Tracer Drop Episode #04: Development Funds

Development Funds

Agenda

  • Internal capital allocation
  • Prizes
  • Tenders
  • Grants
  • Development Fund activities
  • Assessing impact
  • Funding entrepreneurship
  • Cooperating Development Funds
  • Future of Development Funds

Call Recording Link: here

Call Notes

Introduction

  • Mycelium alongside RMIT BIH have been researching development funds as an effective way to diversify DAO treasuries whilst maximising growth
  • Other projects that have done well in this area are Yearn.Finance & Sushi Swap

Internal Capital Allocation

  • The way we spend development funds (grants, tenders etc.) are more important than they seem
  • Not just a side issue, it is fundamental
  • If “DAOs are corporations” then the way we spend the treasury is internal capital allocations
  • If “DAOs are more like governments” then they are moreso like Fiscal policy - how do we spend the money that we raise
  • The challenge is to provide public goods for the ecosystem - historically free markets have struggled resulting in under provision
  • Private access providing public goods (DAOs)
  • Public goods + governance = “Ostrum” goods = private provision of public goods
  • In economics there are 3 problems
    • Planning - know what you want to do and know how to do it - you need to “just do it” (bottom right in matrix)
    • Knowledge - don’t know what you wanna do
    • Coordination - don’t know how you are going to do something
  • Knowledge/Coordination 2x2 Matrix:

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Prize

  • Prizes being used to fund public goods
  • Prizes are the polar opposite case to planning issues (bottom right of matrix)
  • What institutional mechanism do we use to solve the capital allocation problem?
  • Most famous uses of prizes - you know what the goal is, you don’t know how to get there, “the winning team will win a prize”
  • Prize examples:
    • Napoleon
    • Autonomous vehicle prize run by Dapper/Space X
    • Mechanical clocks - people wanted to know where the ship was in the ocean - navigation. 2 clocks separated, 1 clock on the ship, 1 clock on-shore. They didn’t know which body of knowledge would solve the problem (astro/mechanical etc.). Mechanical was the winner
  • Prizes work as an inducement mechanism
  • Prizes work in areas of great radical uncertainty of what the solution is.
  • In DeFi: the goal is that we need to scale/we need a DEX, but we don’t know exactly how that would look
  • Prizes are less resource efficient than other solutions in other areas of the matrix (only 1 winner with multiple people losing)
    • However, these “losers” have now come up with new ideas that could be further explored with their own resources and eventually become successful (spill-over effects)
    • Prizes cultivate innovation

Tender

  • Tender: You know what you want, but you can’t necessarily do it yourself - I need someone to build me x in return for $y.
  • Tenders are more socially efficient that a prize as only one team is working on it
  • Tenders are given to the best applicant for the required work

Grants

  • You don’t quite know what you want, but you are open-minded to getting something
  • Need applications for you chain/dapps - set up a grant/hackathon/pitch process
  • Grant: come to me with an idea and we will fund it - or come to me with ideas in a particular space
  • Pitch: come to me and sell an idea - we may or may not fund it
  • Hackathon: put a bunch of exciting people in a room for a weekend - output is displayed at the end of the period

Development Fund Activities

  • Each of the 4 quadrants have different incentive/spill-over effects
    • Least amount of spill-over from the “Just do it” quadrant
    • Higher amounts of spill-over in Tender and - you may not end up with what you wanted or expected but you will end up with “something”
    • Higher amounts of spill-over in Grants and Pitches - you may not end up with what you expected, but you will end up with something
    • Hackathons are perhaps the most exciting area in the space
    • Highest amount of spill-over effects come from Prize quadrant - 2nd place may have invented something else useful that they can later take to the market

Assessing Impact

  • Now have an integral question - how do we assess whether what was spent has been effective?
  • DeFi community, there are two polar opposite methods:
    • Centralised committee or “team of experts” - assess how the outcome aligns with the Treasury’s objective
    • All stakeholder voting around proposals - uses the distributed information of the community to assess the effectiveness of the approach
  • Each method has costs/benefits:
    • A centralised committee may have very intimate knowledge of the ecosystem’s needs - but they are limited by their own information
    • If completely decentralised voting - what is the incentive for good information to be integrated into the collective choice
    • Leads to experimentation and innovation in terms of quadratic voting, commitment voting etc. to get more information into collective choices

Funding Entrepreneurship

  • A knowledge problem - what should be funded and whether it was effective after the fact
  • An incentive problem - how do you know these projects are aligned with the objective of the Treasury
  • A proposed framework:
    • There are grant rounds - instead of funding individual projects, fund individual philanthropists (people or teams) instead
    • There is an overall grants program (Eg: 1 month) - then each philanthropists (Eg: say five different teams) fund their own grants program
    • Each philanthropist may choose different approaches to solve the problem - some may use the prize mechanism etc.
    • The benefit is that the solution is decentralised amongst a wide range of different people
  • Feedback is necessary
    • End of each round token holders could vote and rank the philanthropists - rewarded on how they met the protocol’s objectives
  • There is no ‘one-size fits all’ development fund architecture
  • The idea is to use scarce funds to fund entrepreneurial activities
  • Two models in the real world:
    • Philanthropic organisations - for purpose
    • Venture capital - for profit, receive a reward if the program is successful
  • Interesting space for experimentation - philanthropists receive the same rewards that venture capitalists do for their investments
    • Issue with grants - there is no obligation to meet the required objectives and do what the grant says
    • Venture capital is quite the opposite - the end result is closely monitored as they have a large stake in the project
  • The ideal - combine the grant model with the long-term incentive structure of venture finance

Cooperating Development Funds

  • The blockchain revolution allows for the decentralisation of many of the current centralised solutions
  • This does not mean discarding legacy mechanisms for cooperation - corporate governance and politics
  • The idea is take what we already know and apply it in the blockchain space to create a framework for allocating resources and making decisions
  • There is no need to reinvent the wheel, but rather how can the wheel work in this space
  • In other words - how does this market work when it is completely decentralised

Future of Development Funds

  • A large variety of different institutional mechanisms have not been able to be put into practise - lack of scale of voting and security of contracts
  • Many of these experimental mechanisms will be failures - however in the context of the DeFi space failure is not necessarily a bad thing
  • If designing a protocol or an ecosystem - there needs to be constant capacity to evolve
  • Development funds is an area where there is a lot of existing real world information - needs to be translated, not recreated, into the space
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