So, what is a DAO?
A decentralized autonomous organization is exactly what the name says; a group of people who come together without a central leader or company dictating any of the decisions. They are built on a blockchain using smart contracts (digital one-of-one agreements). Members of DAOs often buy their way in, most of the time purchasing a governance token specifically for the DAO that gives them the ability to vote on decisions that are made around how the pool of money is spent and managed. These groups can be made up of people from around the world, who often communicate on Discord channels.
A DOA has a “completely flat hierarchy,” according to Jason Yanowitz, co-founder of crypto trade publication Blockworks. “It’s a way to govern people differently around a shared balance sheet.” Source: digiday.com
What does a DAO do?
Each DAO has a different mission, whether it is single-purpose or part of a larger project, and can be associated with any number of industries.
Some of them are based on personal interests, such as the ConstitutionDAO, which banded together in the hope of buying one of the original copies of the U.S. Constitution from Sotheby’s last year. The group ultimately found out it was not the highest bidder and ended up losing the auction, but members were able to receive a refund of their initial investment.
Others have grander goals that involve essentially operating or running a business as a group. One example is Mantra DAO, which is a community-governed decentralized finance platform that allows people to stake, lend and borrow their crypto assets. Source: digiday.com
Types of DAOs
It’s important to understand that DAO is a broad term than encompasses a huge number of different types of groups and business. Two collectives can be vastly different, but still both be DAOs.
Here are a few examples of well-known DAOs:
ThePleasrDAOcollects various NFTs and invests in other assets.
TheHerStoryDAO collects and funds projects by Black women and non-binary artists.
TheKomorebi CollectiveDAO funds women and non-binary crypto founders.
TheFriends with BenefitsDAO is an exclusive social club which you pay to enter.
TheMetaCartel VentureDAO is a for-profit business that invests in early stage decentralized applications. Source: cnbc.com
Why do we need DAOs?
Starting an organization with someone that involves funding and money requires a lot of trust in the people you're working with. But it’s hard to trust someone you’ve only ever interacted with on the internet. With DAOs you don’t need to trust anyone else in the group, just the DAO’s code, which is 100% transparent and verifiable by anyone.
This opens up so many new opportunities for global collaboration and coordination. Source: ethereum.org
How DAOs operate
To understand DAOs, you first need to understand the technology behind them. Most DAOs rely on blockchain technology and smart contracts, which are collections of code than run on the blockchain.
A blockchain is a decentralized, digital ledger. While they are commonly known to publicly document transactions of different cryptocurrencies, like bitcoin, and other digital assets, like NFTs, blockchains can also be used in a number of other ways. For DAOs, the blockchain can act as a backbone, keeping the structure and rules of each on-chain.
In traditional organizations, there’s typically a hierarchy. A formal board of directors, executives or upper management determine the structure and have the power to make changes.
DAOs, on the other hand, are decentralized, which means they aren’t governed by one person or entity. The rules and governance of each DAO is coded in smart contracts on the blockchain and cannot be changed unless voted upon by the DAO’s members.
Instead of a select few having the majority of say, members of each DAO can vote on decisions together, typically on equal footing.
For example, PleasrDAO members collectively decided to buy the Wu-Tang Clan album. After doing so, they created an NFT to represent a deed of ownership to the album. The members of PleasrDAO co-own the NFT deed, and in turn, share ownership of the album.
Sometimes, in larger DAOs, teams may form to tackle different aspects of the organization with leaders that have been voted in. That way, not every single member is needed to vote on every nuance.
The most important aspect of DAOs is transparency, Turley says. Every decision within the DAO is pitched, discussed, voted on and documented publicly. Source: cnbc.com
Each DAO is structured differently, but usually, when joining a DAO, you agree to the code in place. It isn’t easy to change that code, and any changes typically require a vote between members.
DAOs are “very participatory,” says Aaron Wright, co-founder and CEO of OpenLaw, a blockchain-based protocol for the creation and execution of legal agreements. Wright has helped launch several DAOs, including FlamingoDAO, which collects NFTs.
“You don’t have to wait for a quorum or a sufficient number of people to vote in order to make a decision. It kind of runs and operates like the internet, through rough consensus,” Wright explains. “If there’s more people that support a project, a decision is made.”
To obtain voting power or membership in a DAO, you typically buy governance tokens, which are cryptocurrencies that are tied to a certain project. In some DAOs, governance tokens can only be obtained in structured funding rounds, and occasionally, demand exceeds the amount of tokens available. By holding these tokens, members are typically able to own equity in the DAO and help shape the DAO’s future.
While it varies from DAO to DAO, the weight of a member’s vote usually depends on the amount they contributed to the project.
If a DAO doesn’t use governance tokens, it may accept investment of other forms, like in ether, the second-largest cryptocurrency by market value, Wright explains, since the Ethereum blockchain powers most DAOs. But, again, each DAO has its own system.
Beyond voting power, members can also work for their DAO. There are typically a number of internal jobs, including positions in token distribution and treasury management.
“Working for ownership means working for tokens,” Turley says. For example, he’s mainly compensated for his work on DAOs with governance tokens, but can also receive ether or USDC. Source: cnbc.com
The principal-agent dilemma
The main advantage of DAOs is that they offer a solution to the principal-agent dilemma.
Problems can occur in some situations, with a common one being in the relationship between stakeholders and a CEO. The agent (the CEO) may work in a way that’s not in line with the priorities and goals determined by the principal (the stakeholders) and instead act in their own self-interest.
Another typical example of the principal-agent dilemma occurs when the agent takes excessive risk because the principal bears the burden. For example, a trader can use extreme leverage to chase a performance bonus, knowing the organization will cover any downside.
DAOs solve the principal-agent dilemma through community governance. Stakeholders aren’t forced to join a DAO and only do so after understanding the rules that govern it. They don’t need to trust any agent acting on their behalf and instead work as part of a group whose incentives are aligned.
Token holders’ interests align as the nature of a DAO incentivizes them not to be malicious. Since they have a stake in the network, they will want to see it succeed. Acting against it would be acting against their self-interests.
Fully Functional DAOs
DAOs need the following elements for being fully functional: A set of rules to which will operate, a funding like tokens that the organization can spend to reward certain activities to their members, and also to provide voting rights for establishing the operation rules. Also, and most important, is a well and secure structure that allows every investor to configure the organization.
One potential problem with the voting system is that even if a security hole was spotted in its initial code, it can’t be corrected until the majority votes on it. While the voting process takes place, hackers can make use of a bug in the hole of the code. Source: forbes.com
A famous example
MakerDAO – MakerDAO's token MKR is widely available on decentralized exchanges. So anyone can buy into having voting power on the Maker protocol's future. Source: ethereum.org
And the DAO downsides?
Members of a DAO typically receive a “non-fungible token” or NFT in return for their investment. Put simply, non-fungible means that it can’t be exchanged for anything else, unlike cryptocurrencies, which like traditional currencies are designed to be exchanged for something.
Holding an NFT means you are recognized as a member of a DAO and therefore eligible to vote on how it should be managed. But, as writer Geoffrey Mak found when he investigated several DAOs for The Guardian, not all tokens are equal when it comes to voting rights.
One DAO he investigated allowed one vote per token. But, as tokens were also allocated based on the number of likes given to a member’s posts in its chatroom, it was possible for one individual to accumulate a larger number of tokens than other members.
The vulnerability of DAOs to hackers was spectacularly demonstrated in 2016 when a pioneering investment DAO, known simply as The DAO, was hacked. A flaw in the DAO’s code allowed a hacker to extract $50 million in the cryptocurrency Ethereum. Source: weforum.org