Galaxy: Why Futarchy is Important

Author: Zack Pokorny Source: Galaxy Translation: Shan Ouba, Golden Finance

Introduction

The cryptocurrency industry is a breeding ground for innovation and a spirit of adventure, where even the most whimsical ideas can gain support as long as they show potential to become reality. In this process, both teams and investors face challenges. Over the past 12 months, as the industry has begun to focus more on sustainability and real growth, these challenges have become increasingly prominent.

• For the team: How to cultivate a group of token holders who genuinely care about the project in the early stages, do not sell tokens during market fluctuations, and thus do not starve the project of resources? In the fast-paced world of cryptocurrency, how to remain agile, make the right decisions quickly, and adjust direction in a timely manner?
• For investors: How to price an early-stage project that has no revenue, no users, but possesses freely tradable tokens? Traditional tools—such as discounted cash flow models, revenue multiples, and comparable valuations—are difficult to apply in this case. The valuation ultimately resembles venture capital, based on perceptions and beliefs regarding the product, team, and market potential.

These issues are not unique to the cryptocurrency industry, but the decentralized nature of blockchain organizations makes some novel solutions possible. For decentralized autonomous organizations (DAOs), the market-based governance model of Futarchy offers the following advantages:

• Provide clear and economically supported signals for builders, reducing the ambiguity of token holders' positions in decision-making.
• Reduce the degree of information asymmetry to promote the decentralization of DAO governance;
• Form a belief-weighted "capital structure table" (equity structure table) through market forces, continuously leaning towards the most accurate and supportive holders of the project;
• Investors can directly express their support or opposition to a certain DAO decision by adjusting their positions based on market price signals.

This article explores the fundamental role of Futarchy in investment and decision-making during the highly subjective and freely tradable ownership phase of early projects from 0 to 1. Although Futarchy is being experimented with on Solana through a series of futarchy DAOs by MetaDAO, and there are attempts in the grant allocation mechanism of Optimism, this article mainly focuses on its theoretical principles and governance structure, rather than specific practices.

Overall Perspective on Futarchy Governance

The concept of Futarchy, which governs through market and economic signals, was first proposed by economist Robin Hanson in his 2000 working paper "Shall We Vote on Values, But Bet on Beliefs?" He coined the term "Futarchy" by combining "future" (referring to the futures market) with the Greek suffix "-archy" (indicating rule), meaning "ruled by the futures market." He introduced this term rather casually, mentioning on the second page: "I have no particular reason" for adopting this vocabulary.

In the context of DAOs, Futarchy achieves the same goal as traditional token voting governance—namely, guiding strategic decisions—but through a different path. It separates the two processes of "setting goals" and "assessing how to achieve them." In traditional DAO governance, users vote in proportion to their tokens (i.e., "one token, one vote"), expressing a blend of their values and beliefs. In other words, when voting on a proposal, users often express both the outcomes they hope to achieve (such as launching a new feature) and their beliefs about whether a certain proposal can achieve the goal. The proposal with the most votes is ultimately adopted.

Futarchy allows people to vote on goals based on their values, and then a prediction market (i.e., "betting") evaluates which plan is most likely to achieve these goals. The structural advantage of this is that it separates "goal setting" from "predicting outcomes," using the predictive power of financial markets (prices and trades) to guide decision-making. Participants invest real money to express their predictions, greatly enhancing the accuracy of predictions and the rigor of analysis, something that traditional cost-free voting systems struggle to achieve.

The actual operation process is as follows:

Each DAO proposal generates two temporary token markets during the voting period: the Yes market and the No market, each priced in USD stablecoins, assigning different prices to the DAO token. These two markets are driven by independent automated market makers (AMMs) and operate in parallel with the main markets (such as centralized exchanges and decentralized exchanges).

In these proposal markets, anyone can participate in trading without needing to be a token holder of the DAO. For example, even if you do not hold the DAO's tokens, you can buy into the proposal's "approval market" or "rejection market" using stablecoins.

During the voting period, the system will record the time-weighted average price (TWAP) of two markets and compare which is higher after the voting ends. For example, if the token price in the "Yes market" is higher than in the "No market" at the end of the voting for a proposal regarding a new feature, it indicates that the market generally believes the feature is beneficial to the DAO, and the proposal will be adopted. Conversely, it will be rejected.

The key point is: all trading in the proposal market is conditional:

• If you buy DAO tokens "through the market", the transaction will only be completed when the proposal is finally passed; otherwise, your stablecoin will be refunded.
• If you sell DAO tokens in the "veto market", the transaction will only be completed if the proposal is ultimately rejected; otherwise, the tokens will be returned.

It is precisely for this reason that each transaction carries a real economic risk exposure. For example, in the scenario where a certain proposal is ultimately approved:

• Traders who buy through the market will increase their exposure to the token. If the proposal adds value to the DAO, the buyers will benefit; otherwise, they will bear a greater loss.
• Traders who sell "through the market" reduce their exposure, protecting themselves from losses if the proposal is unfavorable to the DAO.

Therefore, the market price no longer reflects "empty talk," but rather judgments that are genuinely supported by money.

The following is a diagram of the Futarchy proposal trading lifecycle:

The same situation will occur when the proposal market fails:

Not only does it determine the outcome of proposals, but Futarchy governance voting itself is a powerful information market. Because it forces participants to "put their money where their mouth is," Futarchy can aggregate decentralized knowledge and sentiment into economically supported signals, a mechanism that often leads to more robust decisions than "risk-free voting." This market-driven feedback provides builders with direct insights, allowing them to better understand the collective perception of the value of their proposals.

For investors, Futarchy offers a unique way for them to directly express their subjective views on DAO decisions and adjust their positions based on the market consensus on the optimal path for the DAO. This mechanism is particularly significant in the context of early-stage DAOs: the valuations of these DAOs are highly subjective and largely depend on the decisions they make and the direction of the final product's development.

Futarchy also means that all participants on the equity table can adjust their positions based on their beliefs about specific decisions, achieving a continuous alignment of financial interests and strategic direction. This dynamic mechanism naturally cultivates a "belief-weighted" equity structure: those whose insights are consistently aligned with successful decisions will have their positions naturally strengthened by market forces, while all holders can always maintain their desired, belief-weighted exposure to the DAO's strategic direction.

Characteristics of Startups and Early Projects

To understand how Futarchy governance benefits builders and investors, we first need to define several key characteristics of early companies:

• Subjective Valuation: Early-stage startups often do not generate revenue immediately as they are usually focused on developing entirely new products. Their value depends on the quality of the product and the team, as well as their ability to stimulate demand in the future through current decisions. Unlike mature companies that can anchor their valuations using historical performance and comparable firms, startups have almost no such reference points; pricing is mainly based on interpreting signals and beliefs based on "intangible" factors.
• Inference-Based Decision Making: Information asymmetry forces founders and investors to piece together fragmented information; teams focused on building often overlook signals from their surrounding ecosystem or competitors. Ultimately, many decisions rely more on probabilistic inference than on conclusive evidence.
• Investor Conviction: Early investors who have a deep, long-term belief in the team's vision can form a patient and goal-aligned holding group. During market fluctuations, steadfast holders help maintain stability, allowing the project time to realize its vision. In contrast, opportunistic or less-convicted investors will sell off at the first sign of market turmoil, amplifying volatility and distracting the team from focusing on building.

Overall, these features imply that founders and investors are always "guessing (and paying for)" the correct narrative and acting accordingly. Futarchy does not eliminate this inherent subjectivity, but rather embraces it directly: allowing anyone to trade tokens on the outcomes of DAO decisions (through/against), leveraging personal beliefs and transforming them into aggregated market signals usable by the DAO. This process converts decentralized intuitions into unified, weighted predictions, effectively directing ownership towards those with the clearest and most enduring beliefs.

By requiring participants to invest real capital based on their opinions, Futarchy transforms the most vulnerable traits of early-stage startups (subjectivity and uncertainty) into a governance mechanism that actively strengthens the project, thereby providing a less arbitrary and more rational path for its development.

How Futarchy Complements Early Company Governance

The benefits of Futarchy for the earliest DAOs are mainly reflected in two aspects:

1. Provide information beacons supported by economic backing;
2. Provide a dynamic cap-table mechanism that directly binds the strategic path of the DAO to the holder base.

Information Beacon

As an information beacon, Futarchy can provide signals for the feasibility of an idea through market-enhanced feedback, directly revealing token holders' economic attitudes towards a certain decision.

Decision-making mechanism supported by the economy

Futarchic governance draws on the principles of prediction markets. Just as predictions supported by economic bets are often more accurate, decisions backed by economic bets should also yield healthier outcomes, as the quality of the results relates to real value. This economic exposure sets a cost for participating in decision-making, reducing arbitrary and poor decisions, and incentivizing participants to present higher quality and information-supported views through "consequential voting."

In addition, this mechanism allows the most accurate predictors to adjust their positions according to their judgments and profit from it, further aligning individual incentives with the overall interests of the DAO.

Moreover, Futarchy allows any on-chain user to participate in voting, thereby reducing information asymmetry and incorporating perspectives from outside DAO holders. It turns voting into a market, enabling anyone willing to take on capital risk to participate in the evaluation of DAO decisions. This market mechanism also makes manipulation difficult: anyone trying to raise or suppress the proposal's "approve/reject" market price will create arbitrage incentives for other market participants, prompting them to trade in the opposite direction. The more manipulation occurs, the greater the incentive for reverse arbitrage.

In addition, this mechanism makes manipulation itself costly, as changing the outcome requires real monetary investment, which could lead to direct financial losses for manipulators or single large holders. As a result, the entire structure can achieve a level of decentralization that is difficult for token-weighted voting to attain.

The Gap Between Voting and Holding

In traditional governance systems, there exists a potential disconnect: how people "vote" (and what the organization ultimately does) may be out of sync with how they "allocate capital." Some may vote against a proposal but still buy more tokens because they are optimistic about the overall project; others may vote in favor but quietly sell out due to concerns about execution risks.

This has created a gap between the "expressed preferences" in governance and the "explicit preferences" in the market, making it difficult for builders to truly understand stakeholders' real attitudes toward specific decisions, rather than just their overall support for the entire project. This blind spot can lead to suboptimal decisions.

In Futarchy, voting behavior and market activities are not separate; instead, the buying and selling of tokens themselves constitute voting. When a proposal is put forward, the market immediately indicates support or opposition through the direct buying and selling of tokens linked to the outcome of that proposal. A key distinction from traditional governance is that in traditional governance, market reactions (such as buying and selling behaviors) are typically completely independent of the voting itself, making it difficult to determine the true motivations behind these market actions or their connection to specific governance decisions.

The integrated design of Futarchy reduces the ambiguity of holder attitude information and the disconnection between this information and optimal decision-making. It allows real opinions and beliefs to be directly captured in the voting mechanism, enabling the DAO to move along the path that best aligns with the economic perceptions of its holder community.

Unlike traditional systems where there is a "public facade of one set of bets while privately trading another set," Futarchy integrates bets and outcomes into a single entity. This relationship is crucial because once the voting concludes, tokens are directly transferred from those who do not believe in the decision to those who do. This not only clarifies market sentiment and directly applies it to the decision outcome but also reallocates ownership to those participants who are (theoretically) most informed and most confident, allowing DAOs to dynamically balance their equity structure throughout the decision-making process.

Market Capitalization Table with Weighted Beliefs

Creating a "truly supportive community of holders who identify with the project's vision" is one of the most challenging tasks for early-stage crypto projects. Most teams struggle to distinguish between genuine supporters and opportunistic speculators, resulting in severe fluctuations in token prices. Founders are forced to invest significant time and energy in managing market dynamics instead of focusing on product development.

The most common early user onboarding strategy is airdrops: using free tokens to incentivize users to use the product. Although this approach can bring initial user activity and improve metrics, it can create some serious problems that undermine the foundation for long-term success:

• Opportunistic Behavior: Airdrop recipients often only engage in minimal and inorganic interactions, with the aim of meeting the eligibility criteria, and then immediately sell as soon as they receive the tokens. This cultivates a group of holders who are only interested in quick arbitrage, showing almost no real faith in the project's future.
• Ambiguous Product-Market Fit Signals: When users primarily use the product for economic rewards rather than genuine demand, the feedback the team receives about product quality and market demand is misleading. As long as there is free money, almost any product can be "used," making it difficult for the team to determine whether the core product truly addresses actual problems.
• Starting from Scratch: After the airdrop ends and opportunistic users exit, projects often find themselves back at square one, without a real community left behind. That brief period of user activity does not lay any foundation for sustainable growth.

This dynamic has led early projects into a paradox: they need users to demonstrate traction, but the methods used to acquire users often attract those least conducive to long-term success.

How Futarchy Solves the Holder Commitment Problem

Futarchy creates a "holder natural selection mechanism" through a market-based governance mechanism to address the issue of insufficient belief. In the continuous governance proposal process, the token supply gradually flows to those voters who are "most accurate" (i.e., who bet correctly in the market) and who have the strongest beliefs, while those who are correct but have weaker beliefs, as well as those who make incorrect judgments (who bet incorrectly in the market), will slowly lose their relative shares in the equity structure table.

This change is gradual (no one will be completely eliminated in a single proposal), but it will continue to occur over time. When Futarchy is used in conjunction with a more organic token issuance mechanism, the holder base of the DAO will become more committed and sticky as the project develops.

Futarchy transforms the subjective and difficult-to-quantify disagreements surrounding DAO decision-making into voluntary, conditional ownership exchanges, where the trading price reflects the aggregated perceptions of market participants regarding the outcomes. Over time, this will lead to token ownership becoming increasingly concentrated in the hands of those who are perceived by the market as "most accurate in their predictions" and "most steadfast in their support" for the future direction of the DAO.

Suppose there is a proposal to add a new feature to the protocol, and the three holders have different opinions:

• Alice: Wants to buy 1 token when the proposal "fails" because she believes this feature is harmful to the DAO. She hopes to have more exposure if the proposal is rejected.
• Bob: Wants to sell 1 token when the proposal "fails" because he believes this feature is beneficial for the application. If the proposal does not pass, he hopes to reduce his holdings.
• Eve: Wants to buy 1 token when the proposal is "passed" because she believes this feature will bring value. She hopes to gain more exposure if the feature is implemented.

If the market ultimately judges that this proposal should "fail" (i.e., the fail price is higher than the pass price), Alice will effectively "gain" 1 token from Bob in this synthetic market. Both of them have bet on the outcome of "proposal failure" in the market:

• Alice increases her exposure by buying contracts with a "failure" condition;
• Bob reduces his exposure by selling off contracts with "failed" conditions that he does not want to hold.

The result is that Alice increased her position, while Bob exited this part of the equity structure table. Both achieved their desired outcomes. Meanwhile, Eve did not experience any actual transfer this time because her buy order was based on the condition of the proposal being "passed," but her relative influence on the equity structure table was diluted by Alice.

This will automatically produce three different results:

• Alice (High conviction, trading on the right side of the market): Acquire more tokens and equity structure shares.
• Bob (Low conviction, trading on the right side of the market): Losing tokens and exiting the equity structure table.
• Eve (Did not bet on the correct outcome): Absolute holdings remain unchanged, but the relative equity structure shares are diluted by Alice.

This result is automatically achieved through a conditional market, which is an elegant mechanism that allows ownership to flow naturally to those whose judgments align with the collective wisdom of the market. It does not attract short-term arbitrageurs like airdrops, nor does it separate voting and participants' perceptions of the decision-making economic prospects like traditional governance. Futarchy ensures that influence is concentrated in the hands of participants who both believe in the decisions and can gain market recognition.

Ultimately, the equity structure table will become increasingly "faith-weighted" and "accuracy-weighted" over time, composed of holders who repeatedly support their own judgments with capital and prove that they truly believe in the direction of the project.

Limitations of Futarchy

Futarchy does not guarantee success. It is merely a means to achieve better decision-making and obtain a better holder structure, rather than an ultimate goal. The team still needs to truly execute based on the insights generated from futarchy governance; the idea of the project itself must be reasonable; and the product must also have genuine market demand.

Moreover, introducing market mechanisms into governance does not guarantee that a DAO will always make the best decisions. The idea of Futarchy is to create an environment that incentivizes optimal decision-making by allowing opinions to have financial consequences. However, people may still act irrationally, and the market may still misprice decisions.

However, compared to "risk-free" token voting (which incurs almost no economic cost for holders when guiding the DAO's strategic direction), Futarchy offers a more incentive-aligned decision-making approach.

The main value of Futarchy does not lie in guaranteeing that all decisions will lead to higher token prices or user growth—no governance system can achieve that. However, compared to traditional alternatives, Futarchy can provide a higher probability of success for DAOs.

Conclusion

Futarchy provides a strong governance framework for early-stage startup projects, allowing the decision-making process to have economic backing, enabling investors to directly align their capital exposure with the direction chosen by the DAO.

This mechanism is particularly beneficial for startups, as it provides a more effective way to apply cold starts and build a strong holder base compared to traditional means. While Futarchy can also benefit mature DAOs, it is especially valuable for projects in the early stages that face significant subjective disagreements and urgently need to establish a highly confident holder community.