Dual Governance

Dual governance is a decision-making mechanism in DAOs where two distinct parties are involved in running the organization rather than one larger body.

Dual governance is a decision-making mechanism in DAOs where two distinct parties are involved in running the organization rather than one larger body.

What Is Dual Governance?

Dual governance refers to a two-pronged system of decision-making in a decentralized autonomous organization (DAO), where two distinct parties are involved in running the organization rather than one larger body. Both parties share equal decision-making power and authority but have different responsibilities and areas of expertise. 
For example, governance token holders and liquidity pool token holders. Both serve different functions and, together, can make decisions to benefit the entire community. Governance token holders are generally interested in the stability of the protocol, as well as its growth. Liquidity pool token holders are instead focused on the pool’s performance. However, the long-term success of the protocol is the ultimate goal for both parties, therefore, they are complimentary of one another. 

Together, they make up the dual governance system, ensuring the protocol is not solely responsible for decision-making that ultimately affects both groups of token holders. 

Dual governance can ultimately ensure that the interests of all stakeholders are represented, and can promote a more decentralized and democratic decision-making process.

What Is Required for Dual Governance?

Although simple in design, dual governance is prone to suffering from issues such as conflicts of interest and governance risks. As such, two key requirements are crucial to supporting the dual governance model and preventing a governance gridlock. 

The most important requirement is that liquidity providers should be granted the ability to veto governance proposals. However, veto powers can only be enacted in the presence of a critical governance decision that changes the covenant between protocol and liquidity providers, or generally goes against their interests. This is to escalate the conflict by blocking the governance party from executing the decision; allow liquidity providers to negotiate with the governance and de-escalate if negotiations succeed; and if all else fails, exit the protocol if they do not.

Another requirement for the mechanism is that it shouldn’t enable cheap attacks on governance. Any attack should bear a considerable material cost. The mechanism should also consider the fact that cooperation between liquidity pool token holders is harder and slower than it is between governance members. This can be specified as three assumptions:

  1. There is a small but active part of the liquidity token holder’s community that can react to a controversial governance decision and escalate promptly.

  2. There is a larger but less-active part of the community that can still participate in escalation given significantly more time.

  3. The rest of the liquidity pool token holders constitute an even larger group that is unable to participate promptly. The estimated sizes of these groups should define the basic parameters of the mechanism.

An example of dual governance would be LDO and stETH for Lido. LDO holders would still vote and execute as before because of their use of the LDO governance token. However, now, a quorum of stETH holders can apply a veto to a vote should they wish, making it possible for active stETH participants to be included in governance, despite not being governance token holders. 

Read more: What Is Lido?

Why Is Dual Governance Needed?

Dual governance is needed to ensure a well-rounded, decentralized decision-making process that takes power away from a single entity. This reduces the risk of centralization,  and it gives stakeholders, like token holders, an opportunity to have their voices in the decision-making process. Additionally, it gives the community a shared voice, the chance to block controversial decisions, and protect those with a financial interest in the protocol.  
For DeFi protocols, true decentralization is the ultimate goal. The unique approach of a dual governance system is a step in the right direction to reaching this goal. By disseminating the decision-making power to two parties, project stakeholders can be sure that their best interests and needs are a top-line priority in the final decision. 

Decentralized decision-making allows for larger community involvement while also ensuring the security and efficiency of the network. Dual governance is devoid of centralized power and, therefore, there are reduced chances that stakeholders can decide on something that only benefits the individual or a small group of the entire community. 

What Are the Fallbacks of Dual Governance?

Decentralization has some downsides too. Coordinating and aligning the interests of two distinct governing bodies can be difficult to navigate. Finding the right balance between efficient decision-making and remaining truly decentralized is not always possible. This leads to delays in decisions being made, which can have a snowball effect on the entire operation of a protocol. 

Reaching a consensus through a dual governance system is not as easy in practice as it is in theory.

What Are the Benefits of Dual Governance?

Dual governance has the potential to make the decision-making process balanced. Both sides can give their opinion on the matter at hand and reach a mutually beneficial vote. Overall, it ensures a fair representation of both groups of stakeholders. This can help prevent conflicts of interest and guarantees the protocol operates efficiently and effectively. With clear communication and collaboration between both parties, finding that balance will be much easier. Dual governance can help to increase trust in the protocol and promote its long-term sustainability.

How Can Dual Governance Benefit DeFi?

For protocols operating with a DAO governance structure, dual governance aims to ensure the alignment of the strategic and economic interests of the protocol users with those of liquidity token holders. 

Dual governance will potentially revolutionize the governance structure of DeFi protocols as a whole. It will provide another solution to move away from any centralization concerns or risks, create a dynamic and inclusive relationship between the deciding parties, and ultimately lead to better democratic decision-making that is beneficial to the entire ecosystem in which the protocol operates. 

Author: Kaspar Rassmusen, CMO at Lido