Arbitrum Botches First Steps Toward Decentralization

The effort to cede control of the Arbitrum blockchain to its community got off to a rough start over the weekend, as a botched governance proposal led to accusations that it’s all just “decentralization theater.”

The controversy has taken a toll on the nascent Layer 2 ecosystem, as Arbitrum’s week-old ARB governance token has fallen more than 18% since Friday, according to data from CoinGecko.

ARB Price. Source: Coingecko

Arbitrum parent company Offchain Labs launched ARB to much fanfare on March 23. The token forms the centerpiece of Offchain Labs’ decision to cede control and ownership of the Layer 2 blockchain to its community of users and investors.

Holding ARB grants de facto membership in a leaderless cooperative, the Arbitrum DAO. Members can vote on any matter that comes before the DAO, and a member’s voting power is equal to the number of ARB tokens he or she owns.

But the first order of business turned out to be explosive.

$1B Foundation

The DAO was asked to ratify its proposed constitution and the creation of a sister organization, the Arbitrum Foundation, a Cayman Islands-registered company that would “serve the ArbitrumDAO community and be governed by it.”

Buried within the proposal – a request that the DAO gift the Foundation more than $1B worth of ARB. Some of the tokens would be sold to pay off debts related to its start-up expenses, but the vast majority would be disbursed at the Foundation’s discretion.

On Friday, DAO delegate Blockworks Research set off a firestorm when it drew attention to the fact that 750M ARB had already been set aside for the Foundation, suggesting the vote was just a formality.

Token Sales

Worse still – 50M ARB had been sent to crypto exchange Binance on March 23, the very first day that ARB started trading, presumably so the Foundation could sell the tokens.

Some observers rushed to judge the vote a sham.

“Good luck trying to prove to regulators and courts that your L2 is substantively distinguishable from a bank with a suggestion box,” Jason Schwartz, a partner and the co-head of digital assets at law firm Fried Frank, wrote on Twitter. Others were more circumspect.

Ecosystem Fund

Ecosystem funds, like the one the Arbitrum Foundation would manage, are common among companies and DAOs that compete with Arbitrum.

The 750M ARB requested by the foundation represents about 7% of the total supply of the token. For comparison, the Optimism Foundation controls 5% of the OP token supply. The Avalanche Foundation received more than 9% of AVAX tokens, and the Solana Foundation more than 12% of SOL tokens.

Olimpio, a pseudonymous participant in a number of DAOs, voted against the proposal with 18M ARB. In a thread summarizing the controversy, he said Offchain Labs could have dodged the controversy had it said from the get-go that 750M ARB would be gifted to the Arbitrum Foundation.

“The difference between the Starknet and Optimism Foundations with the Arbitrum Foundation is that they expressed the Foundation’s allocation on their tokenomics before launching the tokens,” Olimpio wrote. “Arbitrum did not.”

Miscommunication

In a mea culpa, the Foundation called the controversy a “blunder of communication.”

“The Foundation treated this as a ratification of its initial setup, not an initial grant request from the DAO Treasury, and indeed has begun to use these tokens in the interest of the DAO, including conversion of some funds into stablecoins for operational purposes,” Foundation member Patrick McCorry wrote on the DAO governance forum.

Of the 50M tokens sent to Binance, 10M have been sold to fund the Foundation’s current operating expenses. The remaining 40M tokens were loaned to crypto market maker Wintermute.

Amended Proposal

The proposal failed, with three-quarters of the votes in opposition. The Foundation has said it will amend and re-introduce each piece of the massive proposal as separate items to be voted on, likely sometime this week.

Regarding the 750M ARB, a new proposal will specify that the tokens will be subject to a four-year vesting period and will not be used to vote on proposals that come before the DAO. The Foundation will draft transparency reports “to make the community aware of how the funds are spent over time.”

The episode is a reminder that decentralization remains a minefield, even for billion-dollar companies with access to the best advice money can buy.