Not only did spending $90,000 to name a rare Ecuadorian frog species leave the decentralized blockchain project community members dissatisfied; some savvy arbitrage traders just wanted a piece of the action.

By Danny Nelson

• Internal critics of Nouns DAO have long been dissatisfied with the project's reckless spending, such as spending $90,000 to name a rare frog species after themselves.
• The DAO designed a "fork" to provide an exit channel for dissenting members and an escape hatch for itself in case of attack.
• However, savvy arbitrage traders have participated in the governance game for profit, raising serious questions about the appeal of decentralization.

Nouns DAO and Governance Philosophy | Thought for Today

Can you put a price tag on decentralized governance? For Nouns DAO, the answer is $27 million in cryptocurrency.

DAOs are the corporate version of the crypto movement, but with more democracy and (theoretically) no leaders. Anyone who owns the DAO's crypto assets - in the case of Nouns DAO, NFTs - has the right to vote on how the group uses its funds and makes decisions. However, the charters of these groups are constantly evolving and could quickly become chaotic.

At Nouns DAO, things have gotten chaotic. Last week, the NFT experiment lost a portion of its dissatisfied investors, more than its $50 million treasury. They forked from Nouns DAO; in crypto terms, they chose to "fork."

This fork is the culmination of months of controversial discussions about running Nouns DAO, a well-known crypto club with many dramatic events. The debate over allowing the fork was intense; ultimately, the community decided to allow it, arguing that the option would improve overall governance - as a political innovation, as a form of protection for any dissenting movement, and as a step towards greater decentralization. Its designers believe that other DAOs could adopt this approach.

But what happened next - a very expensive fork - is now being described by some observers as a backyard fire. It attracted savvy arbitrage traders who, instead of protecting Nouns DAO from 51% attackers (a core fear for every decentralized crypto project), participated in Nouns DAO's governance game for profit.

Jillian Grennan, a finance professor at the Haas School of Business at the University of California, Berkeley, said, "This Nouns DAO fork could become a cautionary tale."

This story provides a lesson in how DAOs deal with dissent, an issue that is sure to resurface in more earnestly decentralized projects. Few have been as resolute as Nouns DAO in making such attempts. At the very least, this event provides a case study, showing what problems can arise when fund management becomes decentralized in blockchain-enabled experiments.

Background

A review of Nouns community blog posts, Discord messages, Twitter Spaces, and interviews with over a dozen members conducted by CoinDesk shows that this fork is both a result of internal politics and concerns about security and decentralization.

Nouns DAO raises funds for anything its members want to support by auctioning off a colorful JPEG image - the Nouns NFT - every day. For example, last Wednesday's auction brought in nearly $49,000 in ETH for the DAO. That's how it builds its massive treasury. This fork is actually the result of a long-standing battle between two factions within the community.

"In Nouns, there are mainly two factions: the book value faction and the meme value faction," said Hong Kim, co-founder of crypto investment firm Bitwise and a member of the six-person board of the Nouns Foundation.

The meme value faction was the initial driving force behind Nouns DAO, attempting to spread Nouns in popular culture through guerrilla marketing campaigns worth tens of millions of dollars and supporting infrastructure for the Nouns project. Their more creative projects ranged from the quirky - spending $90,000 to name a rare frog discovered in Ecuador - to the infamous - attempting to launch a 3D-printed Noun into the International Space Station.

"Nouns spent millions of dollars doing stupid things on unverified people," said BigshotKlim, the artist behind Nouns' oversized red-eye glasses "noggles," who himself received tens of thousands of dollars in compensation through DAO-commissioned projects, in a Telegram message to CoinDesk.

All of this spending angered the second group, who took a more conservative approach, project members said. The book value faction believes that NFTs should at least equal their share in the inventory. For them, Nouns DAO's extensive spending (CoinDesk estimates the DAO has spent over $26 million on marketing) is wasteful. In the long crypto bear market, some believe they could manage the project better.

Noun 40, also known as Kim, a member of the community, said, "These two factions are deeply triggered by each other's existence, believing that the other has ill intentions, and everything is like that." He said, "We eventually thought, 'How does crypto solve this problem? How do Bitcoin and Ethereum solve this problem?'"

Fork

The two largest, most valuable, and most important public chains have experienced forks when different factions disagreed on the future of the blockchain. Bitcoin's years-long block size war in 2017 gave birth to Bitcoin Cash. In Ethereum's early days, the painful DAO hack event was essentially abandoned by forking from the original chain and is now known as Ethereum Classic.

While political, blockchain forks are also technical: they occur when the underlying computational power of a network is divided to support two different histories. DAOs do not have the equivalent of divorce proceedings.

Perhaps the closest approach is the "ragequit" proposed by MolochDAO in 2019. This mechanism allows DAO members who disagree with the project's direction to exit the original club and take their funds to a branch.

As the project's two core engineers, Elad Mallel and David Brailovsky, introduced this controversial mechanism in a Twitter Space hosted by Noun Square, a media funded by Nouns DAO, ragequit became the topic of Noun Town on December 20, 2022. They positioned it as a security support against 51% attacks, where malicious actors with majority control can force through malicious proposals, such as sending the entire treasury to themselves.

Mallel said in the Twitter Space, "If such an attack were to occur, everyone except the attacker can ragequit. And not only do they leave with their assets, but they also significantly diminish the attacker's gains."

He and Brailovsky positioned ragequit as an alternative for Nouns DAO to counter malicious proposals: Nouns Foundation board members have veto power.

Kim, as one of the board members with veto power, expressed that the Nouns community is not concerned that the foundation might "go rogue," but the mere possibility is still worrisome. A foundation's veto power is seen as a centralized point in the DAO, and the DAO signifies decentralization (even now, those closest to Nouns DAO express a desire to eliminate veto power in favor of alternative methods such as forking).

The forking mechanism was implemented as part of Nouns DAO's V3 upgrade in August 2022. Those familiar with Nouns DAO technology say the design attempts to maximize the usefulness of forking as a theoretical escape route and minimize opportunities for financial exploitation.

Under the new rules, any Nouns NFT holder can request a fork after a disliked proposal. Their appeal only takes effect when 20% of the Nouns NFTs held by the community join. Once the forkers surpass this 20% threshold, all functions of Nouns DAO are frozen for seven days, with no spending, only debate - stay or leave? Then, the forkers enter a forked DAO with their asset shares, following the original governance rules of Nouns DAO, with one significant addition: ragequit. Members of the forked DAO can exit and withdraw their funds at any time.

Soon after, a dissatisfied Noun holder requested a fork and quickly reached the 20% threshold, putting all these assumptions into practice. This was not a 51% attack, but the result of a political struggle between two warring factions. The meme value faction and the book value believers are about to part ways.

For a third group, this is also a moment to celebrate, unrelated to long-time believers in Nouns DAO, observers say. After eight months of gradually accumulating strength and influence, arbitrage traders are now showing their power and mass exiting Nouns DAO.

Arbitrage "This fork is particularly fascinating because there are two completely different factions: those genuinely dissatisfied with Noun DAO's strategic choices, and a group of arbitrageurs who see forking as a simple financial trade-off," said Professor Grennan.

For some investors in the project, ragequit has always been part of the plan.

Arbitrageurs are cryptocurrency investors who bought Nouns NFTs at a price below "book value," betting that they could later ragequit them at a higher price. Some of them paid attention to Nouns DAO during last year's ragequit discussions. Then they started buying. According to Kim, most of the Nouns NFTs auctioned in 2023 were purchased by arbitrageurs.

A community member known as TheBower, who has been writing newsletters for Nouns DAO governance, said, "The discussion about forking has increased the power of radical investors." He said the radicals "began to have a significant impact on Nouns DAO," to the point where forking became necessary - even just to get rid of them.

At the time of the announcement, most forkers had already exited their forked group and taken 62% of the $27 million treasury. Each Nouns NFT exit brought them a profit of 35.5 ETH, roughly equivalent to a 2024 BMW 5 Series. Some sold their NFTs for 27 ETH or less.

While ragequit is new to Nouns DAO, it is familiar to many arbitrageurs. Some of them are prolific radical investors who seek opportunities to trade DAO assets below book value in the crypto space. Once in, they pressure the DAO's power brokers to provide a redemption mechanism - ragequit - to satisfy dissatisfied investors.

One of the largest forkers, a prolific anonymous crypto trader named Blurr, told CoinDesk that they had been watching Nouns DAO "from day one," but only started acquiring 44 Nouns in August 2022 because "it was clear they had to" make the fork happen.

Blurr said, "It's always been a game of maximizing value for all parties involved." They refuted the argument that Nouns' seven-figure NFTs were anything other than an investment game and fiercely criticized Nouns DAO's radical spending. According to on-chain records, the trader received various cryptocurrencies worth $4 million from the DAO fork.

The financial acumen of arbitrageurs has brought expensive consequences for the remaining members of Nouns DAO. The funds they used to sponsor films, donate to charities, commission children's coloring books, rename frogs, and even pay developers have dwindled by $27 million.

The core team of Nouns DAO was not deterred by the treasury loss. A well-known community member who requested anonymity said the group knew there was a risk that people would participate in the fork for economic gain. This person said the risk was worth it, "to push the boundaries of DAO design."

Follow-up The Nouns community - whether staying in the original or forked group - is still trying to understand the causes of the chaos and debating whether it was a success.

Kelly Werder, a professor at the University of South Florida who teaches cryptocurrency courses and is active in Nouns DAO, believes the group "did not spend enough" of its treasury resources to prevent arbitrageurs from taking advantage of book value discounts and ragequit.

However, Toady Hawk, who is still in the original Nouns DAO and operates its Nouns Square media, is more willing to give forkers without ragequit a chance to run a "more financially prudent" DAO.

Professor Grennan, who researches DAO design at the University of California, Berkeley, says Nouns DAO's forking experiment "emphasizes the need for more complex governance structures that meet the needs of various stakeholders without compromising the organization's long-term vision."

She said, "In the grand scheme of things, this one-off example shows that while DAOs offer exciting prospects for community-based governance and collective wisdom, the crowd is sometimes right."

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