Key takeaways from the Golden Boys’ attack on Compound DAO

When it comes to DAO governance attacks, there is a fine line between the crafty methods of a scam artist and an activist investor. Drawing this distinction is vital to understanding — and preventing — governance shakedowns like the one seen recently at Compound DAO. 

The power struggle at Compound DAO transpired between a rogue group of five relatively unknown token holders called the “Golden Boys” and an army of dissenting DAO members. Drama ensued when the Golden Boys submitted a series of proposals to the DAO community for a rather innocuous request — one that would compel the DAO to invest 5 percent of its treasury for the creation of a yield-bearing instrument that would benefit all token holders. The catch? The proposal included a quirk that treasury funds for the new financial instrument would be stored in a vault controlled by the Golden Boys, not the DAO. Unsurprisingly, the proposals received opposition, yet the Golden Boys ultimately managed to squeeze by with a narrow vote of victory on its third try.

Allegations were made that the Golden Boys committed a governance attack and attempted to steal from the DAO’s treasury. While the Golden Boys denied those allegations, the group — to everyone’s surprise — agreed to settle with Compound on the condition that a similar yield-bearing instrument be created and controlled by the DAO. Prior to that truce, the Golden Boys also addressed the community’s security concerns on Compound’s message boards and took steps to mitigate the risk of vault theft by implementing a Trust Setup function.

Governance attacks are typically characterized as self-serving exploits that enrich the attacker to the detriment of other parties, but the Golden Boys’ behavior doesn’t quite fit the bill. To the contrary, this months-long governance struggle had all the hallmarks of an activist investor, not a scammer.

While Golden Boys’ efforts turned out to be an unexpected, welcomed bonus for Compound DAO’s token holders — who now have the option to earn extra passive income — the incident raises doubts about how much organizational trust, transparency, and democracy DAOs actually have. Furthermore, even though this DAO drama ended on an amicable note, what happens when the next round of proverbial golden boys aren’t so nice?

Activist investors can be white knights who maximize shareholder value, but they can also be bullies that drive companies into the ground. Bryan Burrough’s “Barbarians at the Gate” illustrated such a demise. Therefore, DAOs need to have protections in place — like legal agreements and voting participation mechanisms— to ward off activist investors and prevent governance attacks that go awry.

There are two critical steps that DAOs should implement to limit governance dysfunction. First, DAOs should incorporate as limited liability corporations (LLCs) for two reasons: LLCs protect members from personal liability, and the law is flexible enough to allow for custom corporate governance design — both optimal features for DAOs. States like Wyoming, Tennessee, and Vermont have already enacted specific DAO LLC legislation, and Delaware’s LLC Act is another credible option due to its flexibility and the state’s significant body of case law that gives businesses greater insight on transactional liability issues and matters of corporate governance.

Incorporating DAOs may also have downstream consequences that affect DAO voting behavior. Venture capital fund a16z — the largest vote delegator for Compound’s governance — abstained from voting on the Golden Boys’ yield-bearing instrument proposal, yet their participation could have otherwise overturned the winning proposal. a16z may not have participated due to a perceived threat of legal liability. Legal documents show that Compound DAO is structured as a general partnership, which means owners (and possibly actively voting token holders) could have unlimited personal liability for actions of the DAO and its employees.

This threat is legitimate. In a recent legal action against Ooki DAO, the CFTC advocated for a novel theory of liability that would hold all voting members of the unincorporated DAO personally liable for their voluntary participation in DAO governance. To careful onlookers, the Ooki DAO legal action not only created regulatory uncertainty, it created enough fear of liability to deter any voting-eligible token holders with deep pockets from participating in DAO governance.

DAOs with funds as token holders should be on high alert, transform into a protected corporate entity, and prepare for governance attacks by actors who might seek to exploit the voting imbalance created by this regulatory hand tie. On the other hand, newly created DAOs could seek to limit or cap fund participation to prevent whales who do not actively participate in serious governance issues from soaking up market share.

The second critical step that DAOs should implement to prevent governance dysfunction is to evolve governance participation. One purported reason the Golden Boys’ proposal won is because the voting period occurred over the weekend — when participation was expected to be abysmal. Common sense dictates that if voters will be asleep at the wheel, weekends should be vote-free. Such a change would likely not require significant technological input, but rather a simple change in governance process. Exceptions to weekend-free voting could be overturned by a supermajority vote of token holders.

Another way to increase governance participation is to experiment with AI proxy voting where AI models are trained to vote for any given issue in a token holder’s absence. DAO governance processes that allow for proxy voting by AI would need to be authorized in a DAO’s bylaws and be legally compliant with state law where token holders reside. Although this novel method comes with plenty of unanswered questions, proxy voting by AI could be a game changer for DAO governance participation and deserves more attention, legal wrangling, and experimentation.

Without changes to governance participation and design, the attack on Compound DAO’s governance may be the first of many more. The absence of an engaged voting base leaves DAOs vulnerable to activist investors acting in bad faith — or worse, a death spiral of inertia.