive compensation planned for valuable contributions (e.g., Meta-DAO points).
Decision-Making:
Improvement Proposals: Members propose actions through proposals containing commands. Each command specifies a member and a specific action they can take (a Solana instruction).
Impact Estimation: The Meta-DAO estimates the impact of each proposal on the valuation of all members (in a base currency).
Decision Rule: The proposal is executed only if the sum of all estimated impacts is positive. This ensures decisions benefit the entire ecosystem, not just individual members.
Example:
A proposal suggests member A raise prices, potentially increasing its profitability.
However, if member B shares a brand with A and relies on low costs for marketing, the proposal could harm B.
If the estimated impact is +$10M for A and -$15M for B, the proposal is rejected (-$5M total impact)
Calculating Impact:
The impact on a member's valuation is calculated by:
Subtracting the fail price from the pass price.
Multiplying the result by the total supply of the member's token.
There are limitations of market prices as perfect reflections of their intrinsic value. Take the example of meme coins like dogecoin or GameStop from traditional markets. While we look at these experiments we need to understand a few things
Relative accuracy matters: Even if not absolute, market prices can be more accurate than alternative methods like expert opinions, as evidenced by various studies across diverse fields.
Market superiority: Despite imperfections, markets are demonstrably harder to manipulate compared to other institutions.
Focus on fundamentals: While outliers exist, most publicly traded companies exhibit price movements correlated with fundamental metrics like growth rates in SaaS companies.
How do you bootstrap Pass-Fail Token Markets?
Low liquidity and limited interest in the early stages of a Meta-DAO.
Incentivizing participation: Traditional liquidity mining or network mining approaches could involve members allocating tokens to reward early market participants.
Social benefits: Offering NFTs or other social benefits could attract early adopters.
Temporary human oversight: A multisig with veto power over proposals could be implemented as a temporary measure during the initial stages.
Can’t Whales Manipulate it easily?
Proposal 6: Ben Hawkins from Solana Foundation - Offer to buy $50k of META at $33 each (40% discount from the spot price at that moment)
This proposal failed even though Ben Hawkins tried to manipulate the market by buying in the pass market with an additional $250k. This example shows that while whales can attempt to manipulate the market, it is not always successful. Here are some reasons why:
Direct intervention:
Why can’t someone just manipulate by buying in the fail market and selling the pass market? until the pass price was lower than the fail price. If someone is willing to sell pMETA for very cheap in the pass market, that creates an opportunity for someone to buy. They are buying at a lot cheaper price than it's worth and vice versa.
Disinformation campaign: Ethically problematic, damaging personal credibility.
Conditional negotiation: Sets negative precedent, harms individual's token value.
META-DAO so far…
Out of 10 proposals, 4 were approved, and currently, one is active. Each new proposal initiates with a Dutch auction, starting at a high price that decreases linearly until someone places a bid to present the next proposal, thus preventing spam.
As the market approaches its conclusion, it becomes more decisive, with one market showing high certainty and the other turning pessimistic. In this context, a more sophisticated statistical approach could enhance decision-making, as opposed to relying solely on a simple Time-Weighted Average Price (TWAP). Shortening the market duration might also be beneficial.
Implications — Liquidity Concerns:
Futarchy relies on prediction markets, which can face liquidity challenges, especially for smaller markets.
Addressing the liquidity challenge, trading in a Prediction market is inherently zero-sum. A potential solution could involve redistributing the DAO's positive externalities to traders and market makers, thus creating a more equitable ecosystem.
Another solution would be to move to an AMM structure – These can be highly beneficial for smaller markets, providing continuous liquidity and facilitating efficient price discovery.
Improvements to Futarchy:
1. Agenda Control and Proposer Incentives:
Limited Proposal Rate: Putting a rate limit on proposal submissions helps prevent spam and allows for focused consideration of each proposal. There should be clear criteria for who can submit proposals ensure alignment with the project's goals and prevent irrelevant or malicious proposals.
Third-Party Proposals: Incentivizing third-party proposals, potentially through a bounty system or a share of the proposal's outcome (e.g., 5% of the total outcome goes to the person creating the proposal), could broaden participation and 3rd party perspectives.
2. Market Inefficiency and Price Noise:
In scenarios where the market becomes highly confident about an outcome, the incentive to trade in the opposing market can indeed decrease. This can lead to reduced liquidity and potentially increased price volatility in that market.
Alternative Metrics for Market Sentiment: While TWAP (Time-Weighted Average Price) captures the average price over a period, exploring alternative metrics like volume-weighted average price or advanced statistical models could provide more nuanced insights into market sentiment, potentially mitigating the impact of low trading activity in one market.
3. Addressing Market Manipulation: Building mechanisms to detect and penalize manipulative behavior can deter attempts to exploit the system. This could involve transaction history analysis, identifying suspicious trading patterns, and potentially imposing penalties like temporary trading bans or token confiscation.
4. Exploring Advanced Oracles like Statistically Trained Oracles: As suggested, utilizing advanced statistical models or machine learning algorithms as oracles could potentially offer more sophisticated interpretations of market data compared to the current TWAP approach.
Furturary and the Future: Trends to watch
Futarchy applications extend beyond simply binary pass/fail decisions. Exploring different objective functions allows for a wider range of use cases, such as:
Trend 1: Prediction Market Consulting
This can be used to predict new hire performance through a prediction market.
Evaluating employee performance over time using conditional tokens for fairer and more objective employee evaluations.
Trend 2: Applications like Dating
Manifold Markets is building a prediction market, where if you date someone how long you will stay with them - quite interesting :P
Trend 3: Manifold Markets
Futarchy as a service — this could be a good GTM strategy by on-boarding other DAOs
Case Study: Marinade x Meta-DAO
Bribe Platform Development Paused: MetaDAO halted its internal development of a bribe platform due to a competing solution being developed by Marinade.
So Marinade offered MetaDAO a paid opportunity to contribute to their system design, leveraging MetaDAO's expertise.
This collaboration could as a possible path to establish credibility and attract further resources.
Future Proposals: MetaDAO will propose allocating a portion of the Marinade project compensation in META tokens to incentivize participation.
Closing thoughts: Markets x Democracy
Futarchy represents a progressive model for governance, and MetaDAO's bold experiment on Solana exemplifies this by testing its principles in a real-world setting. Success or failure, this endeavor will undoubtedly earn its place in history as a landmark in the exploration of innovative governance frameworks.