Repeated Auctions with Speculators: Arbitrage Incentives and Forks in DAOs

TL;DR

This paper examines how DAO redemption mechanisms can be exploited by speculators, revealing inherent design tensions and proposing governance solutions to prevent costly speculation.

Contribution

It provides a game-theoretic analysis of DAO redemption mechanisms, identifying conditions for exploitation and evaluating strategies to prevent speculation.

Findings

Certain redemption mechanisms enable guaranteed exploitative exits.

Mechanisms designed for security can unintentionally facilitate speculation.

Governance strategies can mitigate speculative exploitation.

Abstract

We analyze the vulnerability of decentralized autonomous organizations (DAOs) to speculative exploitation via their redemption mechanisms. Studying a game-theoretic model of repeated auctions for governance shares with speculators, we characterize the conditions under which -- in equilibrium -- an exploitative exit is guaranteed to occur, occurs in expectation, or never occurs. We evaluate four redemption mechanisms and extend our model to include atomic exits, time delays, and DAO spending strategies. Our results highlight an inherent tension in DAO design: mechanisms intended to protect members from majority attacks can inadvertently create opportunities for costly speculative exploitation. We highlight governance mechanisms that can be used to prevent speculation.