What the Futarchy?
The Meta-DAO is all in on rational governance by conditional markets
Markets are never wrong, opinions often are.
—Jesse Livermore
The governmental body of an organized group is an authority that, in theory, has the benefit of the group as its guiding principle. Yet, mad kings, evil dictators, abusive parents, and predatory corporations are littered throughout history as incentives and power often misalign.
The question of governance is an ongoing debate on how to make the best decisions on behalf of a group. Much of global geopolitical conflict in the 20th century stemmed from philosophical disagreements on governance.
The market is a game in which participants are encouraged to correctly price an asset for financial gain. How can we use markets to make rational decisions?
Long Live the Futarchy!
Futarchy is a system of governance proposed by economist Robin Hanson that is gaining traction as decentralized technologies meet entrepreneurial free-thinkers. By harnessing the power of prediction markets and decentralized autonomous organizations (DAOs), futarchy presents a market-driven approach to governance that has the potential to redefine how groups try to make rational decisions. The quality and impact of decisions are measured by a predetermined metric. With each decision, the futarchy attempts to optimizes the metric by either improvement or non-action.
Futarchy translates market dynamics into decisions by providing two markets for a proposed decision, one pass and one fail market. For the duration of the proposal, participants trade on each market and the market with the higher price wins and determines the fate of the proposal. Trades in the losing market are reverted.
Trading in any market represents an opinion on the fair value of the market. Futarchy listens to the aggregate opinion of all traders in the market and trusts in their judgement as expressed through price.
Enter the Meta-DAO
Founded by Proph3t, the Meta-DAO is the first organization governed by futarchy on and made possible by Solana. The organization uses the price of its META token as an optimization metric to evaluate decision quality and aims to maximize its value. The Meta-DAO leverages three key Solana programs.
a conditional vault that locks up META or USDC and mints two conditional tokens pToken and fToken for trading in conditional markets.
Conditional Vaults for a Proposal a time-weighted average price (TWAP), A weighted average price metric to stably represent the conditional market’s price without risk of manipulation.
an autocrat, a program that orchestrates futarchy by managing other programs.
In the Meta-DAO, proposals are created and submitted by the community and, with sufficient interest, are given to the autocrat program which creates the pass and fail central limit order books (CLOBs) by OpenBook, as well as conditional vaults for people to lock their real tokens and receive two conditional tokens for each real token to trade with, where one of the conditionals eventually settles into the real token.
Trading on the proposal is open for five days, after which the TWAPs of both conditional markets are compared. If there is a difference exceeding 5%, the market with the greater TWAP is finalized, its position is executed by the autocrat program and trades are backed and settled using the locked tokens. Trades on the losing market are reversed.
The conditional markets in Meta-DAO can be thought of as statistical hypothesis testing for the impact of proposals. The null hypothesis is the fail market, where the proposal fails and nothing changes. The alternative hypothesis is the pass market, where something changes from the status quo, and could have either a positive or negative expected value assuming significant change by pricing META/USDC higher or lower than the null market. The proposal passes if the alternative is shown to be greater than the null and significant.
Trades on the conditional markets reflect market participant opinions on the price (expected value) of META/USDC given each hypothesis is true. Hypothetically, in a closed information system, Proposal X+1’s fail market value should equal Proposal X’s finalized market value, assuming accurate market estimations. In reality, new information, concurrent proposals, and shifting market narratives can impact market price estimations between proposals.
Trading in any market is an expression of opinion on the fair value of the asset. Conditional markets used in futarchy condition the market on a universe where the proposal passed or failed.
In the pass market:
Buying META means you think if the proposal passes, META should be valued higher than the price you’re buying.
Selling META means you think that if the proposal passes, META should be valued lower than the price you’re selling.
In the fail market:
Buying META means you think if the proposal fails, META should be valued higher than the price you’re buying.
Selling META means you think that if the proposal fails, META should be valued lower than the price you’re selling.
It’s important to distinguish that conditional markets in the Meta-DAO differ from traditional prediction markets where the latter prices the probability of events happening. Conditional markets trade the expected price of the META token conditioned on either the passing or failing of a proposal, rather than the probability that said proposal passes.
Advantages
How can we be sure that a futarchical system is the best system of governance? We can’t, nor do futarchists claim that it is the best. However, in humanity’s search for trusted and rational decision-making authorities, better than what we have is a step in the right direction. (and is meta-futarchic where we optimize for the most rational governance. ie. A proposal to transition to futarchy or stay as a democracy would pass if the market deems it have a higher rational governance score)
Incentive Alignment: By relying on market dynamics and a carefully selected optimization metric, futarchy places the relevant incentives for people to value correctness and rationality in decision-making. Nancy Pelosi trading options is not an ideal value alignment.
Accuracy: In countless applications and applied studies, it is shown that markets greatly outperform “experts”, polls, and chance. From presidential elections to weather forecasts, to commodity prices, to the winners of the Super Bowl, markets come out on top in prediction accuracy. Thus, markets should be a powerful tool to predict an optimization metric and determine the best decision to make in governance. As an aside, Target once predicted a pregnancy in one of its shoppers and presented diaper and crib curated ads. From Target’s own information, it fairly valued that the lady was pregnant before she even knew!
Leverage Superforecasters: Superforecasters are shown to be above average at fair estimations and their ability is exponentially compounded in an adversarial environment like a market, incorporating many different sources of information, perspectives, and analyses. Futarchy leverages the predictive power of these market participants and channels them into picking the right decision.
Simple: Great proposals should pass, poor proposals should fail, and controversial proposals can be re-submitted at a later time. The absence of human bias and bureaucratic bloat makes futarchy attractive by Occam’s Razor.
Decentralized: From anywhere in the world, people can contribute to the decision-making of a futarchy because of blockchain technology. There is no central agency for collecting votes.
Auditable: Like the Meta-DAO, the architecture and implementation of futarchies can be entirely transparent, auditable, and verifiable. Whereas election tampering and fraud is a concern with modern democracies.
Nihil Option: It is possible for the futarchy to increase its own value by choosing non-action. Similar to an isolationist policy, action is not always correct whereas traditional governments may do anything to seem busy or change for the sake of changing.
Singularity: Futarchy also balances the human preference for short-term financial gain by making proposals singular. A proposal will only decide on action and no-action rather than between two unique actions. Governments overspending is an example with the U.S. running an unsustainable deficit for short-term benefit. Futarchy can reject the short-sighted proposal and pass the long-sighted proposal instead of having a false dichotomy between the two.
Reduced Human Error: In every traditional form of governance, power is given to a human. This component is removed in futarchy which eliminates risk of human corruption, execution risk, and keeps proposals transparent and accountable.
PvP to PvE: In a traditional governance system like democracy or proportional voting in vanilla DAOs, people are in an adversarial environment with direct fractional voting power. This causes problems when a political party can vote against all proposals by the perceived opposition regardless of merit without penalty. Thus, making the wrong decision advantageous. Futarchy redirects the incentive structure to go from PvP to PvE, where the environment is the broader conditional market. In futarchy, making the wrong decision is never advantageous, and making the right decision is always advantageous. By removing game theoretic reasons to be “nasty”, futarchy encourages “niceness”; see Veritasium.
Liquidity Effect: The biggest decisions with the largest potential changes in outcome will draw increased liquidity and thus increased incentive at risk and to be gained. Liquidity has a parallel to network effects where highly liquid markets tend to be the most accurate because liquidity is confidence. With the liquidity effect, futarchy draws from power laws as the majority of the benefit is gained from a minority of the decisions.
Criticisms
As futarchy is still in its infancy, it faces challenges that may impede its adoption.
Illiquid: In any market, liquidity is king and allows for people to trade at fair and convenient prices. Ultimately, liquidity represents people’s confidence in their opinion and without it, it’s difficult to encourage trading volume and organic price discovery. Illiquid markets may not be representative of the governed and could be manipulated by a well-capitalized market participant even with TWAP.
Multiple Proposals: If there are many correlated proposals, prices may be irrational and difficult to price accurately if handled in parallel or with overlapping periods.
Imperfect TWAP: As mentioned by Robin Hanson in a recent Space with Proph3t hosted on X, prices have heteroskedastic errors. This means the variance of prices is not constant through time. This impacts the statistical significance of difference in prices when comparing conditional markets at the end of the proposal period. Liquidity and the depth of the order book is a simple but imperfect proxy for variance with less liquidity signifying higher variance.
Example: If the pass market has price $105 and fail $100, but fail has high liquidity and pass has zero liquidity leading up to and at the time of finalization, the confidence in the pass market mean is low and a confidence interval would be very wide, making it unreasonable to reject the null and finalize the pass market.
Irrational Price Action: Prices can be irrational beyond the timeframe of a proposal. As seen with Gamestop, asset bubbles and divergence from fundamentals can happen easily and quickly in market environments if people do not care about the financial risks and act irrationally or hope to trade off future irrationality. As more liquidity enters futarchy markets, margin and derivatives on conditional markets could introduce nonlinear risks and irrational price movements like short squeezes and gamma squeezes.
Market Inefficiency: Markets do not always follow the Efficient Market Hypothesis, or there would be no incentive for speculators and arbitrageurs.
Scalability: As more and more proposals are brought up, the marginal utility for each person that votes on decreases and accuracy can suffer. Although Proph3t has addressed scalability, with yet to be implemented solutions in the Meta-DAO.
Philosophy
As the reality of the Meta-DAO’s successful proof-of-concept launch and operation sets in, there are philosophical implications to its applicability at scale. Some unanswered talking points and questions include:
Will people want to be governed by programs and algorithms? Is there an underlying desire for a human figurehead?
Can you run a futarchy of algorithmic trading AI without humans?
What happens when collective belief diverges from the bet result? What if right after a proposal passes, new information arises? If allowed, should veto power be a multi-sig DAO or should vetos be new proposals?
What if the market proposes and passes the forcing of other organizations to adopt futarchy?
Markets may be mostly rational, but are they mostly ethical?
Does futarchy promote centralization if there’s veto power?
What will politicians and power hungry people do?
We see U.S. traditional markets as being the largest and most liquid, how would geography result in different outcomes in implementations of futarchy?
What is the risk of your futarchy being attacked? Can a wealthy futarchy attack a poor futarchy and take its treasury? Is there financial deterrence? Insurance?
What is the effect of some people only trading on one conditional market when two tokens were minted? How does that impact price action? What are the risks to having a big difference in liquidity between the pass/fail market of a single proposal?
What are the optimal tokenomics for liquidity and outcomes?
The above points are not intended to raise criticism for futarchy, rather to inspire more discussion and debate. With the truly special benefits that markets impart in adversarial environments, decision-making is a fascinating use case.
Conclusion and The Future of -archy
You will not need futarchy to run your household, or your book club, or your children’s summer camp. Like how quantum physics governs the small, and relativity the large, futarchy has its place.
The unique advantages that futarchy unlocks on a grander scale for regional, national, global or—dare I say—interplanetary decisions cannot be ignored. Futarchy is a technology. Thanks to performant blockchains like Solana, promising experiments with futarchy like the Meta-DAO are stirring up new conversations about the future of governance.
More Resources:
Documentation: https://docs.themetadao.org/
Whitepaper: https://github.com/metaDAOproject/Manifesto/blob/main/Manifesto.pdf
Proph3t: https://medium.com/@metaproph3t | https://twitter.com/metaproph3t
Podcasts: Unlayered and TBA Lightspeed