What are DAOs? Demystifying Decentralized Autonomous Organizations

Decentralized Autonomous Organizations, known by the acronym DAOs, are internet-based entities governed by their members and through transparent computer programs. Utilizing blockchain technology, these organizations can function without centralized control or governance.

What is a DAO?

A Decentralized Autonomous Organization (DAO) operates without central leadership. Instead, decisions are made bottom-up, governed by a community adhering to specific rules enforced on a blockchain.

DAOs represent internet-native organizations collectively owned and managed by their members. They are equipped with built-in treasuries accessible only with the members' approval. The decision-making process involves voting on proposals during designated periods.

DAOs function without hierarchical management and can serve various purposes. They facilitate freelancer networks, where members pool funds to cover software subscriptions, enable charitable organizations where donations are subject to member approval, and even establish venture capital firms owned and operated by the group.

How does a DAO work?

As mentioned, a DAO operates as a bottom-up organization where its members collectively make decisions. Participation in a DAO is typically through token ownership.

DAOs function using smart contracts, blocks of code that automatically execute when specific conditions are met. These smart contracts are now deployed on various blockchains, with Ethereum being the pioneering platform.

The rules of the DAO are established through these smart contracts. Stakeholders holding tokens in the DAO gain voting rights, allowing them to influence the organization's operations by proposing and voting on governance changes.

To prevent spamming with proposals, stakeholders must approve a proposal for it to pass. The method of determining this majority varies across different DAOs and is specified within the smart contracts.

DAOs operate with complete autonomy and transparency. As they are built on open-source blockchains, anyone can examine their code. Additionally, their built-in treasuries can be audited by anyone, as all financial transactions are recorded on the blockchain.

DAO models

The governance of DAOs being determined by their members raises an essential question: how does one become a member of a DAO?

Regarding DAO membership, there are two distinct models - token-based and share-based.

Token-based membership

In a DAO operating on a token-based membership system, voting rights and participation in shaping the DAO's future are granted to holders of governance tokens. Owning these governance tokens automatically makes an individual a member of the DAO. This approach ensures permissionless membership, as these tokens can be freely traded on various crypto trading platforms, including decentralized exchanges (DEXes).

Thus, anyone interested in becoming a part of a specific DAO community can easily acquire the necessary governance tokens, fostering an inclusive and accessible ecosystem.

In addition to acquiring governance tokens through traditional methods, DAOs can offer users alternative ways to obtain these tokens. For instance, members can earn tokens as rewards for staking, validating transactions, and providing liquidity. These mechanisms incentivize participants to retain their token holdings and actively participate in the DAO community.

Token-based models, due to their ability to enable permissionless membership and accommodate extensive communities, DAOs are especially well-suited for larger blockchain projects, such as DeFi protocols.

Share-based membership

The share-based model used in DAOs is permission, although becoming a member may not be difficult in many cases. Interested individuals can typically submit a proposal to join the DAO, and there is a genuine chance of approval. These proposals often involve contributing tokens or offering work to the DAO. Holding a share grants the member voting power and ownership rights in the DAO's treasury. Members are free to leave the DAO with their share of the treasury.

This model suits DAOs centered around smaller, like-minded groups aiming to collaborate on shared objectives. However, it can also be employed to govern protocols and tokens.

How does a DAO make money?

A DAO starts by obtaining capital by exchanging fiat currency for its native token. This native token represents voting rights and ownership proportion among its members. As the DAO succeeds and achieves its goals, the value of the native token is likely to rise.

Furthermore, the DAO can issue additional higher-value tokens to raise capital. It can also make strategic investments in various assets, subject to approval from its members. For instance, the DAO may invest in companies, NFTs (Non-Fungible Tokens), or other digital assets. If these assets experience an appreciation in value, it contributes to the overall growth of the DAO.

DAOs use cases

DAOs are a revolutionary form of organization essential for the modern digital landscape. They embody authentic Internet-native structures, facilitating swift collaboration towards shared objectives and fostering vibrant communities around everyday purposes. By empowering digital-first enterprises with their flat and adaptable framework, DAOs facilitate rapid progress and agility, enabling businesses to operate at unprecedented speeds.

DeFi

DeFi protocols and platforms operate using DAO-based governance structures, wherein governance tokens grant the entire community the ability to participate in decision-making. A prominent illustration is MakerDAO, which oversees the creation of the decentralized token Dai.

A current trend in the DeFi space is the rise of DeFi platforms, often called "DeFi 2.0," specifically centered around inter-DAO collaboration and engagement.

Crypto investment funds

DAOs provide a simple and effective method for individuals to come together and combine their resources to explore investment opportunities in the crypto and NFT markets. Within a DAO, each member is significant in determining how these pooled resources are utilized, ensuring a collective and democratic decision-making process.

Charities

DAOs open up new possibilities for establishing Internet-based charities focused on specific causes. Charitable DAOs can be created with diverse agendas, ranging from fostering the growth of the blockchain ecosystem to championing social well-being initiatives.

Private limited companies

Private company DAOs are decentralized autonomous organizations established within a private company's structure. Unlike public DAOs, open to the broader public and governed by token holders, private company DAOs are restricted to the company's employees, stakeholders, or selected participants. These DAOs leverage blockchain technology and smart contracts to facilitate transparent decision-making, governance, and resource management within the organization.

Public companies

Public company DAOs were still a relatively new concept and had not been widely adopted. However, public company DAOs represent a potential evolution in corporate governance, where publicly traded companies explore integrating decentralized autonomous organizations (DAOs) into their operations.

A public company DAO would extend the traditional corporate structure, incorporating decentralized decision-making and governance mechanisms powered by blockchain technology. The primary goal of a public company DAO would be to enhance transparency, inclusivity, and shareholder participation in crucial decision-making processes.

Why do we need DAOs?

DAOs possess numerous advantages over traditional organizations due to their internet-native nature. One significant benefit is the reduced need for trust between parties. Unlike traditional organizations that heavily rely on trust in their stakeholders, DAOs primarily rely on trust in the code.

The code's trustworthiness is enhanced by its accessibility as it is publicly available and thoroughly tested before implementation. After launch, the community must approve every DAO action, ensuring complete transparency and verifiability.

In contrast to hierarchical structures found in traditional organizations, DAOs operate without such rigid frameworks. Instead, they rely on stakeholders who control the organization through their native tokens. This decentralization empowers any stakeholder to propose innovative ideas, which the community collectively considers and refines. Disputes within the organization are resolved through the voting system, adhering to pre-established rules encoded in smart contracts.

Moreover, DAOs enable investors to pool their funds, facilitating investment in early-stage startups and decentralized projects. This pooling of resources allows investors to share the risks and potential profits that may arise from these ventures.

In conclusion, DAOs offer a revolutionary approach to organizational structures, leveraging the power of blockchain technology and decentralized decision-making. The trust in code, transparency, and inclusive decision-making processes make DAOs an attractive alternative for stakeholders seeking greater transparency and participation in organizational affairs.

Benefits of DAOs

There are several compelling reasons why an entity or group of individuals may opt for a DAO structure, offering numerous advantages for efficient management, such as:

• Decentralization: In a DAO, decisions are made collectively by a broad group of individuals rather than being concentrated in the hands of a few central authorities. This decentralization distributes authority across a diverse range of users, avoiding over-reliance on the actions of a single individual or small group.
• Participation: Participants in a DAO feel empowered and connected to the organization when they have a direct say and voting power on all matters. Even those with relatively lower voting power are encouraged to engage actively, casting votes, burning tokens, or using their tokens in ways they believe best serve the entity's interests.
• Transparency: Votes in a DAO are conducted via blockchain, making them publicly viewable. This transparency encourages users to act in the community's best interest, as their votes and decisions are open for all to see. As a result, actions that benefit the community's reputation are incentivized, while harmful actions are discouraged.
• Global Community: DAOs foster a sense of community on a global scale, enabling individuals from diverse locations to come together seamlessly and work towards a shared vision. Token holders can interact and collaborate with other owners worldwide through

Disadvantages of DAOs

Decentralized autonomous organizations (DAOs) are cutting-edge technology but are not without challenges. Being relatively new, they have faced significant criticism, particularly surrounding their legality, security, and organizational structure.

• Security: Since then, reservations about entrusting critical financial decisions to the masses have not altered its public stance on DAOs, at least not publicly. DAO hack incidents also highlight security issues, as flaws in smart contracts can be challenging to rectify even after being identified.
• Legality: DAOs can operate across multiple jurisdictions, yet no established legal framework governs them. This lack of a regulatory structure could lead to complex legal battles if any legal issues arise, requiring involved parties to navigate various regional laws.

Despite these concerns, DAOs continue to evolve and garner attention in blockchain and decentralized systems. As the technology matures and the industry gains more experience, solutions and safeguards will likely be implemented to address these criticisms and challenges.

History of DAOs

The DAO, introduced in 2016, represented an early version of decentralized autonomous organizations as we know them today. Its purpose was to function as an automated venture capital fund.

Ownership of DAO tokens allowed individuals to reap the rewards from the organization's investments in two ways: through dividends or by benefiting from the tokens' price appreciation. The DAO captured significant attention as a groundbreaking project, amassing a remarkable $150 million in Ether through crowdfunding, making it one of the most extraordinary fundraising efforts of its time.

On 30th April 2016, the DAO officially launched following the release of open-source code for an Ethereum-based investment organization by Ethereum protocol engineer Christoph Jentzsch. Investors participated in the project by exchanging Ether for DAO tokens through its smart contracts.

Shortly after the token sale commenced, a group of developers raised concerns about a potential bug in The DAO's smart contracts, which could enable malicious individuals to exploit and drain the organization's funds. Although a governance proposal was introduced to address the issue, an attacker seized the opportunity and managed to siphon more than $60 million worth of ETH from The DAO's wallet before the bug could be fixed.

Future of DAOs

With the Internet becoming increasingly widespread, there have been more opportunities for people and organizations to collaborate on different projects and causes. Whether through charities or crowdfunding platforms, it has never been easier, especially for regular people, to support a project they like. Nevertheless, those models have limitations, mainly from relying on centralized governance.

As internet-native organizations, DAOs have the potential to change the way corporate governance works completely. While the concept matures and the legal gray area they operate in is cleared, more and more organizations may adopt a DAO model to help govern some of their activities.