The Fei-Fuse Nightmare: A Wake-up Call for Improved DAO Governance
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The Fei-Fuse Nightmare: A Wake-up Call for Improved DAO Governance

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An overview of the Fei Protocol's downfall — a result of disputes, vetoes and lack of trust that created a domino effect.

The Fei-Fuse Nightmare: A Wake-up Call for Improved DAO Governance

Table of Contents

TL;DR

  • Fei Protocol, a decentralized stablecoin protocol, faced a hack causing significant damage.
  • Fei team proposed winding down the project and redeeming tokens for protocol assets.
  • Different stakeholders were impacted differently, with FEI holders benefiting the most.
  • Challenges for DAO governance include aligning incentives, balancing efficiency and democracy, and handling conflicts.
  • Successful DAOs require clear communication, community engagement, and trust among stakeholders.

Introduction

Imagine a world where a single hack can send shockwaves through an entire decentralized autonomous organization (DAO), leaving investors questioning the stability of their assets. This was the unfortunate reality faced by Fei Protocol in April 2022. However, from this dark chapter emerged valuable insights and solutions to enhance the governance of DAOs. In this article, we will unravel the challenges encountered by Fei Protocol, discuss the resolution, and explore the principles of successful DAOs that can help prevent such nightmares in the future.

Background

Source: fei.money

Fei Protocol was a decentralized stablecoin protocol launched in March 2021. It used a novel mechanism called direct incentives to adjust the supply and demand of FEI tokens. The protocol treasury was controlled by Fei and was worth over $200 million. The goal of this protocol-controlled value (PCV) was to maintain the stability of FEI.
Rari Capital DAO was a lending protocol launched in October 2020. In late 2021, Fei Protocol and Rari Capital DAO merged into one entity called Tribe DAO. This was seen as a landmark moment for DeFi and a proof-of-concept for on-chain mergers and acquisitions through protocol politicking. The merger was supposed to benefit both projects by combining their strengths and resources, and the TRIBE governance token was given to holders of FEI and RGT.

The Fei-Fuse Hack

In late April 2022, hackers exploited the Fei-Fuse money market, causing nearly $80 million in damage across seven Rari Capital Pools. Some of the victims included Frax Finance, OlympusDAO, Balancer Labs and Vesper Finance.
In May 2022, the Tribe DAO voted to reimburse all the victims of the hack using Tribe’s treasury, which was applauded by the community. However, a group of FEI insiders, investors and core contributors vetoed the proposal when it was published on-chain by the Tribal Council. They argued that reimbursing the victims would endanger the stability of FEI and its treasury value.

The veto triggered another on-chain vote by the Tribe DAO, where the proposal to reimburse the victims was rejected by the majority of Tribe holders. This was seen as a betrayal by the victims and the community. The Fei team did not communicate or negotiate with the victims or their supporters, despite their attempts to reach out and offer solutions.

Resolution

In August 2022, the Fei team announced that they were winding down the project and proposed a plan to redeem FEI and TRIBE tokens for protocol assets.

The plan had different impacts on different stakeholders. FEI holders seemed to benefit the most from the plan, as they could redeem their FEI for DAI without much loss. The Tribe DAO also voted for victims to be fully repayed. TRIBE holders were somewhere in between, depending on how much PCV was left after paying back FEI holders and hack victims.
The plan also faced some challenges and criticisms from various parties. Some large victims of the hack, such as Frax Finance and OlympusDAO, expressed their dissatisfaction with the low compensation. They allegedly tried to influence or bribe TRIBE holders to vote for full repayment. The proposal also generated backlash on Crypto Twitter for the short-sighted nature with which the Fei Protocol leadership seemed to operate with:
View post on Twitter
The final vote passed with 99% in favor of the plan.

Challenges for DAO Governance

The situation highlighted some of the problems, challenges and lessons for DAO governance:

Aligning the Incentives and Interests of Different Stakeholders

Users, investors, developers and partners are all stakeholders in a DAO. The difficulty of aligning their incentives was illustrated by the conflict between FEI holders and hack victims over the reimbursement proposal. FEI holders wanted to protect their treasury value and the stability of FEI, while hack victims wanted to recover their losses. The veto of the initial proposal by a group of FEI insiders also showed a lack of alignment between the core contributors and the wider community.

Balancing Between Efficiency and Democracy

How to design voting mechanisms, quorum requirements, delegation options and veto powers are essential questions to DAO governance. An example of this was the multiple votes that took place on the Tribe DAO platform. The first vote was done using a snapshot tool that was not binding on-chain, which allowed the Fei team to veto it. The second vote was done on-chain using a quadratic voting system that gave more weight to smaller holders. The final vote was done on-chain using a simple majority system that did not allow any veto. The different voting systems had different implications for the outcome and the legitimacy of the decisions.

Handling Conflicts and Disputes

Resolving disagreements, enforcing accountability and preventing malicious attacks are key parts of DAO governance when things go south. The hack exploited a bug in the Fei-Fuse code that was not audited or tested properly, and it triggered a series of disputes between the Fei team, the Rari team, the hack victims and their supporters. The Fei team did not communicate or negotiate with the other parties effectively, which led to more frustration and resentment. The hack also exposed some vulnerabilities and risks in the protocol design and security.

Principles of Successful DAOs

There certainly are successful DAOs out there, even if their degree of decentralization is questionable:

View post on Twitter

Future successful DAOs will need to follow several principles if they want to be successful.

Clear and Transparent Communication

DAO members should share relevant information, provide feedback and explain the rationale for their decisions with the rest of the community in order to build trust, avoid misunderstandings and foster collaboration. The lack of communication in the FEI Protocol dissolution led to heated discussions and left several stakeholders unhappy after the solution was passed.

High Level of Community Engagement

DAO members should participate in the decision-making process, contribute to the DAO goals, and interact with other members to improve the quality of decisions and foster innovation. FEI failed at aligning the interests of hack victims and those of the protocol founders, leading to the eventual rift.

Fostering Trust and Cooperation Among Stakeholders

DAO members should work together towards a shared vision, support each other and resolve conflicts peacefully. Still, on-chain governance has a long way to go as the Fei Protocol example showed. While decentralized governance does indeed offer a lot of potentials, it also comes with cooperation tradeoffs, which can lead to DAOs falling back on centralized problem resolution.

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