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Arbitrum’s Post-Airdrop Transition to Community Governance Sees Rough Start

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Following the completion of its highly-awaited token airdrop towards the end of last month, the Arbitrum blockchain last week sought to advance to the next phase. The new phase would ultimately bring it under decentralized governance. This endeavor, however, took off in a less than stellar fashion – at least according to the expectations of the token holders. Here is a recap of events ensuing the messy airdrop and the subtleties of the first governance proposal, which sparked controversy until late Sunday.

Topsy-turvy ARB governance token airdrop

Arbitrum Odyssey was first launched in June 2021, and finally, last month, it got a token launch with the ARB offering sent to eligible wallet owners on Mar 23. The airdrop event hardly unfolded in line with prior communication from the project’s developers. The outline was (still is) that the Ethereum layer two scaling solution transition to a governance mechanism where a DAO manages decision-making on Arbitrum One and Arbitrum Nova. The initial plan stipulated that from a total supply of 10 billion ARB in circulation, 56% of the ERC-20 tokens be allocated to the Arbitrum community.

The allocation of this sum was agreed upon as follows – 11.5% of the tokens were to be granted to qualifying Arbitrum users through an airdrop, and 1.1% be distributed to decentralized autonomous organizations (DAOs) operating within the Arbitrum ecosystem. The remaining tokens would then be allocated to a treasury managed by the new governing body, Arbitrum DAO. Meanwhile, the difference left in the initial total supply, a proportion of roughly 44%, would go to the investors and employees of Arbitrum developer Offchain Labs.

Supply distrubtion of ARB tokens. Source: Dune Analytics/Blockworks

Though the latter proportion raised eyebrows within the community, Arbitrum argued that the token offering would make the network more decentralized than competitor chains. CEO Steven Goldfeder also revealed that Offchain Labs would continue as a service provider, despite relinquishing authority to steer the future of the layer two roll-up.

Airdrop initiates gradation into DAO governance

In the lead-up to the event, several crypto exchanges, including Coinbase, added the ARB token to their listing roadmap, a few offering IOUs tied to the token. Bitrue, HTX, MEXC, Binance, and Bybit committed to listing the ARB tokens after the airdrop. The hype around the airdrop saw activity around the optimistic rollup increase, as did the total value locked (TVL) following the event. Arbitrum One has secured a decent position in the fiercely competitive landscape of blockchain technologies scaling Ethereum, with a staggering $5.8 billion locked in.

Arbitrum TVL chart

The TVL bulge has helped cement the project as a dominant player in its Ethereum layer two niche, accounting for a significant 55% of the total market share per data from L2 Beat analytics platform. Markedly, Arbitrum’s shift to adopt a governance system came on the back of several milestones, including a ‘Nitro' upgrade released last August. The roll-up architecture represents the skeleton of the stack onto which Arbitrum One was migrated at the time. From the developer and user experience standpoint, it was necessary to introduce upgrades like Geth tracing, increased output (7x to 10x faster than pre-Nitro), and additional L1 interoperability.

Ahead of the airdrop, Goldfeder explained that the delay in launching the native token compared to fellow optimistic rollup network Optimism was due to Arbitrum’s prioritization of developing tech such as fraud proofs. This has since reached a stage deemed appropriate for the token launch, he added.

A hacker compromised 2400 wallets in line for the airdrop

Still, blockchain analytics firm Arkham Intelligence reported on Mar 20 that a hacker(s) took advantage and managed to compromise up to 2,400 wallets. The transaction performed by the attacker potentially allowed them to falsely claim as much as 3 million ARB tokens, about 0.26% of the total user airdrop. Given that the malicious actor had gained access to the private keys for wallets, the wallet owners could not immediately prevent them from accessing the tokens. The viable option then was revoking the contract that the hacker created.

That said, even after annulling the contract, the wallet owners needed to claim the airdrop before the hacker did manually. The fact that the airdrop happened on Arbitrum rather than Ethereum also posed a challenge for the involved wallets, as users needed to leverage flash bots to gain an advantage in claiming the airdrop before the attacker. The alternative was Offchain Labs blacklisting these wallets, but such a move could have unfairly prevented legitimate users from participating in the airdrop and claiming their fair share.

Controversial proposal details sow seeds of discord

The first step towards community governance involved a proposal to give the Arbitrum Foundation control of 750 million ARB tokens, translating to nearly $1 billion.  The Arbitrum Foundation flagged off the first proposal, Arbitrum Improvement Proposal (AIP-1), to ratify these decisions.  The allocation would have been surplus to that outlined in the initial plan. These tokens would facilitate a “special grants” program to cultivate growth on the Ethereum layer 2 platform. The intricacies of this proposition on the Arbitrum blockchain birthed a disagreement on social engagement platforms on Saturday and for the better part of Sunday.

Claimed ARB distrubtion

Besides the lump sum allocation, which emerged as a bone of contention, the community revolted against the provision in the proposal AIP-1, which essentially excluded ARB holders from determining how the Arbitrum Foundation allocates funds from the chest of 750 million tokens to eligible users. The dispute escalated after the revelation that the Foundation did not wait for the conclusion of the vote before using the ‘budget allocation' by selling the tokens.

Timeline of the first governance proposal

The broad encompassing proposal (AIP- 1) outlined steps to create and empower the Arbitrum Foundation, based in the Cayman Islands, which would be responsible for the growth of the ecosystem. As part of its empowerment, the proposal introduced a secondary administrative budget wallet under the control of the Foundation. Even before the completion of the vote, a multi-sig wallet with an address named “Arbitrum DAO Treasury2” had been created and funded to almost 700 million ARB tokens.

Decentralization concerns

The Arbitrum DAO treasury was meant to receive a total of 4.278 billion tokens, but only 3.527,046,079 ARB tokens have been transferred to its wallet address. Separately, the submitted proposal mandated only the Arbitrum Foundation (without consideration of the community input) to issue special grants. This decision struck many as one that goes against the very nature of governance the project creators envisioned.

The ARB tokens partly derive relevance from their use in making decisions that affect the blockchain and its broader ecosystem. The allocation proposal presented in a since-nullified vote appeared to spurn this aspect, setting the community at odds. The outcome of this unsuccessful first governance vote which has since been discarded in favor of several minor proposals addressing various issues particularly drew mixed reactions from different quarters.

Vote discarded in preliminary stage

Following the ensuing turmoil, the Foundation dropped the vote ahead of a formal final forum. In addition to its purpose, some questioned the sense in allocating an initial lump sum of $1 billion given past incidents of governance examples where large treasuries got drained for ‘pet' projects. Meanwhile, another community member observed early on Sunday that the Arbitrum Foundation sold 50 million ARB tokens out of the allocated lump sum of 750 million without community approval.

Criticism and response from the ARB community

The Foundation shared an update on Sunday to address the drama around the latter on-chain transfer, noting that the 40 million ARB tokens were allocated as a “loan” to a market maker since identified as Wintermute. The remainder fifth proportion (10 million ARB tokens) was converted to fiat to cover operational expenses. Most community members found fault in the Foundation’s actions, with some suggesting the Apr 2 communication was an attempt to fix the reputation.

“If the team needed funding, they should have made that clear. You can’t pretend all it good, then secretly loot the treasury and expect the people to be ok with this. Putting the word ratification on it, after the fact, doesn’t fix it. This is the same as any project launching and selling tokens into the FOMO of the investors. It’s apparently obvious that you attempted to squeeze your funding into a large encompassing proposal, hoping it would go unnoticed.”

Others opined that the Foundation table a proposal to reacquire the sold tokens and another proposal for the DAO to discuss the criteria for allocation and other details like how, and when the ARB tokens will be sold.

“This is an incredible number of words to use to get the point across that the vote wasn’t meaningful. Token holders should have some clarity on the buying and selling of $ARB now that it’s a liquid token and this just incites panic as speculators are wondering what % of the foundation’s tokens are being sold without users knowing. A lot more transparency on balances + selling schedules and the form of selling are necessary,” one user wrote in reaction to the update.

Though the issue is yet to be solved, the Foundation said it had begun some steps to remedy it. The allocation of 750 million tokens will be discussed and voted on under a separate poll. In line with this change, funding for the “special grants” program will be under a rebranded ‘ecosystem development' fund.

“AIP-1 is too large and covers too many topics. We will follow the DAO’s advice and split the AIP into parts,” the community lead wrote.

The Foundation also noted that it would not sell any more tokens in the near term but will “provide context on how the funds” within its budget are used through a transparency report. Patrick McCorry, a user sharing his ‘additional context' on the stance of the Foundation, attempted to address the cause of discord by explaining that the Foundation viewed the AIP-1 proposal as ‘ratification' instead of an actual vote. For this reason, the Foundation believed it had the authority to transfer ARB tokens into stablecoins. Comparing it to the chicken and egg problem, McCorry opined that creating a DAO would require that some aspects be agreed upon in advance. Worth noting, the Foundation's wallet is managed by three directors, namely Ani Banerjee, Campbell Law, and Edward Noyons.

Arbitrum (ARB) price action

The lack of cohesion among ARB holders, as portrayed in recent events, inspired losses in ARB prices across the weekend. Market data shows that the ARB/USD has been declining in the last 48 hours with little relief amid this erosion.  The ARB token was, at the time of writing, trading at $1.21, down 5% on the day. Overall, the pair has shed 89% since the airdrop.

ARB/USD price chart

The vote, which had an initial end date of April 3, had received a majority of the community vote until the news came out, which prompted many to vote against it. Current results show that an overwhelming majority (82.92%) voted against while 1.85% abstained. The new proposal is expected later this week.

Sam is a financial content specialist with a keen interest in the blockchain space. He has worked with several firms and media outlets in the Finance and Cybersecurity fields.