The future of business is automated, and DAOs are at the forefront of this movement. Decentralized autonomous organizations, or DAOs, have been gaining traction in the crypto and blockchain space as the discussion around decentralized finance, or De-Fi, continues to grow. But what are DAOs? And how do they work? Let’s take a closer look.
What is a DAO?
A DAO or Decentralized Autonomous Organization is a term used to describe a group of people who agree to follow certain rules for a shared purpose. The rules for the organization are written into code as smart contracts, which are algorithms that activate when certain conditions are met. DAO’s use blockchain technology to record their activities, exchange currency, or make decisions.
There is no central authority governing the organization, which is why it is considered “decentralized.” DAOs have a flattened hierarchy, meaning that everyone has a stake, and no one person owns or controls the entire organization the way a CEO would in a traditional company.
DAOs have become popular in the crypto space because they offer a way for people to come together and cooperatively invest in projects without going through a centralized authority.
Some examples of DAOs include PleasrDAO, a group of crypto investors who collect NFTs, and Friends With Benefits, a DAO that acts as a social club/crypto publication/artist incubator.
How do DAOs Work?
DAOs are intended to copy a company’s organizational structure, but with rules and regulations that are written in open-source code instead. These rules are executed by something called as “smart contracts.”
Smart contracts are agreements that are programmed to automatically carry out an action when certain conditions are met(If this… then that). In a DAO, the stakeholders–the people who have a vested interest in the organization–decide what those conditions should be. For example, based on the outcome of a vote, the smart contract might automatically issue rewards to token holders, increase the circulating supply of tokens, or burn a certain number of reserve tokens.
The voting process for DAOs is done through a blockchain in order to ensure mutual exclusivity among the options and prevent any one user from having too much power. Each user’s voting power is based on the number of tokens they hold in relation to other users. So, for example, a user who holds 100 tokens would have twice the voting power of a user who only holds 50 tokens.
The idea is that users with more money invested in the DAO are more likely to act in its best interest.
How are DAOs Created?
Creating Smart Contracts
Creating a smart contract is the first step in creating a DAO. Smart contracts are created and stored on the blockchain. Smart contracts are essentially automated contracts that contain rules and conditions that govern how they behave. For example, a smart contract might require certain conditions to be met before it sends funds or performs other actions. Smart contracts are self-executing and self-enforcing — if one side of a contract fails to comply with its terms, the other side automatically takes action.
Funding and Managing
DAOs need capital to operate, which must be raised by their members. This is where people agree to participate in the group when they support its mission and commit to buying a certain amount of tokens in exchange for a stake (governance token).
After raising funds, it becomes important to manage those funds which can be used for strategic investments and operating costs. And for this reason, you can use DAO Treasury Management tool as the next step after the deployment and allocation of the tokens. Also, in DAOs it is necessary to secure the capital of the DAO in a way that prevents an individual party from making unilateral decisions(with the use of smart contract) on how to spend the funds.
After securing the funding, the smart contract gets deployed on the blockchain when all the members of the DAO agree on a particular decision involving the DAO’s growth. From here on out, it’ll be the stakeholders or token holders who’ll decide on the organization’s future course.
How are DAOs Different from Traditional Organizations?
|Organizations are structured in a way that is generally flat and allows for a democratic process.||Usually, hierarchical.|
|In order for changes to be implemented, members must vote on them.||Depending on the organizational structure, changes can be demanded from a sole party, or voting may be offered.|
|Votes are tallied automatically through smart contract, and outcomes are implemented without the need for a trusted intermediary.||If voting is enabled, votes are counted internally, and the result of the vote must be processed manually.|
|The services offered by the DAO are handled automatically through smart contract and in a decentralized manner. (for example, distribution of philanthropic funds).||Organizations usually require human handling or controlled automation that is prone to manipulation.|
|All the activities are transparent and completely public on blockchain.||Activities in an organization are generally private and inaccessible for all individuals.|
Benefits and Setbacks of DAO
DAOs offer an alternative to the traditional centralized decision-making models that most organizations employ. In a DAO, authority is distributed amongst a large group of users rather than being centralized within a small group of individuals (e.g., a CEO or Board of Directors). This decentralized approach has several advantages, including increased resilience to attacks and improved responsiveness to the needs of the users.
The rules of a DAO are coded into the blockchain, and as the program runs, these rules are enforced automatically with smart contracts – without the need for human intervention. This means that the rules are enforced without the biases, errors, or manipulation that can come with human involvement.
DAOs have the advantage of transparency due to the distributed ledger on the blockchain it’s built on that records all changes made by members. This ensures that information about the organization is preserved.
Traditional organizations are typically managed by a founder or co-founders, but DAOs instead distribute power among members to prevent issues like founders taking investors’ money and running. This shift in control allows for more democratic decision-making and often leads to better outcomes for all involved.
One of the key advantages of a DAO is that it promotes accountability and thoughtful decision-making among its members. This is because all members of a DAO can vote on moves and changes, as opposed to electing representatives to make decisions on their behalf. This creates a flatter, more equal organization without the hierarchy hurdles.
When starting an organization involving money, it is important to trust the people you are working with. However, it can be challenging to trust someone you have only ever interacted with online. With DAOs, you don’t need to trust anyone else in the group, as the DAO’s code is 100% transparent and verifiable by anyone.
DAOs have a bottom-up approach. A community of members with voting rights collectively decides on rules, and everyone follows them. So, there’s no hierarchy. DAOs give power back to people.
The decentralized nature of DAOs means that anyone with the appropriate tokens can participate in governance. However, because a small group of investors can hold a large number of tokens, they may have a disproportionate amount of power when it comes to voting. This could lead to problems if they vote for unreasonable proposals. Therefore, DAOs may not completely eliminate the problem of hierarchy.
While the community-based model is typically thought of as a positive for DAOs, it can pose a major problem in the event of a contingency scenario. For example, changes cannot be implemented in the DAO without voting mechanisms.
Furthermore, the voting mechanisms can be time-consuming, and you may have to wait quite some time for each transaction on the DAO. Imagine if the DAO required an immediate modification to the smart contract code to resolve a security vulnerability – you would be waiting quite some time.
If the community disagrees strongly on an issue, it could split the organization into two, which is known as hard fork. This would be detrimental to the organization’s progress and could lead to serious consequences.
Decentralized platforms may face legal uncertainty due to the lack of regulation surrounding blockchain technology. This could lead to DAO founders and investors facing repercussions from the Securities and Exchange Commission (SEC).
While DAOs can be created with a few lines of code, security concerns are a notable problem, as they require a high level of technical expertise to implement. With constant developments in the sector, the tools available to DAOs are improving. Without a strong security foundation, DAOs are at risk of being exploited or worse. Although multi-signature signing can significantly reduce the risk of misuse of funds, there is no guarantee, especially in the world of crypto.
Types and Examples of DAO
DAOs can be classified into the following types
- Protocol DAOs: Tokens are used as a voting metric to decide changes in a technology protocol. Prominent cases include MakerDAO or the Uniswap DAO. In both of these examples, the community decides on changes by voting with their tokens. This allows for a more Decentralized decision-making process and gives power back to the people who hold the tokens.
- Collector DAOs: A number of art collectors join forces to buy NFTs or actual works of art. This includes groups like Flamingo DAO and PleasrDAO.
- Investment DAOs: Investment DAOs are the type of DAOs that invest in companies to generate profits and influence decision-making. An example of such a DAO is Krause House, whose objective is to acquire an NBA team.
- Grant DAOs: Grants are a key part of how Decentralized Autonomous Organizations (DAOs) operate. The objective of Grant DAOs is to fund innovative projects that serve the decentralized community. An excellent example of a project that has received grant funding is Aave Protocol, which uses the money to develop its ecosystem.
- Media DAOs: Content creators who work independently can use Media DAOs to cut out the advertisers and establish a closer relationship with their readers. This alignment of incentives can help content creators produce the quality content that their readers appreciate.
- Social DAOs: Social DAOs prioritize digital democracy through social networking and communication over the financial aspect of DAOs.
What is the Legal Status of DAOs?
The legal status of a DAO can vary depending on the jurisdiction, with some countries recognizing them as legal entity and others not. In July 2021, Wyoming became the first U.S. state to recognize DAOs as a legal entity, with American CryptoFed DAO being the first business entity to be so recognized.
Some previous approaches to blockchain-based companies have been regarded by the U.S. Securities and Exchange Commission as illegal offers of unregistered securities. Although the legal standing of a DAO may be uncertain in some cases, it may still functionally act as a corporation without having any legal status as a corporation, similar to a general partnership.
Which was the first DAO?
Slock. it, a German-based developer, created the first DAO named “The DAO.” The DAO is built on the Ethereum blockchain, Slock. it’s purpose is to connect physical world transactions to the blockchain. This would enable people to conduct transactions such as renting, selling, or sharing property without an intermediary.
What are the prime characteristics of DAO?
The prime characteristics of DAO include Decentralization, Transparency, Democracy, and Automation.
How does a DAO make money?
DAOs raise capital by swapping fiat currency for their native tokens. These tokens give holders voting power and ownership stakes within the organization. If a DAO is successful, the value of its native token will rise. This allows the DAO to issue new tokens at a higher price and raise even more money. Additionally, DAOs can invest in assets such as companies, NFTs, or other tokens. If these assets increase in value, it will also drive up the value of the DAO.
Are DAOs secure?
DAOs are designed to be secure, but they can’t be 100% secure. This is because malicious actors can still attack the system and steal funds.
What are the uses of DAO?
The business model that is used with DAO can be applied to almost every sector. Also, the application of DAO goes beyond finance:
Government: DAOs have the potential to improve a number of processes, including voting, contract preparation and submission, contract execution monitoring, bidding, auditing, and more. By automating these processes and making them more transparent, DAOs could help to improve the efficiency and accuracy of these important functions.
Non-profit Organizations: DAO provides a way for people to receive donations anonymously and to accept members from anywhere in the world. This allows individuals to receive donations without disclosing their identity, and it also allows the members to have a say in how the money is used.
Auditing Companies: DAOs can improve auditing by automating project management, improving tracking, and increasing security. This can help organizations save time and resources by reducing the need for manual oversight. Additionally, DAOs can provide transparency into the decision-making process, which can help build trust among stakeholders.