DAO meets FPE
How Decentralized Autonomous Organizations can benefit from operating as a For-Purpose Enterprise™
PART 1: The Emergence of Decentralized Autonomous Organizations
PART 2: There Has To Be A Better Way … And Somebody Already Found It
PART 3: Synergies between DAOs and FPEs
PART 1: The Emergence of Decentralized Autonomous Organizations
Imagine an organization in the cloud, radically decentralized, without bosses. Its rules are written in code, so-called “smart contracts” and enforced automatically, secured by cutting-edge distributed ledger technology — aka the blockchain. Its participants flock around it from all over the world, launch proposals for what projects to work on, and share the spoils in the form of cryptocurrency tokens, distributed via smart contract after successful completion of the deliverable.
This alien creature is called a DAO — a decentralized autonomous organization — and it is a hungry beast. Since its first major emergence in 2016 it has captured the imagination of thousands of people worldwide — mainly software developers — who devote their time, energy, and skill to various DAOs, often crypto projects, such as MakerDao that revolutionize and disrupt the finance industry and created the field of DeFi — decentralized finance. Anyone with an internet connection and the necessary skill can join in and contribute to and earn in these new organizations.
Blockchain technology dramatically eases coordination and collaboration between strangers, since the economic actions are executed by software code in a ‘trustless’ manner. There is a high degree of transparency and auditability since anyone can check the records on the distributed ledger, which is highly tamper-proof due to it being stored on decentralized nodes of a network instead of centralized on a single server.
It is an exciting time for pioneers, but it can be very messy as well, as evidenced in the major hack of “The DAO”- the first noteworthy instantiation of this new form of organization. A hacker had found a way to exploit a bug in the code and siphoned off the equivalent of 70 million dollars. This forced the Ethereum developer community (the number two cryptocurrency after Bitcoin) to make a hard fork, leaving the old fork, Ethereum Classic, behind to rewrite and fix the code.
Challenges that DAOs are struggling with
Apart from Black Swan events like the one above there are more mundane challenges that DAOs haven’t quite solved yet. In an article for Decrypt, Matt Hussey and Adriana Hamacher summarize the main challenges as follows:
🏢 Flat structure — by not having a clear authority figure, or chain of command, decentralized organizations are slower to operate as decisions take longer to make.
😡 Disagreements — when the community disagrees strongly, it could split the organization into two.
👸🏽 No change — in some DAOs, those with the most tokens call the shots, so governance looks very similar to traditional organizations.
⚖️ Legality — minefields abound in relation to token projects that might be deemed to be securities.
The Governance Myopia of DAOs
DAO Consultant Grace Rachmany identifies several problems related to governance and decision-making in DAOs. Usually, there’s only one (crude) pathway offered for making all decisions: token voting by all the users that hold governance tokens in the DAO. But majority decisions are rarely the best way to make decisions. Who gets to define the problem to be voted upon? Who gets to frame the voting options? What if you can only choose between bad proposals?
Beyond that, she points out that winner-takes-all voting quickly devolves into exacerbating our already dominant competitive tendencies, thereby weakening the spirit of cooperation. It turns out that even a highly skilled and intelligent crowd of software engineers mainly work with default assumptions about how to do governance (majority vote, vote weight based on token share size) that prove to be too unsophisticated for running a complex multi-million dollar operation with thousands of decisions to be made.
The Unclear Legal Status of DAOs
As we saw, many DAOs are used to launch crypto projects. Developers that put in their time and work can earn tokens of that project as a way of payment. Should the price of the token skyrocket later, this could be a massive opportunity for the developer. For those not familiar with the difference between the terms “cryptocurrency” and “tokens”, here’s a definition by Sheba Karamat, which I found helpful:
“While a cryptocurrency operates independently and uses its own platform, a token is merely a cryptocurrency built on top of another pre-existing blockchain. All tokens are cryptos, but not all cryptos are tokens.” (Coinrivet.com)
As the Decrypt article quoted above states, token projects might be deemed to be securities by state regulators. Securities are usually highly regulated. Currently, there are a lot of legal grey areas in the crypto-space, but with trade volumes and market capitalization steadily increasing year by year, the players in the industry increasingly fear an impending government crackdown. Regulators demand formal legal structures, especially in the Decentralized Exchange or “DEX” space. Without formal legal standing, DAOs are at risk of being labeled a default partnership with potential liability implications for all of its members. As everyone knows, two things in life are certain: death and taxes. If there are huge flows of monetary value involved, the state will sooner or later knock on the DAO’s doors — or knock them down.
PART 2: There Has To Be A Better Way … And Somebody Already Found It
Meanwhile, in another corner of the organizational innovation space, there exists a different lineage and tradition of self-organization that has been around since 2016 and shares many similar features with DAOs:
purpose-driven / commons-driven
distributed authority, peer-to-peer
values individual liberty
creates strong community affiliation /loyalty
focus on “power-with” instead of “power-over”
high transparency and awareness
participatory decision-making
no traditional management structure
operating with encoded rulesets
Holacracy — a new social technology for organizations
This lineage started around 2006 with the Holacracy® operating system — a new social technology to run an organization differently, based on clear rules and processes that distribute power from the top of the former management pyramid to mutually defined roles and circles. The rules of the game — the “code” of the Holacracy ”OS” — are enshrined in the Holacracy Constitution, a living document, open-source and collaboratively built by the worldwide Holacracy community of practice on GitHub.
Although Holacracy got rid of managers and bosses it didn’t collapse into a “flat” structure like the DAOs. Instead, it replaced a hierarchy of people with a hierarchy of work functions (circles, roles, and accountabilities) that capture different scopes in which the work of the organization lives. It replaced the CEO as a centralized force of alignment with an organizational purpose statement: purpose is the new boss. All work is organized around purpose, all roles and circles fractally reflect the overarching purpose of the organization. Roles are filled with “Role Leads” (people) and Role Leads are granted a lot of autonomy and authority to act on behalf of the organization:
As a Role Lead, you have the authority to take any action or make any decision to enact your Role’s Purpose or Accountabilities, as long as you don’t break a rule defined in this Constitution. When prioritizing and choosing among your potential actions, you may use your own reasonable judgment of the relative value to the Organization of each. (Art. 4 — Holacracy Constitution v5.0)
This simple authority to act on behalf of your role already takes care of the thousands of small decisions in an organization that need to be taken and executed — without having to call a freaking town-hall meeting
A Superior Governance Process
But how are roles and circles and policies created in Holacracy? Who decides about that? In a Holacracy-powered organization, each one of the fractally nested circles holds regular Governance meetings to update the mutual expectations in the circle. Each of these expectations is invalid unless it is written down in the Governance records and is the result of the due Governance process as prescribed by the constitution. Anyone who fills a role in a circle counts as a member of that circle and is eligible to bring a new Governance proposal for that particular circle. (This takes care of the fuzzy boundaries problem that some flat organizations struggle with where everyone and their mum can vote on virtually anything.)
A proposal must seek to address a “tension” sensed from a role that the person fills in the organization — not just from a personal agenda. A “tension” is any gap between what currently is and what could be. A proposal in which the proposer cannot explain how it would help his role address a similar tension in the future will be discarded by the Facilitator of the circle. In Holacracy all proposals need to be grounded in real organizational tensions. Proposals lacking a proper definition of the problem will get filtered out.
Once the tension and the proposal are established the elected Facilitator leads his circle members through the Integrative Decision-Making Process specified in the rules. I won’t go into too much detail here, but simply present the sequence of carefully calibrated steps that maximize the efficiency of the overall outcome:
Present Proposal
Clarifying Questions
Reaction Round
Option to Clarify
Objection Round
Integration
Nobody can use vetoes to block the process. Aspects like job seniority or the number of tokens owned are irrelevant to bringing proposals or voicing concerns against proposals. Concerns are tested whether they qualify as objections according to strict criteria. All legitimate objections must be integrated by amending the proposal, while the original tension still needs to be addressed. Once all objections are integrated into an amended proposal and no new objections surface, the proposal will get adopted and become an official part of the governance records of the circle from then on.
Please note that this elaborate method is not used to make all those itsy-bitsy operational decisions. Operational decisions are still being made autonomously by Role Leads while interpreting the purpose of their roles. The Governance process only answers the meta-question “Which role can be expected to make which decision and under which constraints?” These are considered to be questions of governance in Holacracy.
Again — every circle updates its structure of expectations and authorities (its roles, accountabilities, domains, and policies) via the Governance process in a regular rhythm (usually monthly). This way, the governance process scales across all circles throughout the organizational holarchy. A “holarchy” is a nested structure of holons — wholes, arranged in a growth hierarchy — think atoms — molecules — cells for example. Holacracy mimics the way natural systems deal with complexity — via holarchies.
Co-Owning a Self-Organized Entity: The For-Purpose Enterprise™ (FPE)
Holacracy was a giant leap forward. It gave an organization a clear way to structure its work according to its purpose. Along the way, it differentiated “role from soul” — the organization from its people. While Holacracy says a lot about organizing the work it remains silent on how to organize the community of people. Also, it left the legal framework, the ownership, and the investment structure untouched. You can adopt the practice regardless of which legal container you have chosen. But of course, every legal container comes with its own requirements and limitations — oftentimes detrimental to the intentions of self-management. For example, most legacy structures create a distinction between two classes of people, owners, and employees, which undermines peer-to-peer relationships needed for self-management.
Tom Thomison, a co-founder of HolacracyOne, sensed these tensions and quickly found purpose allies who felt the same way and wanted to address them. The result is the For-Purpose Enterprise™ model first developed and embodied by the company encode.org, which covers three spaces or contexts. It addresses the need for a systematic powershift beyond just organizing the work of the Organization Context. It creates a space for the people as well, the People Context with its distinct rules and agreements. The third space, the Company Context, encodes the legal framework and embeds decentralized Governance mechanisms directly into the operating agreement. In an FPE all members of the Organization (“the Partners”) are simultaneously legal members of the Company (“the legal entity”) and associates of the People Context (“the people”). The highest circle, called Anchor Circle, replaces the legal Board and contains representatives from all three contexts. The Anchor Circle integrates and balances the needs of each context against the enterprise’s overarching purpose using the Governance protocols of Holacracy. Each context has its own explicit ruleset. Currently, the FPE model runs on top of a modified Nevada-based LLC structure.
Slicing Pie for Startups — the Many Currencies of a For-Purpose Enterprise
A huge problem for startup founders is that at some point they will have to determine which of the multiple founders owns which percentage of the company. Usually, they sit down upfront and agree on a percentage, maybe 50/50 in the case of two owners — or 70/30, if it is clear that one of them invested much more in terms of time and personal cash (both of which is risky to different degrees). With three founders you might have a simple 33/33/33 split, or 40/30/30, and so on … you get the picture.
The reason why this often becomes problematic is that things change — especially in the busy world of startup ventures. One founder drops out because his spouse got sick, one works his ass off day and night, while the other takes it much slower. Suddenly some extra cash investment is needed which only one of the founders is able to make from his own pocket to keep the business afloat, etc., etc. The variables are ever-shifting until the business becomes profitable, but when it eventually does, the profit shares are fixed due to a decision made blindly and predictively at the very beginning of the journey. Dynamic Equity is an alternative way of arriving at the capitalization table and percentages of shares among the investors of a company.
At encode.org swapped out this old predict and control equity model in favor of the Slicing Pie Dynamic Equity model by Mike Moyer. In fact, we love Mike’s work so much that we baked Slicing Pie principles right into the operating agreements. We encoded Dynamic Equity into the operating agreement by creating a new class of membership interest, the Allocation or “A Unit”. But there are three others as well. Here’s a list:
Dynamic Equity, A Units
Deferred Interests, D Units
Profit Interests, P Units
Capital Interests, C Units
To find out more about the different units and what they are there for check this in-depth article.
Together these units of account provide founders with new financial vehicles and instruments to play with, bringing a high degree of flexibility to navigate a broad range of situations — especially during phases with low cash flow.
These different “currencies” of an FPE were conceptualized before blockchain technology really took off in a big way. Now they literally scream to be tokenized and put into a distributed ledger.
PART 3: Synergies between DAOs and FPEs
As we explored in the previous articles, there are a lot of commonalities between DAOs and FPEs. In this article let’s have a closer look at the obvious points of synergy between both models.
What FPEs have to offer to DAOs
Systematic PowerShift
The seat of power shifts from a collection of people to a collection of rules. The rules bind everyone equally with no personal authority over the rules themselves or over others.
Scalable Holarchical Structure
The embedded Holacracy® framework replaces a hierarchy of people with a nested hierarchy of organizational roles and circles (“holarchy”) that is highly scalable.
High Agency and Autonomy for Role-Leads
The rules of the game empower Role-Leads to make decisions with a high degree of autonomy within clear bounds.
Robust Governance Process
The Holacracy Constitution provides clear rules and an efficient process on how each circle governs itself and can develop the expectations and boundaries on its roles.
Dynamic Equity and New Financial Instruments
The FPE frameworks legally encode a way to account dynamically for the inputs of different partners during the start-up phase using the Slicing Pie methodology. The various units of account (Dynamic Equity – A-Units, Deferred Interests – D-Units, Profit Interests – P-Units, Capital Interests — C-Units) provide greater financial flexibility.
Clarity on the Legal Framework
The company encode.org already managed to encode its principles of Purpose, Structure, Awareness, Agency, and Transparency in the legal documents of its Nevada-based LLC container. It is currently adapting it to fit the brand-new Wyoming LLC DAO solution. This will make encode.org “a legally registered power-shifted DAO, operating as an FPE” — a solution that could be highly attractive for any existing DAO and its members as well.
What DAOs have to offer to FPEs
On-Chain Representation of Governance Records
DAOs live on the blockchain. Currently, FPEs and organizations that practice Holacracy still store their governance records in software tools that are hosted centrally by the respective tool providers, GlassFrog and Holaspirit. A decentralized app (“dapp”) version of these tools could make them tamper-proof and would increase trust in their veracity. This would be especially relevant for larger organizations with many hundreds or thousands of people.
Elaborate Tokenomics and Well Working Incentive Systems
The crypto space in general and DAOs, in particular, have figured out how to create well-working incentive systems. They have managed to attract a huge inflow of money, skill, and attention. FPEs could definitely use more of all of those.
Summary
It is an exciting time and technological, as well as organizational innovation is moving at neck-breaking speed. For anyone with eyes to see, it is obvious that DAOs and FPEs have many points of convergence that should be explored for mutual benefit. Their respective value sets are overlapping to a large degree: both value radical transparency, aspire to distribute power systematically, encourage participatory decision-making, and enable peer-to-peer collaboration for a common goal or purpose. It’s a match made in heaven — a legally registered power-shifted DAO, operating as an FPE.
Would you like to learn more about how to become a For-Purpose Enterprise™?
Are you participating in a DAO and would like to explore the possibilities?
