"Shadow-Centralization" and Governance Effectiveness in Decentralized Autonomous Organizations: From Token Holding to Voting Power

Decentralized Autonomous Organizations (DAOs) aim to foster decentralization but often exhibit "shadow-centralization" (i.e., a small group essentially exercises their governance power in voting, despite the wide distribution of voting rights). While prior literature has noted the potential for centralization in DAOs, it has not adequately distinguished between the centralization of governance power (i.e., tokens) holding and the centralization of power exercise through voting, nor has it examined the transition from the former to the latter. Furthermore, the literature has underexplored the consequences of this power transition for governance outcomes and the related contingent factors.

Our study fills this gap by explicitly examining how centralization shifts from holding to voting and how this transition impacts the performance of DAO-governed decentralized applications (DApps). We also examine how these effects are contingent on the capability of voters and the nature of the governance issues. Focusing on both on-chain and off-chain DAOs, we find that an increase in centralization from holding to voting negatively affects DApp performance, confirming that concerns about "shadow-centralization" are warranted.

We also find that this negative impact is mitigated when voters possess greater experience and connectivity than the broader group of token holders. Also, the adverse effect is more salient for proposals requiring higher deliberation and is less salient for novel proposals. Our study advances the understanding of DAO governance by highlighting the source of shadow centralization and reveals that it implications depend on who votes and what they vote on.