Why decentralization is important for DeFi projects and how a DAO built on Colony can help achieve this through reputation-based voting
This article focuses on an innovative reputation-based voting technology designed to upend and improve the current state of affairs in decentralized finance. We will look at the example of a DAO built on Colony, but first, it is important to understand the importance of decentralization to the industry and talk about what DeFi. This approach will help us get a holistic view of the issue at hand.
What you need to know about DeFi
Let’s start with the root question, “What is DeFi, how does it work, and what is its value?” We’ll break down the basic concepts to move forward.
DeFi is blockchain-based financial tool (services and apps). They become an alternative to the banking sector and replace the traditional technologies of the current financial system with open-source protocols. This approach will open up a lot of people to decentralized lending and new investment platforms, and allow them to earn passive income from cryptocurrency assets.
To summarize, the idea behind DeFi is to create a free and transparent ecosystem for all participants, uninfluenced by financial market regulators and the human factor. Users resolve financial issues directly with each other without third-party involvement. The activity of traditional banks, courts, and brokers become impractical. All necessary functions for interaction must be implemented through special software. Ethereum is currently the most universal and popular platform. Many popular DeFi products run on it today.
Let’s summarize. What are the key differences from traditional financial systems DeFi has?
1. Cryptocurrencies and tokens, not government currencies, are considered money.
2. Money is not issued by the state or banks, but by people (miners) themselves. The money then goes into general circulation.
3. Credit issues are not handled by licensed banks, but by decentralized platforms managed by the community of users. That is, here, too, we are talking about equal participants.
4. The exchange of assets is not just exchanges and brokers, but special decentralized exchanges. The main difference between their activities is the anonymity of the clients (participants). Users do not store data and do not ask for documents to perform the required actions.
5. Investments are not made in shares, bonds, vouchers, etc., but in tokens.
This is enough to understand the power and prospects of DeFi, which in the future has all the chances to revolutionize the financial sphere of the planet radically. The key problem for the industry right now, which is limiting the application, is the imperfection of the technological component. This is rapidly being addressed today.
Voting as the key thing for decentralization in DeFi
Thus, decentralization is a fundamental thing of the DeFi industry. The ability to move away from interaction with traditional financial systems will give more freedom of action to ordinary users. As a result, decentralized finance:
Will give access to financial products to anyone who is currently isolated from traditional financial institutions;
· Make the user able to manage transactions independently and with minimal intervention — no in-depth understanding of the processes is required;
· Provides an opportunity to store personal data anonymously;
· Members of the ecosystem manage it on an equal footing, without a “central controlling hub”;
· Have no intermediary costs for transactions;
· Anyone can launch here their financial products and link them to other financial products within the ecosystem.
The advantages of DeFi also include equal transaction security and open source. The disadvantages of the industry at the moment are considered to be the lack of a body responsible for the actions of participants in any such system, as well as market volatility, regulatory uncertainty, risks of hacking and fraud, and technical problems.
We have told the most important things about DeFi above, and also outlined the importance of the concept of decentralization for this industry. Now let’s go further in exploring the subject matter of this article.
Voting theory underpins many consensus algorithms and DeFi governance models. A blockchain always contains voting elements. Their set differs depending on the architecture of a particular blockchain. For example, they could be miners, master node owners, validators, or token owners.
Voting is critical to blockchains, including DeFi. Protocols like Proof-of-Work (PoW) or Proof-of-Stake (PoS) allow you to determine the validity of a transaction through voting, for example. You get even more insight into the importance of this concept if you understand the scale of the actions that voting takes, from getting tokens, to changing the consensus protocol. That is, voting is important for decentralization because it supports all the main ideas of DeFi’s existence that distinguish the new industry from traditional financial systems.
What are some ways to vote? Let’s look at examples according to voting theory to see how this applies to DeFi.
· Plurality Vote is a very traditional and recognizable model, where each voter chooses one candidate or abstains from voting, and the candidate with the highest number of votes in their favor wins.
· Anti-Plurality Vote is the inverse of the previous model. It is a process of voting against one candidate (or abstaining from voting). Whoever gets the least number of votes “against” wins.
· Instant Run-Off — You can vote for any number of candidates, but only the two with the most votes win. The winner is determined in the second round by direct vote for one of the two candidates. More than two candidates may advance to the second round if there is a tie in the first round.
· Borda-Count — Each candidate receives a certain number of points from a voting member. The number of points is determined by the number of candidates. For example, in a vote between three candidates, a person gives 2 points for the winner, 1 point for the runner-up, and 0 points for third place. The candidate with the most points wins.
This list could go on, but the general mechanics of voting you should now understand to move forward in learning this mechanism at DeFi. The main point is that voting theory is the theoretical basis for DeFi’s most well-known consensus and control protocols. Effective governance mechanisms are essential to the success of DeFi, and they must implement robust voting mechanisms to do so. Voting theory may be considered a little-known area of game theory, but it is extremely important in DeFi.
We can now talk in detail about the Colony Project and their DAO perspective using the concept of reputation-based voting.
How a DAO built on Colony can help achieve decentralization suing reputation-based voting
In this section, we will need to explore all the concepts one by one to arrive at a conclusion and an answer to the question posed.
What is a DAO
DAO is an acronym that stands for “decentralized autonomous organization” quite simply. It is such an autonomous system in blockchain, which is controlled by software code and does not depend on the notorious human factor. The main feature of DAO is that it has no central node, which manages the entire system without coordination with other participants. In other words, there is no hierarchical structure in decentralized autonomous organizations, and all participants in the ecosystem have the same rights and can vote for changes in the protocol on an equal basis with other participants. This is the root thing that defines the decentralization of blockchain and its voting mechanics.
Colony project’s background
Blockchain is growing, and new DeFi crypto projects are facing the limitations of the DAO infrastructure. Colony aims to give more powerful tools for DAO developers.
Colony is a platform for organizing and fostering teams, projects, and communities that is currently on the xDAI network. The project was founded in 2014 based on Ethereum. At the time, it was a comprehensive framework for DAO that is fully decentralized, trust-free, and 100% open source. Colony helps create a user interface that is beginner-friendly but allows you to work with complex DAO structures. It’s a concept that encourages technical and user growth at the same time.
Colony has more than 20 software features, including a sophisticated reputation-based voting system, token creation, a “lazy consensus” management system, and the Coin Machine, a mechanism that offers one of the fastest and easiest ways for DAOs to sell tokens. Key merits include a user reputation system that is proportional to internal merit, as well as rapid issuance of personal ERC20 tokens, cheap transactions with the prospect of becoming free through meta transactions, and lazy consensus with the need to vote only when there is disagreement among system participants.
The value of the concept of reputation-based voting for decentralized DeFi using Colony as an example
Reputation is the evaluation of a user based on their contribution to processes over time. Reputation is needed to determine the user’s influence on decisions based on his or her experience. It is also important for determining reward amounts. A user’s reputation is determined by direct or indirect evaluation of the user’s actions by his peers. The purpose of the Colony mechanism is to create a dynamic decision-making hierarchy that takes user experience into account, changes flexibly according to the situation, and does not skew in favor of a limited number of top users. All participants would be in their seats and their influence would be extremely objective. This moves away from the unworkable model with equal rights for all participants without regard to their contribution to the common cause and allows for a more flexible and fair system of decentralization.
What do flexibility and dynamism of change mean? Being an important part of the ecosystem on “past merit” is impossible. A user gets a reputation from peers solely for direct actions within the system but loses personal points due to mistakes, unworthy actions, and simply downtime and inactivity.
According to the Colony concept, there are three types of reputation. Reputation by:
Reputation by Domain means that the user has a reputation in all existing domains, even zero. Changes in reputation in one domain mean equivalent changes in other domains. This applies to parent and child domains relative to the domain in which the change occurs.
Regarding Reputation by Skill, we expect domains to be primarily used as an organizational hierarchy within a colony. However, this does not necessarily reflect the type of work a user performs to gain reputation. The study of the work a user performs is done by the skill cloud. The skill cloud is the same standard for all colonies. When an expenditure is created and placed in a specific domain in a colony, it can also be marked with one or more skills from the skill cloud. When a recipient earns reputation by claiming a payout, he receives a reputation for all the skills on which the expenditure was marked, with the reputation distributed evenly among the skills. This is in addition to the reputation earned in the respective domains. The skill cloud is a universal thing; the reputation of certain skills is unique to each colony. Earning the reputation of a skill in one colony does not affect the reputation of the user of that skill in other colonies.
Reputation by Colony means a person’s reputation in a root domain. This is a general measure of reputation when making decisions involving everyone in an untrustworthy colony. Reputation within a colony does not apply externally, that is, reputation in one colony is not bound by reputation in another colony, even for the same account. This is where reputation from spending, arbitration, and so on is determined.
We can state that this approach provides a new understanding of decentralization and adequate equity for participants in such systems. Several specialized voting and reputation mechanisms give more flexibility than generalized techniques.
The mechanism described in the article is precisely the one that can reduce risks from casual participants and provide adequate rights to the relevant users. An intermediate approach without authoritarianism and outright communism with dynamically changing opportunities “somewhere in the middle” for each participant in the system can be considered a promising approach to developing the industry and improving one of its key concepts: decentralization.