From the rapid growth of crypto to the dramatic volatility of the asset class, governments around the world are responding through regulatory and legislative actions. Some jurisdictions have announced clear and accommodating frameworks in the hope to create the crypto hubs […]
"In the state of nature, profit is the measure of right.”
— Thomas Hobbes
Smart Contracts vs. Social Contracts: DeFi’s State of Nature
The 17th-century philosopher Thomas Hobbes posited that without laws, man existed in a “state of nature” — a “nasty, brutish, and short life” of “every man against every man.”
Being reasonable, however, men could be expected to construct a “Social Contract,” giving an authority the power to enforce laws.
That was his argument for submitting to the often arbitrary authority of a Monarch: Any law, however imperfect, is better than no law.
Today, the Social Contract is firmly codified in gazillions of laws, so we don’t think much about the alternative.
I’d argue those laws are more fair than not. But that doesn’t stop us from complaining: We want our laws to be perfectly fair — even when we can’t agree on what that might be.
Which is the problem with Social Contracts: one person’s fair is another’s unfair.
Still, we should remind ourselves it’s better than the alternative, which is living in a Hobbesian state of nature.
That, however, is where DeFi still resides, as evidenced by this weekend’s news that TribeDAO would shut down — and the reaction it provoked.
Code is said to be law in crypto, but there are limits to what can be governed by code. Beyond that limit, there is nothing but opinion.
Where smart contracts end, social contracts begin.
Read Me My Rights
It’s often said that DeFi is speedrunning the history of finance, but it may also be speedrunning the history of property rights, corporate governance and political philosophy.
On current evidence, I’d say we haven’t gotten much past the starting line.
If you are a depositor to a DeFi protocol, you have no rights as a creditor, beyond what is hard coded into the smart contract.
If you own a token issued by a protocol, you have no legal claim on the protocol’s assets.
You don't even really "own" that token — you have no enforceable property rights.
And, if you feel any of those non-rights have been violated, there is no court to appeal to other than the court of public opinion that is always in session on Twitter.
That’s where DeFi’s Social Contract was debated over the weekend after the founders of TribeDAO proposed that the high-profile protocol be shut down.
Amongst other measures, the proposal foresees TribeDAO paying out all of its assets to token holders, except for about $14 million set aside to compensate users who were victimized in an exploit.
Not all users would be made whole, however: Frax Finance, for example, would be compensated for just 2% of its losses.
That prompted Frax founder Sam Kazemian to label the proposal “fraud.”
In DeFi, fraud is in the eye of the beholder — there are no laws to violate, so fraud in a legal sense is not really possible.
Itis, however, possible to violate the Social Contract of DeFi, and I think that’s what Sam K. is accusing the Tribe founders of doing: He thinks Tribe’s users should be treated as creditors.
Depositors to Tribe’s Fuse pools, like Frax, were not formally creditors to Tribe — they were just users interacting with smart contracts that Tribe had coded and deployed. Tribe has no legal responsibility to reimburse users of that code.
You could even argue that their fiduciary responsibility is to TRIBE token holders, who are arguably entitled to receive all of Tribe’s assets. Except that there is no fiduciary duty in crypto — because there are no laws.
There is only Social Contract, which is open to interpretation.
Sam K’s interpretation of DeFi’s social contract is that protocols are implicitly liable for losses incurred by users of the code they deploy.
In the case of TribeDAO, there is precedent for that expectation: When Tribe was formed by the merger of Fei and Rari, protocol assets were used to "pay back victims of the previous Rari Fuse pool hack." The victim’s losses were referred to as “obligations” of the DAO.
So, users of Tribe’s Fuse pools were treated like creditors in the merger, and their losses were treated like debt ("obligations.")
But that was then (all of nine months ago) and this is now: In the proposed wind-down of TribeDAO, hack victims are treated more like charity cases than creditors.
This is extra aggravating to exploit victims because TribeDAO did originally intend to treat them like creditors: In May, token holders voted to make all of their losses whole.
That decision was, however, was reversed in June, when the Tribe’s NopeDAO vetoed the Tribal Council decision.
That sentence makes only slightly more sense to me than it does to most of you, because Tribe’s decision-making structure is a confusing mix of made-up layers of governance: Tribe DAO, Tribal Council, NopeDAO, Optimistic pods, Guardian Pods.
Creatively naming new governance structures is fun, but there’s a reason it’s not done in TradFi: You don't want to re-learn governance every time you invest in a company.
All the complexity obscures the underlying fact that people, not smart contracts, are behind most of TribeDAO actions.
That’s not unusual: Like Holy Roman Emperors (being neither holy, nor Roman), most Decentralized Autonomous Organizations are neither decentralized, nor autonomous. (And not very organized, either).
DAO votes tend to be non-binding, only taking effect when implemented by people — who have no legal obligation to do what they’re told.
Keeping it Fair
Apart from the issue of reimbursing hack victims, the proposal to wind-down TribeDAO seems pretty fair: The DAO’s assets will be distributed proportionately to all token holders, just like you’d expect in TradFi.
Unlike in TradFi, however, it doesn’t have to be that way.
If the founders mustered 51% of the votes, they could distribute all of the DAO’s assets to themselves. Or to one-half of token holders and not the other half. Or to the local dog rescue.
That’s unlikely, of course (much as I’d like that third option to happen), but it’s not impossible.
It’s probably not that hard, either: You’d only need 51% of the tokens that bother to vote, which is not a high bar: Only 13% of Rari token holders voted on the merger that created TribeDAO.
And 13% is actually pretty good: In the most momentous decision in the history of crypto, only 5% of ETH voted on whether to hard fork Ethereum after The DAO hack in 2016.
90% voted in favor of the hard fork, which is nice. But 90% of 5% is not much of a mandate.
And you generally don’t even need that: If the DAO is a multisig, as (I think) most are, you only need 50% of the signers. Two or three people will generally do it.
All of which is to say, it’s only voluntary adherence to a not-yet-settled Social Contract that’s protecting the interests of DeFi’s users, creditors and token holders.
In state-of-nature DeFi, where smart contracts end, opinions rule.