Allocating a treasury is one of the great challenges in decentralized governance. Crypto's most memorable controversies often feature a large pool of shared capital and conflicting claims of misappropriation.
Treasury allocation is a simple idea. Set an objective, find a project or activity that appears to achieve the objective, and then provide the resources it needs to achieve it. For a lone protocol developer, deciding how to allocate funds is both uneventful and a necessary part of their work.
However, once the developer outsources treasury allocation to a large, distributed network, these questions take on new dimensions: Who sets the objective for the protocol? How do we ensure we're evaluating the most relevant opportunities? How much should we allocate to any project? How do we prevent self-dealing? How do we collectively measure progress? Who or what holds us accountable?
These questions become even more complex when we consider the diverse nature of a large protocol's stakeholders. Protocol networks can include thousands or millions of tokenholders who span a range of preferences, pursue conflicting goals, and possess highly variable contextual knowledge. To rely on a simple token-weighted average of their opinions is problematic. It incorporates misleading signals while simultaneously discarding valuable insights. For example, with limited resources to deploy, a compromise between two objectives is, ostensibly, a commitment to neither. Diverting funds towards infrastructure improvements limits the resources available for growth objectives.
Token voting, then, can only guarantee the following: every treasury allocation it produces maximizes the interests of its largest or most influential tokenholders—or their delegates. All we care to know, however, is which allocations are best for the protocol as a whole. Conditional Funding Markets aim to address this challenge.
In the most general sense, a protocol is a collection of well-enforced rules. Like institutions, protocols serve as social building blocks, transforming individual acts into powerful feats of coordination like propagating languages, conducting global trade, or launching rockets into space.
Both institutions and protocols begin to fail where their rules can be misinterpreted, changed without warning, or arbitrarily bypassed by insiders for their own personal gain—transgressions we've come to accept in society's most important institutions, like law, education, family, and government. But as failures chip away at society’s building blocks, people stop relying on them and society’s engine begins to sputter.
Blockchain protocols overcome this problem by outsourcing their enforcement to a network of competing validators. This creates rules that can’t be misinterpreted or arbitrarily bypassed, on top of which we’ve created new forms of money and markets. With more durable building blocks we can support even greater feats of coordination.
Unfortunately, token voting-based governance still leaves room for misinterpretation and self-interest, threatening the promise of blockchain-backed institutions.
Our vision is MechGov, where cryptoeconomic mechanisms govern blockchain protocols. Cryptoeconomic mechanisms combine rules and economic incentives to guarantee a system’s properties, such as security in the case of a blockchain, or stakeholder alignment in the case of a protocol’s governance. By limiting the opportunity for self-interest to undermine blockchain protocols, we can guarantee they will serve as durable building blocks society can rely on.
**Conditional Funding Markets (CFMs)**, an implementation of Futarchy, are a special type of prediction market. CFMs leverage speculative markets to estimate the probability that a funding decision will produce a desired effect before the funding decision is made. The resulting probability distribution of all possible allocations is subsequently used to allocate the funding.
CFM users set a target metric, such as protocol revenue, and allocate a pool of funding to the mechanism. Each applicant produces a set of corresponding Conditional Tokens or “Outcome Tokens” whose value corresponds to the target metric in a future world where they receive funding. The token’s value increases as the metric approaches the target, e.g., $10 million in protocol revenue.
Markets speculate on the value of these tokens, with each individual trader attempting to maximize their own payoff using the information available to them. By way of the market mechanism, token prices will eventually come to reflect all available information about the most likely result of a funding decision.