Research Report: Allocating Capital in Decentralised Networks: Mechanisms for the Cosmos Hub
Authors: Darcy Allen, Chris Berg, Sinclair Davidson (RMIT Blockchain Innovation Hub)
We are excited to share our latest research paper, supported by the ATOM Accelerator DAO. The paper, Allocating Capital in Decentralised Networks: Mechanisms for the Cosmos Hub, is available for download at the Social Science Research Network here.
This research complements our previous work on governance in Cosmos (on the governance of interchain security, also supported by AADAO) but focuses on the governance of capital allocation from the community pool.
How should the Cosmos Hub think about robustly allocating shared capital to competing alternatives?
Allocating funds from the community pool is necessary to facilitate growth. But Cosmos, like all decentralised ecosystems, will never be able to allocate shared capital perfectly.
There will always be tension about what to fund, how to ensure accountability and transparency on the delivery of projects, and the constant threat of opportunistic behaviour. Decisions must be made in an uncertain environment, with evolving objectives and community disagreements.
Our paper applies institutional economics to this problem and examines a variety of mechanisms for capital allocation (e.g. grants, prizes, tenders, and in-house production). Our focus is on how what we call capital allocation DAOs – bodies that have been delegated power over allocating some shared funds – should think about deploying mechanisms. We emphasise the need for a diversity of capital allocation mechanisms in different contexts.
We welcome any further community discussion on these topics as we continue to research and engage in the Cosmos ecosystem.
Summary of research report
In this paper we contribute to the problem of allocating shared capital in Cosmos. We draw on both institutional economics and a robust political economy project to examine these challenges.
Allocating shared capital is hard for many reasons such as knowledge, opportunism and coordination problems.
Building decentralised infrastructure is fundamentally uncertain. Much of the relevant knowledge about problems and solutions is contextual and local. There will always be subjective views about different objectives and allocation decisions.
There is also the threat of opportunism. We cannot assume people are good all of the time. Both people who are allocating funds, and people who are receiving them, can act badly. Just like in centralised delegation, opportunism can manifest through nepotism, failure to deliver outcomes, overstating of contributions, or theft. Many of these are principal agent problems that stem from delegation.
The focus of our research is on how capital allocation DAOs can structure their allocation of capital to capital recipients.
Capital allocation DAOs are bodies with some delegated responsibility to allocate shared digital assets for different purposes (e.g. development, maintenance, research, growth). The Cosmos Hub has of course funded AADAO as a type of capital allocation DAO. There may also be others that will allocate capital for the Cosmos Hub and across the Atom Economic Zone (AEZ).
The focus of our research is on how capital allocation DAOs can structure their allocation of capital to capital recipients.
Capital allocation DAOs should seek to develop robust institutional mechanisms in the face of knowledge problems and opportunism. Their key challenges include difficulty in decision-making due to distributed information, diverse community preferences, and complex coordination tasks. The other major threat are opportunistic behaviours and principal agent problems.
Capital allocation DAOs need robust institutional systems to deal with these dual problems. We examine four mechanisms for allocating capital that can be applied in different contexts of knowledge or coordination problems.
- Grants: Grants are ideal for uncertain objectives, but where the capital allocation DAO can plausibly identify combinations of resources in the community to resolve the issue. Grants help to reveal local information from the Cosmos community about both problems and solutions.
- Prizes: Prizes incentivise and reward innovative activities after the fact. They’re ideal when the capital allocation DAO has uncertainty both about the solution they are after and about how to coordinate or identify the resources necessary to achieve it. Prizes skew towards rewarding innovative moonshots.
- Tenders: Best suited for scenarios where the problem is clear but the method of solving it is not. Tenders provide a structured approach for receiving proposals and ensuring alignment with specific goals of the capital allocation DAO. But they also come with risks of poorly defined problems and inflexibility in enabling contributions outside the defined criteria.
- In-House Production: Capital allocation DAOs could undertake some activities in-house. When they know the problem and the solution, direct control and execution of tasks may be desirable. This approach depends largely on internal knowledge and resources of the capital allocation DAO. This approach may conflict with decentralisation objectives, and raises a different scope of opportunistic behaviour.
The mechanisms we have outlined here have different costs and benefits in building a robust approach to capital allocation DAO. Different capital allocation DAOs will deploy them in their own way, learning and adjusting the make up of mechanisms as they evolve.
Our research here has examined how capital allocation DAOs can allocate shared capital in the Cosmos ecosystem. Many of the lessons about how this diversity of mechanisms work will be revealed through practical experimentation, which should be encouraged.
