Futarchy: Introducing market mechanisms into DAO governance.

Futarchy transforms the subjective differences in DAO decision-making into ownership exchanges based on collective decisions of market participants.

Written by: Zack Pokorny

Compiled by: AididiaoJP, Foresight News

Introduction

The cryptocurrency industry has always coexisted with innovation and risk, and even the most outlandish projects can gain support in the crypto space. However, over the past 12 months, as the industry has begun to gradually focus on sustainable development and real growth, the core contradictions of the industry have become particularly prominent:

For the team: How to build early loyal token holder community consensus? These communities truly care about the project's development, rather than immediately selling off during market fluctuations, resulting in the project losing development time and funding. In the rapidly changing crypto industry, how to maintain agility and information sensitivity to make the right decisions quickly?

For investors: How to value early projects that have no revenue or user base? Traditional tools such as discounted cash flow models (DCF), revenue multiples, and price-to-earnings ratios are difficult to apply in this case. Valuation is more like venture capital, relying on subjective judgments about the product, team, and market potential.

These challenges are not unique to crypto companies, but the decentralized nature of blockchain provides new ideas for solving problems. When applied to Decentralized Autonomous Organizations (DAO), market-based governance models like Futarchy can offer the following advantages:

• Provide clear market consensus for builders, reducing the emotional fluctuations of token holders during the decision-making process;
• Restrict information asymmetry and promote the decentralization of DAO decision-making;
• Form a belief-weighted equity structure shaped by the market, naturally inclined to support the decisions of the DAO;
• Investors can directly express their approval of specific DAO decisions by adjusting their positions and acting on market signals generated by proposal votes.

This report will delve into how Futarchy fundamentally improves the investment and decision-making scenarios of early crypto companies, which are highly subjective, have freely tradable ownership, and where breakthroughs from zero to one are the core goal. Currently, the MetaDAO series of experimental DAOs in the Solana ecosystem and the grant distribution program of Optimism have begun to experiment with Futarchy, but this article focuses on the foundational principles of Futarchy and DAO governance, rather than specific implementation details.

Overview of Futarchy Governance Mechanism

Economist Robin Hanson first introduced the idea of governance through market and economic signals in his 2000 working paper "Shall We Vote on Values, But Bet on Beliefs?" He named this alternative system "Futarchy," combining "future" with the Greek suffix "-archy" (rule), meaning "ruled by future markets." Futarchy aligns with the goals of traditional token voting in DAO governance, which is to guide strategic decision-making, but the paths to achieve this are different: it separates the process of goal setting from the evaluation of means to achieve it.

In traditional DAO governance, voters typically express their values and beliefs through weighted voting with "risk-free" (voting without financial risk) tokens (one token, one vote). For example, when a voter selects a certain proposal outcome, it may reflect their values or be based on their belief in the proposal's feasibility. The path that ultimately receives the most token-weighted votes will be adopted.

Futarchy is different: individuals vote on goals based on their values, while prediction markets are used to assess the best means to achieve those goals, effectively separating goal setting from predictive execution. The core advantage of Futarchy lies in leveraging the predictive capabilities of financial markets (asset prices and trading) to guide decision-making, with participants required to invest real money in predictions. This market-driven approach promotes accurate predictions and rigorous analysis through economic incentives, which ordinary voting typically fails to achieve due to the lack of vested interests.

In practice, DAO proposals will establish two temporary conditional token markets: the "Pass" market and the "Fail" market, both priced in USD stablecoins. These two markets operate during the voting period, running parallel to the normal trading in the main market. Special-purpose Automated Market Makers (AMM) "Pass AMM" and "Fail AMM" support the markets. Voters can buy and sell tokens in either market, driving the price fluctuations of the synthetic proposals. Anyone can participate in these markets, regardless of whether they hold DAO tokens. For example, users holding stablecoins but not DAO tokens can purchase tokens through the proposal's "Pass" or "Fail" market.

At the end of the voting, the system will record the time-weighted average price (TWAP) of each market, with the higher one determining the proposal result. For example, if the community proposes to activate a certain protocol feature, and at the end of the voting the token price in the "pass" market is higher than that in the "fail" market, it indicates the market collectively believes that the feature is beneficial for the DAO, and the proposal passes; otherwise, it is rejected. The trading in the proposal market is conditional: if a user buys tokens in the "pass" market, they will only actually receive the tokens if the proposal passes; otherwise, the stablecoins will be returned. Similarly, selling tokens in the "fail" market will only be executed if the proposal fails; otherwise, the tokens will be returned.

Since the ownership transfer is only settled when the corresponding result occurs, each transaction carries real economic risks. Suppose a certain proposal is approved:

• Traders who buy tokens on the market increase their exposure; if the proposal appreciates, they gain more profit, but if the proposal passes without appreciation (or harms the DAO), they incur greater losses;
• Traders who sell through the market forgo potential gains by reducing their exposure, but are protected from losses if the proposal is harmful.

Therefore, market prices reflect not only vague opinions but also the real judgments related to interests. The diagram below shows the trading lifecycle of the Futarchy governance proposal:

The dynamics when the proposal market fails are similar to:

Futarchy governance voting is not only a decision-making tool but also an effective information market. By requiring participants to "vote with money," Futarchy aggregates market sentiment and opinions into economic signals, theoretically producing more robust decisions than "risk-free" voting. This market-driven feedback provides builders with direct insights into the collective understanding of a proposal's value. For investors, Futarchy creates unique opportunities to express their subjective views on DAO decisions directly and to adjust their exposure based on what the market collectively perceives as the optimal path. This is particularly important for early DAOs, whose valuations are highly subjective and depend largely on decision-making and product trajectories. Futarchy also allows each participant in the equity table to adjust their holdings to reflect their level of endorsement for specific decisions, achieving a continuous alignment of financial interests with strategic direction. This mechanism naturally drives projects to form belief-weighted equity structures: participants whose insights remain consistent with market decisions will be reinforced, while all holders can maintain belief-weighted exposure aligned with the DAO's strategic direction.

Characteristics of Startups and Early Stage Companies

Understanding the key traits of early-stage companies helps recognize the value of Futarchy governance for its builders and investors:

• Perceived Valuation: Early-stage startups typically have no revenue and often develop innovative products. Their value depends on the quality of the product and the team, as well as the market's belief in the future demand released through current decisions. Unlike mature companies, startups lack historical data and comparable benchmarks, and valuation mainly relies on the interpretation and belief of "invisible" input signals.
• Inference-driven decision-making: Information asymmetry forces founders and investors to piece together partial data, while builders focused on construction often overlook signals from adjacent ecosystems and competitors. Decisions often rely on probabilities rather than conclusive evidence.
• Investor Belief: Early investors who have a long-term belief in the team's vision will form a patient and aligned holding group, providing stability during market fluctuations and allowing space for project execution. Conversely, speculative or low-belief investors will sell off during the initial volatility, exacerbating fluctuations and forcing the team to divert their attention to market management rather than product development.

In summary, founders and investors must continuously guess and invest in the correct narratives and act accordingly. Futarchy does not eliminate this subjectivity; rather, it transforms individual beliefs into aggregated market signals that serve as the basis for DAO actions by allowing anyone to trade tokens on the "pass/fail" outcomes of DAO decisions. This process converts decentralized intuitions into unified, financially weighted predictions, concentrating ownership among the groups with the clearest and most enduring beliefs. By requiring participants to back their beliefs with real capital, Futarchy will turn the fragile factors of startups into mechanisms that enhance governance, providing a path of development with less arbitrariness.

The Value of Futarchy for Startups

The dual value of Futarchy to early DAOs lies in:

1. Provide market signals;

2. Provide a dynamic equity structure construction mechanism that directly associates the DAO strategic path with the interests of the holding group.

market signal

Futarchy provides creative feasibility feedback from the market and directly highlights the economic sentiment of token holders regarding decision-making.

Market economy decision-making

Futarchy governance is similar to the logic of prediction markets: just as the predictions of a market economy are more accurate, the decisions of a market economy should also yield more favorable results because of the interests of the participants being aligned. This result alignment reduces redundancy from random and low-quality decision-making and incentivizes voters to offer more robust and expert opinions. The system also rewards the most accurate predictors, allowing them to adjust their holdings as needed and potentially profit, further aligning individual incentives with the collective interests of the DAO.

By allowing anyone to vote, Futarchy transforms voting into a market, limiting information asymmetry and capturing perspectives beyond the DAO holding group. Anyone willing to take on capital risk can evaluate DAO decisions. This market-driven system also increases the difficulty of manipulation, as any attempt to control the vote may be diluted by other market participants. The stronger the manipulators push the token "pass" or "fail" market price away from the main market, the stronger the incentive for others to take the opposite action and arbitrage. Furthermore, manipulation requires sacrificing real funds to affect the outcome, possibly leading to direct economic losses. The level of decentralization under this structure is difficult to reach with token-weighted voting.

Voting and Ownership Separation

In traditional governance systems, there may be a disconnect between people's voting behavior and capital allocation. Someone may oppose a proposal but still increase their token holdings; another person may support the proposal but quietly reduce their holdings, fearing execution risks. This creates a division between stated preferences in governance and those displayed in the market, making it difficult for builders to distinguish stakeholders' true opinions on specific decisions from their overall support for the project. This blind spot can lead to suboptimal decisions.

In Futarchy, voting behavior is closely integrated with market activities, where the buying and selling of tokens is the vote itself. When a proposal is made, the market expresses support or opposition through the direct buying and selling of the tokens linked to the proposal. This is in stark contrast to traditional governance: in the latter, the market response is completely independent of the vote, making it difficult to discern the true motivations and their correlation with specific governance decisions. This integrated approach reduces the ambiguity of holder sentiment information and its connection to optimal decisions, ensuring that genuine opinions and beliefs are directly reflected in the voting mechanism, allowing the DAO to remain aligned with the economic views of its holding community. In traditional systems, supporters may act inconsistently, whereas Futarchy unifies market behavior and outcomes. The key to this relationship is that at the end of the voting, tokens flow directly from the decision skeptics to the believers. This process not only clarifies market sentiment and applies it to decision outcomes but also realigns the most informed and believing participants with ownership, enabling the DAO to dynamically balance its equity structure according to decisions.

Faith-weighted equity results

One of the most challenging aspects of launching early-stage crypto projects is having a loyal holding community. Most teams struggle to distinguish between genuine supporters and speculators, leading to token price fluctuations, which causes founders to divert their attention to managing market dynamics rather than focusing on the product.

The mainstream strategy to attract early users is airdrops, which incentivize users to use the product by distributing tokens for free. Although it can enhance activity and metrics in the short term, it may lead to long-term damage:

• Speculative behavior: Airdrop recipients typically engage in only minimal non-continuous activities to meet the reward conditions, immediately sell the tokens after acquisition, forming a speculative holding group, lacking faith in the project's future.
• Ambiguous product-market fit signals: When users primarily use a product for economic benefits, the feedback received by the team can mislead their understanding of the product's quality and market demand. When there are incentives, people may use any product, making it difficult to determine whether the core product addresses real problems.
• Back to square one: After the airdrop ends and speculators exit, the project returns to its original point, lacking an active community. The brief peak in activity is difficult to provide a sustainable foundation for growth.

This contradiction puts early projects in a dilemma: they need users to prove attractiveness, but the methods to attract users often introduce harm to the long-term development of participants.

How Futarchy Solves the Belief Problem of Token Holders

Futarchy creates a natural selection mechanism for holders through market governance. In continuous proposals, the token supply gradually concentrates among the most accurate and high-belief voters, while correct but low-belief or incorrect holders (i.e., those whose trades contradict market outcomes) gradually decrease their token share. This process is gradual but continues over time. When combined with a more organic token distribution mechanism, Futarchy can help DAOs find a more loyal holder community.

Futarchy transforms the subjective differences in DAO decision-making into voluntary conditional ownership exchanges based on the collective perceptions of market participants. This gradually concentrates token ownership in the hands of the most accurate predictors in the eyes of the market and the staunchest supporters of the DAO's development path.

For example, a proposal suggests adding new features to the protocol. Three holders have different views:

• Alice hopes to buy 1 token when the proposal fails, believing that this feature is detrimental to the DAO. If the proposal does not pass, she hopes to increase her exposure.
• Bob hopes to sell 1 token if the proposal fails, believing that this feature is beneficial for the application. If the proposal is not approved, he wishes to reduce his exposure.
• Eve hopes to purchase 1 token when the proposal is approved, believing that this feature is valuable. If the proposal is approved, she hopes to increase her exposure.

If the market collectively decides that the proposal should fail (failure price > passing price), Alice actually receives 1 token from Bob through the synthetic proposal market. The transactions between Alice and Bob are consistent with the final outcome of the market: Alice buys under failure conditions, and Bob sells the tokens he does not want to hold under failure conditions. Alice gains exposure, Bob exits, and both get what they want. Eve, on the other hand, relies on the proposal passing for her conditional purchase, and there is no direct token transfer, but her relative influence in equity is weakened by Alice.

This produces three results:

• Alice (High conviction, trading aligns with market outcomes): Obtains tokens and equity share.
• Bob (low confidence, trading aligns with market outcomes): loses tokens and exits.
• Eve (not staked through result): maintains absolute holdings but relative equity is diluted by Alice.

This process is automatically completed through market mechanisms: ownership naturally flows to participants whose judgments are consistent with the collective wisdom of the market. Futarchy ensures that influence is concentrated among participants who have confidence in their decisions and whose predictions are trusted by the market. The result is that over time, tokens increasingly flow to holders who repeatedly support their views with capital and have confidence in the direction of the project.

Limitations of Futarchy

Futarchy cannot guarantee success; it is a tool for optimizing decision-making and stakeholder structures, not an ultimate goal. The team still needs to execute the insights generated by Futarchy governance, the underlying product concept must be reasonable, and the product itself must have real demand.

In addition, introducing market mechanisms into the decision-making process does not guarantee that the DAO will achieve the best results every time. The concept of Futarchy is to reinforce opinions through economic outcomes, creating an environment conducive to optimal decision-making. People may still act irrationally, and the market may still misprice decisions. However, compared to "risk-free" token voting, holders can still influence the strategic direction of the DAO without having a vested interest, and Futarchy offers an incentive-compatible decision-making mechanism.

The core value of Futarchy does not lie in ensuring that decisions drive prices up and adoption; no governance system can achieve that. However, compared to traditional solutions, Futarchy can provide a higher probability of success for DAOs.

Conclusion

Futarchy provides a powerful framework for early-stage startups, supporting market-driven decision-making that allows investors to align their financial exposure with the direction chosen by the DAO. This mechanism is particularly beneficial for startups, offering a stronger cold start mechanism for building applications and establishing a loyal holding community. While mature DAOs can also benefit from Futarchy, the model is most valuable in the early stages where subjectivity prevails and building a high-belief holding community is crucial.