Forbes: Exposing the Myth of Decentralization

Author: Nina Bambysheva, Maria Gracia Santillana Linares, Forbes

On November 2 last year, holders of a cryptocurrency called Aragon network token (ANT) Be told that their investment will be honored whether they want it or not. The tokens were issued by the Aragon Association, a non-profit entity based in Zug, Switzerland, which writes software that helps run 7,500 decentralized autonomous organizations (DAOs) managing $25 billion worth of crypto. assets. The Aragon Society has also created its own DAO, with the lofty yet quirky goal of creating a court system to resolve disputes in the online world, where ANT holders would be eligible to serve as jurors.

The concept caught the attention of crypto-friendly venture capitalist Tim Draper. Tim made early investments in outstanding companies such as Hotmail, Baidu, and Skype. His Draper Associates purchased $1 million worth of tokens in February 2020, but has since cashed out. Tim Draper tweeted at the time that this "new form of governance in Aragon" was "very exciting."

A crappy acquisition?

This may still be the case, but ANT holders will no longer participate. They were kicked aside because the Aragon Association, the benchmark for decentralized finance, did something very centralized: it unilaterally decided to place its assets beyond the reach of corporate activists. A group including hedge fund Arca Investments hopes to close the gap between the roughly $200 million Aragon Association held in early May, when the token was trading for just over $3, and ANT's $123 million market capitalization. Two months ago it was only $2. Arca did not respond to a request for comment via its website.

Fearing that investors could ultimately control more than 50% of the voting rights, the association proposed an acquisition of ANT for 0.0025376 Ethereum (approximately $5.76), with holders given 12 months (By November this year) Cash out. The deal will see at least $11 million, if not more, go to a nonprofit company formed by the Aragon Association. The association did not respond to a request for comment.

Not only that, the whole thing may have developed more details. Disgruntled ANT holders managed to obtain $300,000 in the DAO and used the money to hire a law firm to oppose the Aragon Association’s strategy.

"Decentralization is a means to an end, not an end in itself."

——Aragon X CEO Anthony Leutenegger

If this all looks like the pinnacle of Wall Street's corporate predatory culture of the 1980s, that's because it is. Aragon’s story illustrates that decentralization of finance and governance, where decisions are made by large numbers of individuals rather than a handful of large organizations, may be nothing more than a utopian fantasy.

The Utopian Challenge

Camila Russo, founder of The Defiant, a publication focused on decentralized finance Said, “Decentralization is what you have to do in cryptocurrency if you want to attract new investors and gain more legitimacy. Many cryptocurrency businesses simply imitate what is already available in traditional finance. business, but with an alluring high-tech narrative.”

The Aragon Association, founded in 2016, aims to be a “token-governed digital Jurisdictions". It aims to create a “decentralized court” that governs user conflicts outside of the programmable content of smart contracts, the self-executing protocols that underlie decentralized finance. Customers of its management software include Lido, the dominant crypto staking service, and virtual world provider Decentraland.

The association raised $25 million through the sale of ANT tokens in May 2017 and later issued a manifesto declaring that it would create free, open source technology to govern the DAO as part of its "fight for freedom" "a part of. But it was not until January 2023 that the Aragon DAO was officially launched, with the purpose of becoming the organization’s governing body and custodian of funds – including the proceeds from the sale of ANT, which remains in the custody of the association.

Sources familiar with the organization’s inner workings said that over that year, the goal was to slowly transfer assets to the DAO. “At the time they were under pressure internally and externally to become a DAO that built technology for DAOs.”

Ironically, the people who provide voting technology for decentralized organizations found that it was impossible to completely go Centralization doesn’t necessarily work. Anthony Leutenegger, CEO of Aragon Rather than an end in itself."

Leitenger said that when the redemption period of ANT tokens ends, Aragon X will be reorganized into a traditional Swiss non-profit company in November this year. He said that his team is not part of the Aragon Association board of directors and cannot resolve the legality of the DAO’s dissolution.

The company’s reason for forcing ANT holders to withdraw is that Swiss law requires it. The association said in a blog post on May 9 last year that the activists were "a coordinated group" and that "evidence suggests that they participated with the aim of extracting value from Aragon for financial gain. Aragon" The tribute treasury was established with the express mission of supporting builders advancing decentralized governance infrastructure."

The intention is to make ANT a utility token under Swiss regulations, with the express purpose of "holding for the token The Aragon Association believes that turning a social mission into a profitable enterprise could "lead to regulatory enforcement actions."

Arca said in an open letter that although the goals of the Aragon Association are "ambitious and noble", "in order to unlock future utility and governance value, its financial value must be recognized, otherwise it will risk dissolution" ." It recommended that the Aragon Association purchase ANT tokens to drive up its price, similar to a share buyback on the stock market.

Arca eventually got the buyback it sought but found the terms "bittersweet". The deal provides $11 million in funding for a new non-profit organization that will take over the DAO's intended role, but if any ANT is not tendered by November, it will become worthless, and ala The Tribute Association will retain the funds. Arca estimated in an article on its website in November that 25% to 35% of circulating tokens would not be redeemed, leaving the new company with between $43.5 million and $61.4 million in assets. According to data from DuneAnalytics, more than half of ANT tokens (approximately 17.4 million) have been surrendered so far.

New chaos

Just after the Aragon Association transferred the first funds (totaling $300,000) to the Aragon DAO, the association There was a dispute with Arca. The remaining ANT holders chose to work with Patagon Management (an investment firm that had filed a lawsuit against the DAO founding team) and provided it with $300,000 with the intention of negotiating with Aragon or taking legal action against it. The acquisition of ANT tokens from the DAO "is directly harmful to the interests of investors without legal basis." Patagon did not respond to a request for comment, and posted on X, "In our opinion, this is a whitewash. "Excessive, glorified theft."

Decentralization has been a driving concept for thousands of entrepreneurs and developers since the launch of the first cryptocurrency, Bitcoin, in 2008. Bitcoin’s mysterious creator, Satoshi Nakamoto, envisioned a peer-to-peer payment system that would rely on cryptographic proofs to verify transactions, replacing intermediaries such as banks and brokers.

This concept has spawned an entire industry, with the total value of all cryptocurrencies now approaching $1.7 trillion, that relies on distributed ledgers to exchange, track and determine ownership of assets ranging from precious metals to real estate Everything from physical assets to digital currencies themselves. Companies such as JPMorgan, Samsung and Tencent use underlying blockchain technology for supply chain management, data security and digital identity verification.

PitchBook data shows that just in 2021 and 2022, the peak of the latest bull market in cryptocurrencies, venture capital investors poured nearly $50 billion into the blockchain-based economy.

How did these companies end up with more debt than they could initially handle? The answer is simple, because they offer attractively high yields.

Dan Morehead, founder and managing partner of Pantera Capital, a blockchain-focused hedge fund, wrote in a letter in July 2022: " All parties agree to transact openly and transparently on the blockchain, rather than behind the scenes by opaque, artificial and potentially contradictory financial actors. This is the vision we should strive to achieve, rather than clinging to inefficiencies. Centralized financial system." He believes that decentralized finance (DeFi) can provide investors with better protection than companies with centralized management.

At almost the same time, however, cryptocurrency brokerage Voyager and digital lending company Celsius filed for bankruptcy as plummeting cryptocurrency prices disrupted their business models. Morehead sees these failures as a strength of DeFi — in the case of Celsius, for example, the company was forced to repay lenders via smart contracts to preserve collateral — but the counterargument is that changing conditions is not allowed You can't run an industry with inflexible automation protocols.

How did these companies end up with more debt than they could initially handle? The answer is simple, because they offer attractively high yields. While banks and their neobank competitors are offering 4% to 5% interest rates on high-yield savings accounts, DeFi lending companies are charging rates as high as 20%.

But a series of hacks and crises in DeFi and the entire industry, culminating in the collapse of Sam Bankman-Fried’s FTX in November 2023, has left investors were shocked. According to data aggregator DeFi Llama, the number of cryptocurrencies held in DeFi projects currently stands at $54.7 billion, below the level of a mid-sized regional bank, compared with a peak of approximately $179 billion in November 2021. While much of this decline is due to falling cryptocurrency prices, rising interest rates on low-risk assets such as U.S. Treasuries as governments withdraw market support during the COVID-19 pandemic have also undermined the appeal of DeFi.

A bigger problem is that the concept of decentralization seems to work better in theory than in practice. One reason is that blockchain projects can be hijacked if one entity or a group of allies controls more than half of the computing power or the rights to verify transactions on the network. In this situation, known as a "51% attack," a bad actor could block new transactions or reverse settled transactions, or send the same token to multiple recipients, potentially damaging the entire blockchain. is fatal.

The Aragon Association said something similar happened when it transferred the first batch of ANT tokens to the DAO, stating in a May 9 blog post that it suffered “an Organized social engineering and 51% attacks." This isn't exactly the same as an attack on the blockchain, as the DAO is supposed to be governed by its token holders, but the Aragon Association decided to take matters into its own hands to satisfy what it saw as legal requirements, suggesting that real-world concerns can limit Pure decentralization.

“The complete decentralization of DeFi is illusory,” economists at the Bank for International Settlements (BIS) wrote in a 2021 assessment of the industry. "DeFi platforms have a centralized element, often revolving around holders of 'governance tokens' (usually platform developers) who vote on proposals, not unlike a company's shareholders."

< p> Andre Cronje, founder of yield farming robo-advisory company Yearn.Finance, told Forbes in 2022 that decisions on major DeFi projects often would not go through without the support of founders and financial backers. . “Although people are talking about decentralization, it will not be approved unless it goes through back channels.” That year, researchers at the University of Luxembourg voted on the tokenization of nine large DeFi projects. Research was conducted and found that its power was "highly concentrated" and its exercise rate was "very low".

Unlike voting on regular stocks, there is no obligation for token holders to notify of an upcoming vote, and for those who store their DeFi tokens on exchanges like Coinbase, there is not even a mechanism to allow voting. .

“The development of DeFi is much more concentrated than expected,” said Russo of “The Defiant”. “You see this centralization reflected in governance (usually a small team making most of the decisions) and the distribution of token ownership – with the majority of tokens being owned by the team and a handful of venture capitalists. And then there’s also the Technical centralization, such as backdoors in smart contracts."

But she added: "This drama of decentralization is not necessary. I think everyone can understand that this decentralization "The ideal of centralization is gradual." "You can't be completely decentralized from the beginning. I just wish that all these protocols were more straightforward about how centralized they are. There are ways to develop in a more transparent way." ”

Lawmakers and regulators are also exacerbating DeFi’s dilemma

In June this year, a U.S. judge ruled in favor of the Commodity Futures Trading Commission (CFTC)'s default judgment ruled that the decentralized collective Ooki DAO is a "person" under the law and is therefore responsible for illegally operating a trading platform and illegally acting as a futures trader. The organization was ordered to pay $643,542 and close itself.

Ian McGinley, executive director of the CFTC, said: "The founders created Ooki DAO with the purpose of evading legal liability, with the clear goal of operating an illegal trading platform." This decision should give any confidence to anyone This sounds alarm bells for those who believe that the law can be circumvented by adopting a DAO structure with the intention of insulating themselves from law enforcement and ultimately putting the public at risk.

None of the DAO members responded to the subpoena or appeared in court, and the founders of its predecessor organization, bZeroX, were identified in the default judgment as Tom Bean and Kyle Kyle Kistner - also did not respond to our request for comment.

Multiple amicus briefs submitted on behalf of Ooki argued that the DAO should not be regarded as a single entity. "The reason amicus efforts are so important is if a DAO member comes forward and says, 'Hey, I'm a DAO member and I want to defend this,' they're putting themselves in the crosshairs," Gabrielle said. said Gabriel Shapiro, an attorney who helped file a brief supporting Ooki. What's more, he added, "According to the CFTC's reasoning, 100% of DeFi is illegal. Why? Almost all DeFi involves margin, financing, or leverage."

Except for DAOs , authorities are also pursuing open source software, such as the cryptocurrency mixer Tornado Cash, which allows users to hide digital transactions. In August 2022, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) sanctioned the service, claiming that it had been used to launder more than $7 billion worth of virtual currencies since its creation in 2019, including allegedly $455 million stolen by North Korean hackers. Days later, Dutch authorities arrested Tornado co-founder Alexey Pertsev on money laundering charges. He is still in the Netherlands and his trial is scheduled for March.

The following year, U.S. prosecutors indicted two other Tornado developers, Roman Semenov and Roman Storm. According to blockchain analytics firm Elliptic, Semyonov is on the run and is believed to be in Dubai, while Storm is under house arrest at his home in Washington, Coindesk reported. His trial is scheduled for September.

On January 22, Storm posted a video on X in which he asked for donations to fund his and Pertsev’s defense. "My legal team and I will present a strong defense at trial, not just for my family but for future software developers and financial privacy," Storm said. The lawsuit, titled "Open Source Is Not Crime's donation drive has raised more than $500,000. Storm and Semyonov did not respond to requests for comment.

In this regard, the industry has also fought back. “OFAC’s action creates a A dangerous new precedent that significantly exceeds their authority and undermines the privacy rights of law-abiding Americans. OFAC must see Tornado Cash for what it is: it is a tool that anyone can use. OFAC should not sanction tools that have legitimate purposes , but should continue to focus on bad actors abusing such tools."

Despite internal setbacks and regulatory resistance, decentralized systems remain popular in the cryptocurrency world.

“Decentralization is more like a ‘means to an end’ – as a developer, what can you do on these new platforms that you couldn’t do before?” Blockchain Governance asked Austin Green, co-founder of the platform Llama. After all, “The only way to achieve the best organizational structure is to try a lot of different things and see what works and what doesn’t.” Syndicate, a provider of blockchain-based Internet product infrastructure Co-founder Will Papper said: "For a long time, decentralized technology has always been less efficient and usable than centralized technology. Ultimately, storing data in a trusted system (such as a database), it is always more efficient than storing data on 10,000 widely distributed nodes."