CeFi (Centralized Finance) vs DeFi (Decentralized Finance) and underlying DAO infrastructure that enables DeFi is subject of interest in recent times. A decentralized autonomous organization (DAO), sometimes called a decentralized autonomous corporation (DAC), is an organization represented by rules encoded as a computer program that is transparent, controlled by the organization members and not influenced by a central government.

CeFi vs DeFi

The following diagram taken from Alex Mashinsky post on medium summarized the The Best of Both Worlds of CeFI vs DeFi.

Due to the nature of DAOs (requires no employees or executive managers), these organizations can survive on almost impossible margins, and only need to cover the cost of existing. Any business or financial entity can benefit from a model with DAO-like ambitions.

Decentralized Autonomous Organization: ShapeShift Story

In this blog post I look deeper into what it entails for a traditional / centralized organization transitioning into a DAO. The recent decision of ShapeShift to decentralize the entire company is a classic example to narrate this transition. ShaeShift is founded in 2014 by Erik Voorhees as chain exchange with 6 billion in lifetime volume, 1500,00 monthly users, 500,000 wallets, and $2.5 billion in associated assets. Going by fintech startup Revolut valuation of $33 billion with 15.5 million user base measures valuation at $2k per user. Following a similar logic, ShapeShift can be valuated at a billion dollar mark.

But on July 16th 2021, ShapeShift became a DAO via the largest crypto token airdrop in history of 340 million FOX Tokens granted to over one million recipients. This follows its announcement in January of integrating DEX (Decentralized Exchange) technology into its business model. This converted SshapeShift from a normal VC backed shareholder company with a board and an executive team to a DAO where the governance and the value accrual ends up revolving around the token instead of the shares.

According to Erik Voorhees, ShapeShift is ultimately trying to build an open source multi-chain self-custody crypto platform and to do that it has to be decentralized by uprooting the shackles that keep the it tethered to the normal corporate world. For not violating the regulations, ShapeShift ensured not do anything that is regulated and corporations by their existence are regulated and so one way to avoid that is to no longer be a corporation ultimately. This is about aligning ShapeShift with the ethos of crypto generally which is open immutable and borderless by becoming decentralized.

ShapeShift has gone through a phased evolution to become a DAO and certainly the name Shape-Shift has become very apropos for what they are by “shape-shifting” their users. ShapeShift started in early 2014 in the wake of the Mt. Gox catastrophe. The two core principles that lead to the formation of ShapeShist are,

1. Safeguarding the world from using centralized custodial exchanges because of all the danger of that Mt. Gox went through by almost destroying the whole industry back then
2. In the wake of burgeoning ecosystem of digital assets (in pre-ethereum era – but the trend was pretty clear that people were creating new digital assets for different use cases and with different technology), fuse these two things and basically create an easy way for people to convert one digital asset into another with as little friction as possible and without a central authority taking control of user funds or having deposits of customers

The early version of SshapeShift extremely resonant with Uniswap where user input one token get out another token without a centralized exchange and no custody. It was before DeFi and worked as the earliest version of Uniswap, If a user wanted to trade BTC for ETH, user would be presented with a BTC address or a Bitcoin QR Code and then user would also give ShapeShift their ETH address. User send Bitcoins and then ShapeShift would shape shift it into Ether and user could do this for any pairs, for example send Bitcoins receive Monero, send Monero to receive Bitcoin Cash etc.

ShapeShift in the backend was a centralized exchange but it was felt atomic. User just input one token and then received the other and shape-shifted all the magic in the background and it worked across chains which was really key. So to provide that service which was cross-chain, ShapeShift ultimately had to be the counterparty to the trade with users so when someone sent the bitcoin, ShapeShift received that into their own hot wallet. ShapeShift had an inventory of ETH and would send that out to that user offering a great user experience being very fast and simple.

By 2018, ShapeShift had grown fairly large with close to 100 employee making lots of money and everyone loved the service. This led ShapeShift to invest into the regulatory investigation to deepen its understanding of to what degree are various global financial regulations going to apply to them. That investigation led to the very depressing conclusion that ShapeShift would potentially be treated like a financial institution which meant it would have to impose KYC/AMC and all the various financial surveillance apparatus onto shapeshift customers. Before that ShapeShift had no KYC offering a services anonymously to protect users by not taking their private information.

ShapeShift user base reacted shareply to that move on KYC and mad at them for violating core principles that ended up losing like 99% of business. Most of the customers just went off to other competitors that were not taking the USA regulatory environment as seriously as ShapeShift were at the time. User simply wanted a service they didn’t want to be spied on.

This led ShapeShift working harder for over 2 years and reinventing the product to be not just an exchange but really like a an integrated wallet where people could use their hardware wallet or software wallet, see all their assets in a self-custody way, and trade them when they wanted. That didn’t get a ton of traction again because ShapeShift had all this KYC and people just didn’t like it.

Then in late 2019 Ethereum which had been created and spawned DeFi ecosystem and by early 2020 it had gotten large and Uniswap in particular started seeing days where it was rivaling Coinbase in its volume. But Uniswap has made it worked for Ethereum assets and Ethereum’s great but it is only a piece of the ecosystem and it does not include the most important asset of all which is bitcoin by market cap and liquidity. Learning from Uniswap’s awesome value prop, ShapeShift started about doing this across chain.

In 2020, ShapeShift decided to integrate Uniswap and in particular the 0x aggregator which allowed 12 different DEXes into ShapeShift. This allowed their trading engine and ability to interact with customers as a trader and outsource with these decentralized protocols taking the regulated activity which had gotten ShapeShift caught in all this barbed wire. Outsourcing to a decentralized immutable protocol that was the start of ShapeShift understanding the power of decentralized technology. Later extended to THOR chain which is like Uniswap but it allows trades across chains making it super cool technology and integrated that in April 2022. With this ShapeShift moved away from KYC and not an intermediary at any step of the process. It made ShapeShift is back to being frictionless platform where people can trade without worrying about being surveilled on leveraging DeFi the technology.

ShapeShift by replacing all of their back end with Uniswap, 0x and THOR chain positioned then to the next-kevel DeFi play. But it almost took ShapeShit undergo three-year struggle through every nuance of global financial regulation, millions of dollars of spend, countless hours of discussion with internal and external counsel trying to figure out what were the sensitivities and where could maneuver and ultimately led them to a decision that offering any regulated services keeps them under regulatory vigilance. So they stopped providing regulated services and users started interacting with DeFi protocols directly and ShapeShift moved away as the middleman and stopped even collecting fees making user transactions a direct service through their software interface, Note here that the laws can always change and should constantly watch regulations carefully. But under the current laws ShapeShift is not an intermediary and therefore it’s not responsible for the financial regulation that an intermediary would be.

ShapeShift becoming a truly a non-custodial bankless exchange is just one portion of the regulatory infrastructure, but how about the other part being a legal corporation (LLC), shareholder agreements, traditional bank accounts etc. in order to function in some nation state jurisdiction? To address this second part, ShapeShift started assessing DAOfying their organization. Initial primitives considered were letting users govern parts of their FOX tokens. With reception of the ShapeShift-Uniswap integration, progression of DeFi protocols, DAOs and the tooling, ShapeShift realized that their platform is going to be most competitive if it is open source and all other protocols can build onto it instead of having to fight for bandwidth from their own small development team. This shift in thinking led to the number of reasons to be a central entity just started falling down.

Shareholders & Employee Transition To Decentralized Autonomous Organization

The real question left now is, how shareholders and employees embrace ShapeShift transition to DAO. According to Eric, ShapeShift executive team had decided to do it back in late April and employees learned about it in May and then it all became public on July 14th which is coincidentally Bastille Day (which has symbolism that is incredible!). On this occasion, Eric tweeted that “Just as it made sense for every company to utilize the cloud to avoid friction in the 2000s so too will it make sense to utilize defy to avoid political and economic friction going forward. Buzzwords both and yet revolutionary.”

Only time will say whether DAOtizing traditional organization will be of the same magnitude of cloud, but the economics seems to be the same. But recollect that initially there was lot of skepticism on cloud and now cloud became popular because it reduced the cost of holding and running infrastructure and reduced it not by like 10% but reduced it by like 90%+ There is so much cost and friction in running regulated financial services. People do not see this because it just gets passed on to the end user and all the banks & zombie organizations that have zero interest in innovating, do not complain about regulations because they are just a tentacle of the state themselves. We have an environment in which financial regulations cost society hundreds of billions of dollars per year and the the all of society simply bears that cost today because there isn’t an alternative.

DeFi comes along offering these financial primitives and protocols which fulfill many of these financial services without any middlemen, without any intermediaries, without any staff, without any taxes, without any compliance obligations. DeFi is open immutable code that runs in cyberspace in ethereum or other blockchains as they develop that is incredibly powerful. ShapeShift with partner ecosystem offered a better service to their users than trying to run through it as a friction-laden organization The other organizations may come to the same conclusion of ShapeShift for leveraging DeFi to protocolize their products. Using DeFiand crypto endows to take the actual legal structure and turn that into code first with products and then DAOfying company.

ShapeShift is not yet fully decentralized at the time of this blog post and have 100+ centralized team. Erik and ShapeShit is currently working on two themes. First work on on the product side to open source all of the ShapeShift code that will allow the community to build on this product and to have a stake. ShapeShift had to distribute the FOX token to all those people so that they have an economic incentive to care and to participate. Economic incentives fuels everything and so the airdrop which was the largest in history went to all of their past customers and over a hundred thousand members of other DeFi communities making those people now have a stake in the decentralized ShapeShift

The second theme is about the legacy entity. ShapeShift is a Swiss corporation with several subsidiaries in different jurisdictions, ultimately all that stuff has to get wound down, the balance sheet has to get liquidated out to shareholders, and all of the contracts have to be wound down.

Then comes the employees of ShapeShift and the long-term future. With an LLC, you actually have an employment contract where everyone actually have to show up for work. But with DAO things will happen differently. Anyone whoever run a business knows the challenge of HR generally and having to have an entire department just to manage the logistics of incoming and outgoing staff with payroll and there’s a whole world of regulation just around that leading to ton of costs just handling the regulation of the people.

ShapeShift at the time of writing this article has about 65 employees and all of them will no longer be employees by the end of this year. Erik in a recent interview explained about the three waves and roughly a third of the employees are in each of these waves getting very generous severance. More importantly they all got very considerable grants of FOX tokens which unlock over the coming three years depending on where the price goes. This grant for many of them will be more valuable than the salary that they were making as W2 employees so that is now their option on how they wish to engage with the DAO. Some of them expected to be conservative and to go find some new W2 role at some company somewhere. Others will probably value the freedom that they have and they’ll work on ShapeShift part-time however they wish. The third trench are very committed to continuing full-time work for ShapeShift, but not in an official capacity just as a economically incentivized member and someone who cares about their vision. Interesting enough, Erik in new ShapeShift DAI won’t be CEO anymore and may remain simply as an influential member of the community having heavily economically incentivized to make sure it is a success.

The skeptics may continue to have doubts on the organizational model of new DAO structure without a CEO, no employees, and no employment agreement. This leads to many doubts on how does anything get done in this structure? ShapeShift may not have answers to every question and has to figure out how the DAO a new form of economic organization persist in the 21st century. It was impossible before the advent of tokens that provide an almost unlimited design space for economic incentives and you coordinate people around the economic incentives of a token instead of coordinating people around the much more rigid incentive structure of salaries and equity ownership. So it’s a model in which people are far more free that is far more appropriate for work-life balance because every person can figure out for themselves what they want to do/ They can work at flexible hours of the day or nigh, can travel around the world with their family and work at their that that suite to the lifestyle and needs.

How Structureless Decentralized Autonomous Organization Works?

The BIG question is how can you actually align around one goal and produce a product or application that is revenue generating in some sense and revenue generating may only mean that the token value appreciates over time. Some kind of economic activity has to be going on, allow more and more people around the world have to be finding it valuable and it has to have a sense of growth. That definitely will be an interesting experiment and that leads to a whole new workforce, a different type of workforce that begins to work within ShapeShift right. The DAO structure very much is a permission-less and not limited to the people inside of contractor or employment agreements. Anyone can come enter your discord and start working with ShapeShift. ShapeShift is already experiencing that experts from other DeFi community projects have come into the discord in their forum and started proposing things that are kind of interesting ideas fueling innovation and this never would have happened in closed corporate state.

Don’t misunderstand that the tokens on chain sound a lot like shares in the equity world and this whole thing is just going to collapse back to shareholder governance, corporate structures, boards of directors etc. The mere fact that a person can buy one token and sell one token globally 24×7 at a liquid price demonstrates how different this is than any kind of normal corporate equity situation. When there is a startup someone in some random country around the world can’t go by ten dollars of that project and participate just by being involved in the forum that is something wholly new. This concept is far more appropriate for the internet age than the traditional equity structure, so there are certainly overlaps and similarities between equity shares and tokens.

The governance of ShapeShift will revolve around FOX tokens just as the governance of corporate ShapeShift revolves ultimately around the shareholders and the board of directors that are brought in by them. So there’s certainly parallels and overlaps. It’s not like everything in a normal corporation is bad and there are some very good practices that have developed in the corporate world. A lot of those same principles will emerge in the token-based world but what you will get rid of is a lot of the corporate bureaucratic cruft that is not necessary and is not productive for a digital global project in the 21st century.

Let us peek into the DAO payment tool called Coordinate on Bankless. This is tool enables DAO to allot a certain amount of tokens and then opens it up to out all DAO members to essentially allocate these tokens to their peers and reward their peers for contribution in the DAO. The cool thing about that is it gives the people who are in the trenches the ability to reward their nearest neighbor reward the person on their project who’s contributing that they see doing something in the DAO with some additional tokens. it’s like if employees were able to choose their local environment of other employees as to who they think should be rewarded the most. Many times in the corporate world, we all know who the big contributors are and we all know who the freeloaders are essentially. The people who most know that aren’t the bosses, it’s those that are in the trenches actually working with these individuals. Imagine if employees have the ability to vote for who gets a bigger salary and that’s what this protocol enables.

Erik agrees that ShapeShift was never a large corporation with just 65 employees or a little over 100 at most and even at that level there is a degree of bureaucracy that led to counterproductive. So from what said above, in ShapeShift’s scenario, if someone in the trenches wanted their peer to get a bonus that has to get raised through at least one or two levels of managers. There has to be a couple meetings about it. It doesn’t comply with the company’s bonus policy. Good ideas die in that environment. ShapeShift took a radical approach to experiment the decentralized token-based structure. Now FOX token is the power of ShapeShift DAO. ShapeShift airdropped roughly 340 million FOX tokens (a third of overall supply close to a billion tokens) to a million past ShapeShift customers and a 120,000 members of DeFi and ethereum based protocols including Uniswap, Aave, THOR chain etc.,

Note that majority of the FOX tokens are distributed to community and kept for future distribution. Building good communities is very key to the success of DAO. So the underpinning truth is that the advantage has to live with the outsiders instead of the insiders. The insiders definitely deserve something but they have to be at the disadvantage relative to the community and you don’t have to be altruistic to make that decision because ultimately it is on in all of the insider’s benefit at DAOs like ShapeShift for this to be a success long term as a open community. The ShapeShift team understood the rationale on why are strangers getting so many of these tokens, it’s because you have to foster and cultivate this decentralized model. It ranged from 200 FOX tokens at the smallest to several thousand FOX tokens at the high end based on how many times that address had traded with ShapeShift or based on if that person had registered a keep key given to them some extra bonuses. I will write a separate blog on the FOX token distribution to manage the length of this post.

The Future of Decentralized Autonomous Organization

DeFi and DAOs are emerging set of technologies which are financial in nature and which cannot be stopped or changed by any central party. They can be regulated in name only but they will keep on functioning as the rules of the immutable code declare. These decentralized financial systems that are un-regulatable at least on the base layer and this clash is the story of the rise of the cryptocurrency industry. None of us know how it will unfold and it will be something that takes place over many years and with many battlefields and unfortunately with many casualties.

One hope is that a lot of these regulators recognize this financial technology brings about a degree of soundness and transparency transparency, honest-ness and gives the entire world a level of access to financial services which their prior status quo financial system has never been able to do. Let’s again hope that nation states don’t see it as a pure enemy to them even though it will clash with many of their objectives. Centralized zombie entities will never get this crypto thing to work, because governments want to control the money system. Period.

Do DeFi believers should keep trying to make this industry and these tools so damn useful that regulators will have to embrace it that their population will rebel against them if governments try to quash this industry and quell it like the internet. The early days of the internet there were those who were of the mindset that communication technology is too powerful for everyday citizens. Strong cryptography exactly another example you share that hope. What do you think so for those who don’t know strong cryptography was illegal to normal usage. It was considered a munition and could not be exported out of the united states and there was a whole series of regulatory battles about this in the 90s.

It became so damn useful that the entire world had to let it be open and available to everyone even though it allows all people to hide messages from surveillance. That parallel is really important when it comes to financial technology in the same way that you should allow all people to hide messages from government. The same thing is true for financial transactions. There is no reason that finance is less deserving of privacy than communication and ideas generally and just as it is legal today to go encrypt your email in a strong way that not even the NSA can interpret. So too should it be legal to have privacy in your finances. This is not a popular concept. Most people seem to support the status quo where the government surveils all financial transactions of all people. It’s incredibly Orwellian, creepy and unethical. Especially the younger generations grow up in a world in which they have the option of financial privacy many more of them will start to care passionately about that as an important social casein.

In Summary

Decentralized Autonomous Organization brings sound money concept to masses. Nation states and traditional organizations has to closely analyze the merits of DAO and assess in true spirit its viability. ShapeShift story presented in this blog post offers a potential path to transition to a Decentralized Autonomous Organization. Let’s take a step forward in DAOfying our future!

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