Futarchy: Introducing market mechanisms into DAO governance.

Written by: Zack Pokorny

Compiled by: AididiaoJP, Foresight News

Introduction

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

For the team: How to establish early consensus among loyal token holders? These groups genuinely care about project development, rather than immediately selling off during market fluctuations, which results in the project losing development time and funding. In the fast-paced changes of the crypto industry, how to maintain agility and information sensitivity to make the right decisions quickly?

For investors: How to value early-stage 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 offers new ideas for solving problems. When applied to Decentralized Autonomous Organizations (DAOs), market-based governance models such as Futarchy can bring the following advantages:

Provide clear market consensus for builders to reduce the emotional fluctuations of token holders during the decision-making process.

Limit 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, acting on market signals generated by proposal voting.

This report will delve into how Futarchy fundamentally improves the investment and decision-making scenarios of early crypto companies, which are highly subjective, ownership is freely tradable, and achieving breakthroughs from zero to one is the core goal. Currently, the MetaDAO series of experimental DAOs in the Solana ecosystem and the grant allocation 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 it differ: it separates the goal-setting process from the evaluation of the means to achieve those goals.

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

Futarchy is different: individuals vote to choose 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 utilizing the predictive capabilities of financial markets (asset prices and trading) to guide decision-making, where participants must invest real money in predictions. This market-driven approach promotes accurate predictions and rigorous analysis through economic incentives, which ordinary voting typically cannot achieve due to a lack of vested interests.

In practice, DAO proposals will establish two temporary conditional token markets: a "pass" market and a "fail" market, both priced in USD stablecoins. These two markets operate during the voting period, running parallel to the normal trading of the main market. Special-purpose Automated Market Makers (AMMs) "pass AMM" and "fail AMM" support the markets. Voters can buy and sell tokens in either market, driving the synthetic proposal price fluctuations. Anyone can participate in these markets, regardless of whether they hold DAO tokens. For example, users holding stablecoins but without 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 outcome of the proposal. For example, if the community proposes to activate a certain protocol function and at the end of the voting the token price in the "pass" market is higher than that in the "fail" market, it indicates that the market collectively believes the function is beneficial for the DAO, and the proposal is approved; 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 is approved, otherwise a stablecoin 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 settled only when the corresponding result occurs, each transaction carries real economic risks. Suppose a certain proposal is passed:

As traders increase their token exposure by buying through the market, they will profit more if the proposal appreciates; however, if the proposal is approved but does not appreciate (or harms the DAO), the losses will be greater.

Traders who sell through the market forgo potential gains by reducing exposure, but they are protected from losses if the proposal is harmful.

Therefore, the market price reflects not only vague opinions, but also the real judgments related to interests. The chart 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 opinions and sentiments into economic signals, theoretically producing more robust decisions than "risk-free" voting. This market-driven feedback provides builders with direct insights into the collective perception of a proposal's value. For investors, Futarchy creates a unique opportunity for them to express their subjective opinions on DAO decisions directly and adjust their exposure based on what the market collectively deems the optimal path. This is particularly important for early DAOs, whose valuations are highly subjective and mainly depend on decision-making and product pathways. Futarchy also allows each participant in the equity table to adjust their holdings to reflect their approval of 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 consistently align with market decisions will be reinforced, while all holders can maintain belief-weighted exposure that is consistent with the DAO's strategic direction.

Characteristics of Startups and Early-stage Companies

Understanding the key characteristics of early companies helps to 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 products and the team, as well as the market's belief in the future demand that can be unleashed through current decisions. Unlike mature companies, startups lack historical data and comparable benchmarks, and their valuation mainly relies on the interpretation and belief in "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. In contrast, speculative or low-belief investors will sell off during the initial fluctuations, exacerbating volatility and forcing the team to divert their attention to market management rather than product development.

In summary, founders and investors must continually speculate 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 dispersed intuitions into unified, financially weighted predictions, concentrating ownership among the groups with the clearest and most enduring beliefs. By requiring participants to support their beliefs with real capital, Futarchy turns the fragile elements of startups into mechanisms that reinforce governance, providing a development path with less arbitrariness.

The value of Futarchy for startups

The dual value of Futarchy for early DAOs lies in:

1. Provide market signals;

2. Provide a dynamic equity structure construction mechanism that directly links 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 towards decision-making.

Decision-making in a market economy

Futarchy governance resembles 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 outcomes because of the participants' aligned interests. This correlation of outcomes reduces redundancy from random and low-quality decisions, incentivizing voters to present more robust and professional opinions. The system also rewards the most accurate predictors, allowing them to adjust their positions 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, limits information asymmetry, and captures perspectives beyond the DAO holding group. Anyone willing to take on capital risk can assess DAO decisions. This market-driven system also increases the difficulty of manipulation, as any attempts to control the vote may be diluted by other market participants. The greater the force with which manipulators push the token "pass" or "fail" market prices away from the main market, the stronger the motivation for others to operate in the opposite direction and arbitrage. Moreover, manipulation requires sacrificing real funds to affect results, which may lead to direct economic losses. The level of decentralization under this structure is difficult to achieve with token-weighted voting.

Separation of voting and ownership

In traditional governance systems, there may be a disconnect between people's voting behavior and capital allocation. Someone might oppose a proposal yet still increase their token holdings; another person might support the proposal but quietly reduce their holdings, fearing execution risks. This creates a split between stated preferences in governance and preferences shown 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 constitutes the voting itself. When a proposal is put forward, the market expresses support or opposition by directly buying and selling the tokens associated with the proposal. This is starkly different from traditional governance: in the latter, market reactions are entirely independent of voting, making it difficult to discern the true motivations and their connection to specific governance decisions. This integrated approach reduces the ambiguity of holder sentiment information and its relation to optimal decisions, ensuring that genuine opinions and beliefs are directly reflected in the voting mechanism, keeping the DAO consistently aligned with the economic views of the holding community. In traditional systems, supporters may act inconsistently, whereas Futarchy combines market behavior with outcomes. The key to this relationship lies in the fact that at the end of voting, tokens flow directly from the decision dissenters to the believers. This process not only clarifies market sentiment and applies it to decision outcomes but also realigns ownership with the most informed and believing participants regarding the decisions, allowing the DAO to dynamically balance its equity structure in accordance with decisions.

Weighted equity results of belief

Having a loyal community of holders is one of the most challenging obstacles in launching early-stage crypto projects. Most teams struggle to distinguish between genuine supporters and speculators, leading to token price volatility and forcing founders to divert their attention to managing market dynamics instead of focusing on the product.

The mainstream strategy to attract early users is airdrops, incentivizing users to use the product by distributing tokens for free. Although it can boost activity and metrics in the short term, it can cause long-term harm:

Speculative behavior: Airdrop recipients typically engage in minimal non-continuous activities just to meet the reward conditions, selling off the tokens immediately 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 the team receives can mislead their understanding of product quality and market demand. When there are incentives, people may use any product, making it difficult to judge whether the core product addresses real problems.

Back to square one: After the airdrop ends and speculators exit, the project returns to its starting point, lacking an active community. A brief peak in activity is hard to provide a sustainable foundation for growth.

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

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 the correct but low-belief or incorrect holders (i.e., those whose trades contradict market outcomes) gradually reduce their token share. This process is gradual but continues over time. If 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 a voluntary conditional ownership exchange based on the collective perceptions of market participants. This can gradually concentrate token ownership in the hands of the most accurate predictors in the eyes of the market and the most steadfast supporters of the DAO's development path.

For example, a proposal suggests adding new features to the protocol. The three holders have different opinions:

Alice hopes to buy 1 token when the proposal fails, believing that this feature is detrimental to the DAO. If the proposal is not passed, she wishes to increase her exposure.

Bob hopes to sell 1 token when the proposal fails, believing that this feature is beneficial to the application. If the proposal is not approved, he hopes 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 wishes to increase her exposure.

If the market collectively decides that the proposal should fail (failure price > passing price), Alice actually acquires 1 token from Bob through the synthetic proposal market. The transactions between Alice and Bob are consistent with the final market outcome: Alice buys under failure conditions, and Bob sells the tokens he does not wish 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 does not experience an immediate token transfer, but her relative influence in equity is weakened by Alice.

This produces three results:

Alice (High Confidence, Trading and Market Results Consistent): Obtain Token and Equity Share.

Bob (low belief, trading consistent with market outcomes): loses tokens and exits.

Eve (not staked through the 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 tokens increasingly flow over time to holders who repeatedly support their views with capital and have confidence in the project's direction.

The limitations of Futarchy

Futarchy does not guarantee success; it is a tool for optimizing decision-making and holder structures, rather than 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 idea 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 any vested interests, as Futarchy provides an incentive-compatible decision-making mechanism.

The core value of Futarchy lies not in ensuring that decisions drive price increases and adoption, something that no governance system can achieve. 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 holder community. Although mature DAOs can also benefit from Futarchy, this model is most valuable in the early stages where subjectivity prevails and building a high-confidence holder community is crucial.