Futarchy Governance Explained

We recently hosted a Twitter Space on a fascinating topic: futarchy, or governance driven by markets. We had the pleasure to talk to Proph3t from the MetaDAO who sat with our protocol specialist Othman and talked about the concept, practical applications, challenges and future possibilities of futarchy. Below you’ll find a recap of the conversation. 

Listen to the full conversation here

Futarchy is a new governance framework, in which people democratically vote on the things they value, for example, higher GDP, and then they use these predictive markets to evaluate how specific policies would be able to achieve these values they require or need.

In this market participants are posed questions such as “Will implementing a certain policy improve GDP? Participants can bet on yes and no, and whichever has the higher vote count (or token price in the context of crypto), gets put into action. 

Chainflow: Proph3t, what is a simple way of explaining futarchy? 

Proph3t: Sure. Let’s assume the goal is to increase the token price or to increase the value of a token - similarly to wanting to increase the value of a company’s shares. You want to maximize wealth for shareholders. With futarchy, you let people speculate on whether a certain action would increase the token value. If people decide it would, then you do the thing. If they say the action would not raise the token price, you don’t do it. 

Chainflow: How can Futarchy be adapted to varying scales of organizations from small DAOs to large blockchain networks? Do you think that futarchy is something that should be scaled to a larger blockchain network? 

Proph3t: Probably not yet because the concept still needs to be proven. With an entire blockchain network the question would be what values you're trying to forward. Maybe we don't want Solana, for example, to be governed just based on what will make its token go up. Maybe we want to increase developer satisfaction - but then you can also use futarchy governance on developer satisfaction.

Chainflow: You mentioned that there are specific goals to keep in mind if you want to scale futarchy and use the framework. What are the specific goals that the MetaDAO community has in mind and how do they use Futarchy to achieve that? 

Proph3t: MetaDAO is an economic organization, much like a corporation, and its goal is just to increase the net present value of future cash flows. 

Chainflow: How would a typical user interact with a futarchy based system? Can you describe the typical user journey once you get involved in MetaDAO? 

Proph3t: I'll give an example with Solana; imagine Solana were a futarchy and the goal is to maximize the $SOL price. 

Say someone creates a proposal to burn 90% of fees instead of the 50% that is being burnt now. If you’re bullish on the proposal, you will buy more SOL or you’ll buy SOL at a higher price. If the proposal were to pass, what you would do in a futarchy is lock your USDC into what we call a conditional vault. You lock 1,000 USDC for example, and you get back 1,000 “pass-USDC” and 1,000 “fail-USDC”. If the proposal passes, you would redeem your “pass-USDC” for USDC and if it fails, the “fail-USDC” is redeemed for USDC. 

Then you swap your “pass-USDC” for “pass-SOL” as long as you like the price. Say you vsn buy “pass-SOL” for 100 per SOL. You’ve put 1,000 USDC in the vault, you’ve swapped them for 1,000 “pass-USDC” and you buy 10 “pass-SOL”. You end up having “pass-SOL” and “fail-USDC”. 

At this point, if the proposal passes, you'll be able to redeem your “pass-SOL” for regular SOL. If the proposal fails, then it’s like the trade never happened and you can redeem your “fail-USDC” for USDC.

Put simply, you have front-run the decision and pre-bought SOL. 

Chainflow: Let’s talk about the risks and challenges of futarchy. Can it remain free from manipulation? What does manipulation look like in futarchy? 

Proph3t: Imagine John Smith created a proposal just on behalf of himself to buy a bunch of our native token $META below the current spot price. That’s a sweet deal for him because he’s buying at a discount. He wants the proposal to pass so he spends some money trying to manipulate the market in his favor. He drives the price so much that the price of “pass-META” is significantly higher than the spot price of META. 

However, people move in the opposite direction and they say to themselves that if the proposal passes, META would not be worth so much. They sell hoping to buy back cheaper later, and this drives the price back down. Eventually the proposal fails. 

It's in a market participant's interest to trade against noise traders, and this is what they do.

Chainflow: It seems like it really relies on the participation of the parties involved. What are the participation rates in a futarchy environment? Do you think it helps with low governance participation rates that some systems are experiencing?

Proph3t: We usually see on average 20 to 60 people trade a few hundred thousand dollars in a proposal

Does it make engagement better? I’m not sure. The goal of any governance mechanism is to make good decisions. Voting systems require some level of engagement because otherwise a few people can sway the vote however they want. With futarchy you don't really depend on that - it increases the quality of the engagement as people vote with their money.

Chainflow: Let’s discuss the implementation and integration aspects of futarchy. If a DAO or another project with traditional governance wants to transition to a futarchy model, how should they approach this? How do you assess if futarchy is right for your organization? 

Proph3t: One way to do this is to allocate a part of your organization to a futarchy, see how it performs and decide whether you want to take it further. 

Another approach is to run futarchy markets and don’t necessarily do what they suggest you do. You can still run conditional markets and see the prices. In my opinion, this is probably  the better way because then you really get to see how much you lose if you don’t do what the futarchy vote decides. 

Chainflow: What would be the potential impact of futarchy on network security? How would validator decisions and actions be affected? 

Proph3t: The normal way that blockchains govern themselves is by pretty loose social consensus. Whatever developers say has to be manually adopted by the people who produce blocks. A futarchy is simply an input onto that social consensus, it can’t do anything that brings down the network. 

If governance passes automatically, there could be security concerns, especially for smaller networks that can’t be restored from backups. 

Chainflow: Looking forward do you see any barriers to widespread adoption of futarchy?

Proph3t: One reason is that insiders often don't want to give up control. It's pretty nice to have a monopoly over a given industry and to extract money from having power. That’s the big structural issue that I do worry about. 

There are some engineering challenges that we can solve. We can also provide education on futarchy to help it spread. 

There are some open questions about the actual design of a futarchy. Keynesian beauty contest is a problem with markets - sometimes markets aren't really reflecting information because people are just speculating not necessarily on the assets' underlying value but on where other people are going to trade in the future.

I guess those would be the big three that we should solve.

Curious to learn more about futarchy? Listen to the full interview here: