Key Points

• Blockchain technology enables new types of organizational structures. Decentralized autonomous organizations (DAOs) are a prime example.

• As a distributed network, blockchain allows DAOs to operate independently without the need for a central authority.

• DAO represents an organizational model that focuses on community-based development and management.

Introduction

The advent of blockchain technology has enabled new types of organizational structures. Decentralized autonomous organizations (DAOs) are a prime example of innovative organizations that can run independently without a central authority.

The first DAO was launched in 2016 with the vision of its members collectively acting as a governing body. DAOs can serve a variety of purposes, from pooling member funds for venture capital to validating the integrity of off-chain data.

What is DAO?

DAO stands for decentralized autonomous organization. The concept is rooted in blockchain technology, which allows for the creation of organizations governed by code rather than by a centralized authority or individual.

In other words, a DAO is a community-based entity governed by computer code. Because the rules that dictate the organization’s behavior are integrated into its design, a DAO can function autonomously without the need for central leadership.

Unlike traditional organizations, DAOs do not allow one 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 entire group, not just a few influential people.

Crypto enthusiasts love DAOs because they make teamwork more equitable. Instead of a handful of users making decisions, everyone gets a say in how things are run. This is a big change from traditional companies that concentrate power in the hands of top executives and large shareholders.

How Does DAO Work? 

In a DAO, the rules and guidelines for how the organization operates are written into code, usually using smart contracts on a blockchain. These smart contracts automatically execute actions based on predetermined conditions to ensure that the organization operates according to agreed-upon rules without the need for human intervention.

Typically, DAO members participate in decision-making by owning tokens or shares in the organization. Each member’s influence in the decision-making process will be proportional to the number of tokens they own, so these tokens represent voting power.

When decisions need to be made, such as approving a proposal or allocating funds, members can vote on the issue using their tokens. This democratic process ensures that decisions reflect the collective will of the community.

DAOs often have a treasury or pool of funds that are collectively managed by their members. These funds can be used to finance projects, invest in new ventures, or support community initiatives.

Proposals on how to use these funds are submitted by members and voted on by the community. Once a proposal is approved, the smart contract will automatically execute the necessary actions, such as transferring funds or minting new tokens.

Transparency and accountability are core principles of the DAO. 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 they operate on a decentralized network, DAOs are resistant to censorship and tampering. This ultimately increases trust and reliability. In some ways, DAOs function like corporations or nation states, but operate in a more decentralized manner.

DAOs and the principal-agent problem

DAOs address a problem in economics called the agency dilemma. This problem 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 agents are motivated to act in their own self-interest, they can ignore the interests of the principal.

Compounding the problem is that there may also be information asymmetry between the principal and the agent. The principal may never know that they are being exploited and have no way of ensuring that the agent is acting in the principal's best interests.

Common examples of this problem are elected officials representing citizens, brokers representing investors, or managers representing shareholders.

By enabling the higher level of transparency that blockchain technology enables, a well-designed DAO can eliminate some of these problems. In particular, if the DAO manages to avoid information asymmetry and align incentives within the community. Because all transactions are recorded on the blockchain, the operation of a DAO is completely transparent and more resistant to fraud.

Benefits of DAO

Decentralized

In traditional organizations, the most important decisions are made by a central authority. In a DAO, decisions that impact the entity are made collectively by the community.

Transparent

Transparency demands accountability from every member of the DAO. Voting in a DAO is done through the blockchain and is publicly visible. Anyone can search transaction records. This motivates community members to act in good faith and discourages actions that are detrimental to the community.

Community based

DAOs can bring people from all over the world together to achieve a common goal. Every member has the opportunity to contribute to the project. Unlike traditional corporate structures, everyone can express their ideas and propose organizational actions through decentralized governance mechanisms.

Example DAO

• MakerDAO: MakerDAO is a DeFi project with a crypto-backed stablecoin called DAI that is pegged to the US dollar.

• Aave: Aave is an Ethereum-based money market where users can borrow and lend a 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 that allows users to swap various cryptocurrencies without the need for an intermediary.

• Yearn.Finance: Yearn.Finance (YFI) is a DeFi platform that automates yield farming strategies and other DeFi opportunities. The platform operates as a DAO where community members govern protocol upgrades and decisions.

Is Bitcoin a DAO?

Some consider the Bitcoin network to be an early example of a DAO. Its operations are decentralized and coordinated by a consensus protocol with no hierarchy among participants.

The Bitcoin protocol defines the rules of the system, while bitcoin (BTC) as a currency provides incentives for users to secure the network. This ensures that various participants can work together to keep Bitcoin running as a decentralized autonomous network. The overall goal in the case of Bitcoin is to store and transfer value without a central entity coordinating the system.

However, it is important to note that there is no single way to define a DAO. Currently, the term is generally used to describe an organization that runs on top of an existing blockchain and is governed by its community through smart contracts. This definition makes it different from Bitcoin.

What else is the use of DAO?

More complex DAOs can be implemented for a variety of purposes, such as decentralized venture funds or social media platforms. DAOs can also coordinate the operation of devices connected to the Internet of Things (IoT).

A subset of DAOs is emerging called decentralized autonomous companies (DACs). DACs can provide similar services to traditional companies, such as ridesharing services. The difference is that DACs operate without the corporate governance structure found in traditional businesses.

For example, a car that owns itself and provides ridesharing services as part of a DAC can operate autonomously to transact with humans and other smart devices. Through the use of blockchain oracles, the car can even trigger smart contracts and perform certain tasks on its own.

Ethereum dan “The DAO”

One of the earliest examples of a DAO was “The DAO”. The DAO consisted of a complex smart contract running on the Ethereum blockchain that was supposed to function as an autonomous venture fund.

In May 2016, The DAO tokens were sold in an Initial Coin Offering (ICO) that gave people ownership and voting rights in the decentralized fund. However, shortly after launch, about a third of The DAO’s funds were drained in one of the largest hacks in cryptocurrency history.

The result of this event was that Ethereum split into two chains after a hard fork. In one chain, the fraudulent transactions were successfully reversed as if the hack had never happened. This chain is now called the Ethereum blockchain. The other chain, which adheres to the principle of "code is law", left the fraudulent transactions alone. This blockchain is now called Ethereum Classic.

Limitations of DAO

Law

The regulatory environment surrounding DAOs remains highly uncertain as most jurisdictions have yet to determine their approach to this new type of entity. The continued uncertainty of the legal status could be a significant barrier to DAO adoption.

Coordinated attack

The desired characteristics of DAOs (decentralization, immutability, trustlessness) carry inherent performance and security risks. The DAO is an example of how this new form of organization can pose significant risks if not designed properly.

Centralization point

It can be said that decentralization is not a state, but rather a range with each level being suitable for different types of uses. In some cases, full autonomy or decentralization may not be possible or make sense.

DAOs can allow more participants to collaborate than ever before, but the governance rules set out in the protocol can become a point of centralization depending on how the DAO is designed.

Cover 

Overall, DAOs represent a new approach to organizational governance by leveraging blockchain technology to create inclusive, democratic, and transparent communities.

DAOs allow organizations to break free from reliance on traditional hierarchies and structures. Rather than a central entity coordinating the actions of participants, governance rules are automated and direct members toward outcomes that are most beneficial to the network.

The key to designing a good DAO is to use an efficient set of consensus rules to solve the complex participant coordination problem. The real challenges facing DAO implementation may be more technological than social.

Further Reading

• What is a Smart Contract and How Does it Work?

• Blockchain Uses: Governance

• Blockchain Oracle Explained

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