A decentralized autonomous organization (DAO) is an emerging legal structure with no central governing body whose members share a common goal to act in the entity’s best interest.
Popularized through cryptocurrency enthusiasts and blockchain technology, DAOs are used to make decisions in a bottom-up management approach.
KEY TAKEAWAYS
- A decentralized autonomous organization is an entity structure in which token holders participate in the management and decision-making of an entity.
- There is no central authority of a DAO; instead, power is distributed across token-holders who collectively cast votes.
- All votes and activity through the DAO are posted on a blockchain, making all actions of users publicly viewable.
- One of the first DAOs, named The DAO, was an organization created by developers to automate decisions and facilitate cryptocurrency transactions.
- A DAO must prioritize security, as exploits can leave a DAO drained of millions of dollars of its treasury savings.
What Is the Purpose of Decentralized Autonomous Organizations (DAOs)?
One of the major features of digital currencies is that they are decentralized. This means they are not controlled by a single institution like a government or central bank but instead are divided among various computers, networks, and nodes. In many cases, virtual currencies use this decentralized status to attain levels of privacy and security that are typically unavailable to standard currencies and their transactions.
Inspired by the decentralization of cryptocurrencies, a group of developers came up with the idea for a decentralized autonomous organization, or DAO, in 2016.1 The concept of a DAO is to promote oversight and management of an entity similar to a corporation. However, the key to a DAO is the lack of central authority; the collective group of leaders and participants acts as the governing body.
How DAOs Work
DAOs rely heavily on smart contracts. These logically coded agreements dictate decision-making based on underlying activity on a blockchain. For example, based on the outcome of a decision, certain codes may be implemented to increase the circulating supply, burn a select amount of reserve tokens, or issue rewards to existing token holders.
The voting process for DAOs is posted on a blockchain. Users must often select between mutually exclusive options. Voting power is often distributed across users based on the number of tokens they hold. For example, one user owning 100 tokens of the DAO will have twice the voting power weight over a user owning 50 tokens.
The theory behind this practice is that users more monetarily invested in the DAO are incentivized to act in good faith. Imagine a user who owns 25% of overall voting power. This user can participate in bad acts; however, by doing so, the user will jeopardize the value of their 25% holding.
DAOs often have treasuries that house tokens to be issued in exchange for fiat. Members of the DAO can vote on how to use those funds; for example, some DAOs to acquire rare NFTs can vote on whether to relinquish treasury funds in exchange for assets.
In 2021, ConstitutionDAO was formed to buy a copy of the U.S. Constitution. Though the DAO failed to acquire the asset, the DAO proved a collection of like-minded individuals could form and pursue such endeavors.
Benefits of DAOs
There are several reasons why an entity or collective group of individuals may want to pursue a DAO structure. Some of the benefits of this form of management include:
- Decentralization. Decisions impacting the organization are made by a collection of individuals as opposed to a central authority that is often vastly outnumbered by their peers. Instead of relying on the actions of one individual (CEO) or a small collection of individuals (Board of Directors), a DAO can decentralize authority across a vastly larger range of users.
- Participation. Individuals within an entity may feel more empowered and connected to the entity when they have a direct say and voting power on all matters. These individuals may not have strong voting power, but a DAO encourages token holders to cast votes, burn tokens, or use their tokens in ways they think are best for the entity.
- Publicity. Within a DAO, votes are cast via blockchain and made publicly viewable. This requires users to act in the best way, as their votes and decisions will be publicly viewable. This incentivizes actions that benefit voters’ reputations and discourage acts against the community.
- Community. The concept of a DAO encourages people worldwide to come together to build a single vision seamlessly. With just an internet connection, token-holders can interact with other owners wherever they may live.
Limitations of DAOs
Not everything is perfect regarding DAOS, though. There are severe consequences to improperly setting up or maintaining a DAO. Here are some limitations to the DAO structure.
- Speed. If a CEO guides a public company, a single vote may be needed to decide a specific action or course for the company. With a DAO, every user is allowed to vote. This requires a much longer voting period, especially considering time zones and priorities outside the DAO.
- Education. Like the speed issue, a DAO educates many people concerning pending entity activity. A single CEO is much easier to keep in charge of company developments. At the same time, token-holders of a DAO may have ranging educational backgrounds, understanding of initiatives, incentives, or accessibility to resources. A common challenge of DAOs is that while they bring a diverse set of people together, that diverse set of people must learn how to grow, strategize, and communicate as a single unit.
- Inefficiency. Partially summarizing the first two bullets, DAOs run a major risk of being inefficient. Because of the time needed to educate voters, communicate initiatives, explain strategies, and onboard new members, it is easy for a DAO to spend much more time discussing change than implementing it. A DAO may get bogged down in trivial administrative tasks due to the need to coordinate many more individuals.
- Security. An issue facing all digital platforms for blockchain resources is security. A DAO requires significant technical expertise to implement; without it, there may be invalidity in how votes are cast or decisions are made. A trust may be broken, and users leave the entity if they can’t rely on the structure of the entity. Even using multi-sig or cold wallets, DAOs can be exploited, treasury reserves stolen, and vaults emptied.
DAOs
Pros
- Individuals can collectively come together from around the work to act as a single entity.
- More individuals have a voice in the planning, strategy, and operations of the entity.
- As votes on the blockchain are publicly viewable, token-holders are naturally incentivized to act more responsibly.
- Members of a DAO may feel empowered to collaborate with like-minded individuals with similar goals within a single community.
Cons
- It often takes longer for decisions to be made as there are more voting participants.
- There is often more burden to educate users as the collective voting population is diverse with varying ranges of education and knowledge.
- More time is needed to cast votes or gather users due to the decentralized nature of the entity.
- Severe exploits, such as theft of treasury reserves, are possible if the DAO’s security is not properly established and maintained.
DAO Example: The DAO
The DAO was an organization that was designed to be automated and decentralized. It acted as a venture capital fund based on open-source code without a typical management structure or board of directors. The DAO was unaffiliated with any particular nation-state to be fully decentralized, though it used the Ethereum network.
The DAO launched in late April 2016 thanks to a month-long crowd sale of tokens that raised more than $150 million in funds. At the time, the launch was the largest crowdfunding campaign ever.
Why Did The DAO Get Disbanded?
By May 2016, the DAO held a massive percentage of all ether tokens that had been issued up to that point (up to 14%, according to reporting by The Economist). At roughly the same time, however, a paper was published that addressed several potential security vulnerabilities, cautioning investors from voting on future investment projects until those issues had been resolved.
Later, in June 2016, hackers attacked the DAO based on these vulnerabilities. The hackers accessed 3.6 million ETH, worth about $50 million. This prompted a massive and contentious argument among DAO investors, with some individuals suggesting various ways of addressing the hack and others calling for the DAO to be permanently disbanded. This incident also figured prominently in the hard forking of Ethereum that occurred shortly thereafter.
What Are Some Criticisms of The DAO?
IEEE Spectrum said the DAO was vulnerable to programming errors and attack vectors.6 The fact that the organization was charting new territory regarding regulation and corporate law likely did not make the process any easier. The ramifications of the organization’s structure were potentially numerous: investors were concerned that they would be liable for actions taken by the DAO as a broader organization.
In July 2017, the Securities and Exchange Commission (SEC) issued a report, which determined that The DAO sold securities in tokens on the Ethereum blockchain, violating portions of US securities law.
The DAO operated in murky territory about whether or not it was selling securities, as well. Further, there were long-standing issues regarding how the DAO would function in the real world. Investors and contractors needed to convert ETH into fiat currencies, which could have impacted ether’s value.
Following the contentious argument over the DAO’s future and the massive hacking incident earlier in the summer, by the fall of 2016, several prominent digital currency exchanges, such as Kraken, de-listed the DAO token, marking the effective end for the DAO as it was initially envisioned.
What Is a DAO?
A DAO is a decentralized autonomous organization, a bottom-up entity structure with no central authority. Members of a DAO own tokens of the DAO, and members can vote on initiatives for the entity. Smart contracts are implemented for the DAO, and the code governing the DAO’s operations is publicly disclosed.
What Is the Purpose of a DAO?
A DAO is intended to improve the traditional management structure of many companies. Instead of relying on a single individual or a small collection of individuals to guide the entity’s direction, a DAO intends to give every member a voice, vote, and opportunity to propose initiatives. A DAO also strives to have strict governance that is dictated by code on a blockchain.
How Does a DAO Make Money?
A DAO initially raises capital by trading fiat for its native token. This native token represents voting power and ownership proportion across members. If a DAO is successful, the value of the native token will increase.
The DAO can then issue future tokens at a greater value to raise capital. A DAO can also invest in assets if the members approve such measures. For example, a DAO can acquire companies, NFTs, or other tokens. Should those assets appreciate, the value of the DAO increases.
