Key Takeaways
Blockchain technology allowed for new types of organizational structures to be created. Decentralized autonomous organizations (DAOs) are prime examples.
As distributed networks, blockchains enable DAOs to operate autonomously without the need for a central authority.
DAOs represent an organizational model focused on community-driven development and management.
Introduction
The emergence of blockchain technology enabled new types of organizational structures. Decentralized autonomous organizations (DAOs) are prime examples of innovative organizations that can run autonomously and without a central authority.
The first DAO was launched in 2016 with a vision to have all its members collectively act as the governing body. DAOs can serve various purposes, from pooling members’ funds for venture investment to validating the integrity of off-chain data.
What Is a DAO?
DAO stands for decentralized autonomous organization. It's a concept rooted in blockchain technology that enables the creation of organizations governed by code rather than by centralized authorities or individuals.
In other words, a DAO is a community-led entity governed by computer code. Because the rules that determine the organization’s behavior are built into its design, it can function autonomously without the need for central leadership.
Unlike traditional organizations, DAOs do not allow a single person or group to unilaterally enforce decisions. Instead, everyone in the community can suggest ideas and vote on them. This ensures that decisions are made by the whole group, not just a few powerful people.
Crypto enthusiasts like DAOs because they make teamwork more fair. Instead of a few big shots making all the calls, everyone gets a say in how things are done. This is a big change from regular companies, where the top executives and large shareholders usually have all the power.
How Do DAOs Work?
In a DAO, the rules and guidelines for how the organization operates are written into code, typically using smart contracts on a blockchain. These smart contracts automatically execute actions based on predefined conditions, ensuring that the organization operates according to the agreed-upon rules without the need for human intervention.
Typically, members of a DAO participate in decision-making by owning tokens or shares in the organization. These tokens represent voting power, with each member's influence in the decision-making process proportional to the number of tokens they hold.
When a decision needs to be made, such as approving a proposal or allocating funds, members can vote on these matters using their tokens. This democratic process ensures that decisions reflect the collective will of the community.
DAOs often have treasuries or pools of funds that are managed collectively by the members. These funds can be used to finance projects, invest in new ventures, or support community initiatives.
Proposals for how to use these funds are submitted by members and voted on by the community. Once a proposal is approved, the smart contracts automatically execute the necessary actions, such as transferring funds or minting new tokens.
Transparency and accountability are key principles of DAOs. All transactions and decisions are recorded on the blockchain, making them publicly accessible and verifiable by anyone. This transparency ensures that members can trust the integrity of the organization and hold each other accountable for their actions.
Additionally, because DAOs operate on a decentralized network, they are resistant to censorship and tampering, further enhancing trust and reliability. In some ways, a DAO works similarly to a corporation or a nation-state, but it operates in a more decentralized fashion.
DAOs and the principal-agent problem
DAOs tackle a problem in economics called the principal-agent dilemma. It occurs when a person or entity (the “agent”) has the ability to make decisions and take actions on behalf of another person or entity (the “principal”). If the agent is motivated to act in their own interest, they may disregard the interests of the principal.
What exacerbates the problem is that there might also be information asymmetry between the principal and the agent. The principal might never know that they are being taken advantage of and have no way to make sure that the agent is acting in their best interest.
Common examples of this problem occur with elected officials representing citizens, brokers representing investors, or managers representing shareholders.
By allowing a higher degree of transparency enabled by blockchain technology, well-designed DAOs can eliminate parts of this problem. Especially if the DAO manages to avoid information asymmetry and align the incentives within the community. Since all transactions are recorded on a blockchain, the operation of DAOs is completely transparent and more resistant to fraud.
Benefits of DAOs
Decentralized
In a traditional organization, the most important decisions are made by a central authority. In a DAO, decisions impacting the entity are made jointly by the community.
Transparent
Transparency calls for accountability of every member of the DAO. Votes within a DAO are made via blockchain and are publicly viewable. Anyone can look up transaction records. This motivates community members to act in good faith and discourages acts against the community.
Community-based
A DAO can bring together people from all over the world to work toward a shared goal. Every member has the opportunity to contribute to the project. Unlike traditional corporate structures, everyone can express their ideas and propose courses of organizational action via the mechanisms of decentralized governance.
DAO Examples
MakerDAO: MakerDAO is a DeFi project with a crypto-collateralized stablecoin called DAI, which is pegged to the US dollar.
Aave: Aave is an Ethereum-based money market where users can borrow and lend a wide variety of digital assets, from stablecoins to altcoins. The Aave protocol is governed by AAVE holders.
Uniswap: Uniswap is a decentralized exchange (DEX) protocol that operates as a DAO, allowing users to swap various cryptocurrencies without the need for intermediaries.
Yearn.Finance: Yearn.Finance (YFI) is a DeFi platform that automates yield farming strategies and other DeFi opportunities. It operates as a DAO where community members govern protocol upgrades and decisions.
Is Bitcoin a DAO?
Some consider the Bitcoin network an early example of a DAO. It operates in a decentralized fashion and is coordinated by a consensus protocol with no hierarchy between participants.
The Bitcoin protocol defines the rules of the system, while bitcoin (BTC) as currency provides an incentive for users to secure the network. This ensures that the different participants can work together to keep Bitcoin running as a decentralized autonomous network. The common goal in the case of Bitcoin is storing and transferring value without a central entity coordinating the system.
It’s worth noting, however, that there is not a single way to define DAOs. Nowadays, the term is commonly used to describe organizations that run on top of an existing blockchain and are governed by their community through smart contracts. Such a definition makes them different from Bitcoin.
What else could DAOs be used for?
More complex DAOs may be deployed for different use cases, such as decentralized venture funds or social media platforms. DAOs could also coordinate the operation of devices connected to the Internet of Things (IoT).
A subset of DAOs have emerged called decentralized autonomous corporations (DACs). A DAC may provide similar services to a traditional company, for example, a ridesharing service. The difference is that it works without the corporate governance structure found in traditional businesses.
For instance, a car that owns itself and provides ridesharing services as a part of a DAC could operate autonomously, carrying out transactions with humans and other smart devices. Through the use of blockchain oracles, it could even trigger smart contracts and perform certain tasks on its own.
Ethereum and “The DAO”
One of the earliest examples of a DAO was the aptly named “The DAO.” It was made up of complex smart contracts running on top of the Ethereum blockchain that were supposed to act as an autonomous venture fund.
In May 2016, the DAO tokens were sold in an Initial Coin Offering (ICO) and provided an ownership stake and voting rights in this decentralized fund. However, shortly after launch, about a third of the funds were drained from The DAO in one of the largest hacks in the history of cryptocurrencies.
The result of this event was that Ethereum split into two chains following a hard fork. In one, the fraudulent transactions were effectively reversed, as if the hack never happened. This chain is what’s now called the Ethereum blockchain. The other chain, faithful to the principle “code is law,” left the fraudulent transactions untouched. This blockchain is now called Ethereum Classic.
Limitations of DAOs
Legal
The regulatory environment surrounding DAOs is still very uncertain as most jurisdictions haven’t yet defined their approach to this novel type of entity. A continuously uncertain legal status could become a significant barrier to the adoption of DAOs.
Coordinated attacks
The desirable properties of DAOs (decentralization, immutability, trustlessness) inherently carry some performance and security risks. The example of The DAO demonstrated that this new organizational form can introduce significant risks if not designed properly.
Points of centralization
It can be argued that decentralization isn’t a state, but rather a range, in which each level is suitable for a different type of use case. In some cases, full autonomy or decentralization might not even be possible or make sense.
DAOs may allow for a wider range of participants to collaborate than ever before, but depending on how the DAO is designed, the governance rules set in the protocol might become a point of centralization.
Closing Thoughts
Overall, DAOs represent a novel approach to organizational governance, leveraging blockchain technology to create inclusive, democratic, and transparent communities.
DAOs allow organizations to break free from reliance on traditional hierarchies and structures. Instead of a central entity coordinating participants’ actions, governance rules are automated and steer members toward the most beneficial outcome for the network.
The key to designing good DAOs is to use an efficient set of consensus rules that resolve complex participant coordination problems. The real challenge facing the implementation of DAOs might not be more social than technological.
Further Reading
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