Imagine shaping the path of an organization that has no central leadership and is governed by millions of people from all over the world. An organization that doesn’t employ executives to steer its wheel. An organization where you can establish your own rules. However unrealistic this may sound, DAOs make it all possible. Let’s find out more about what DAOs are and how they work.
TL; DR. A DAO is a decentralized organization controlled by a group of people who agree with particular rules for a common goal. Those rules are encoded in the smart contract of a DAO. DAOs issue governance tokens that give stakeholders voting rights. The more currency a stakeholder has, the more voting power they have to shape the future of the organization. Despite lingering concerns about security and legal aspects, DAOs are picking up steam. Many industry experts say that DAOs might replace some traditional organizations in the future.
1. What is DAO?
DAO stands for Decentralized Autonomous Organization. These member-owned communities have no central authority. Instead, members collectively come together to decide where the company’s money should go.
A DAO is governed by rules that are embedded into the blockchain code through a smart contract and approved by its members. DAOs operate without a traditional management structure, meaning there are no boards of directors, office-like environments, or bureaucratic hurdles.
2. How do DAOs work?
There’s no CEO or central government in a DAO. Instead, a group of internet users owns the organization. There are many ways to run a DAO, with the most common one being through ownership of a token.
DAOs are run using three major components: smart contracts, tokenization, and governance.
2.1. Smart contracts
Before launching a DAO developers design the smart contract for it. The contract consists of the rules specifically designed to run that particular DAO.
Every DAO has smart contracts. These special computer codes automate actions when certain criteria are met. They are called “smart” as they self-execute—no human intervention is needed.
Let’s consider Uber as an example. Once you finish your journey, Uber has implemented rules in its code to debit the fare amount automatically from your bank account. Part of it goes to the driver, while the rest goes to the Uber head office for infrastructure.
2.2. Tokenization
When developers finish writing smart contracts, they need to agree on how to control the DAO and raise funds for blockchain projects. The most common way DAOs receive funding is through token sales.
A token is a digital asset that gives a person the right to own something or perform certain actions. They’re usually issued by companies using existing third-party blockchains. The most popular blockchain to create tokens, and therefore smart contracts, is Ethereum, although people deploy smart contracts on various blockchains.
In the context of DAOs, tokens are used to enact governance. They give token holders voting rights. The more of a particular cryptocurrency you hold, the more voting power you have in shaping the future of the organization. Holders of DAO currency also benefit from dividends or by selling tokens when their price increases.
2.3. Governance
Once both smart contracts and governance rules are set, a DAO gets deployed on the blockchain. From this point on, investors start to purchase the organization’s tokens.
Owning crypto means influencing how the organization operates by agreeing on or creating new governance proposals. By and large, the governance model of a DAO says that new proposals pass only if the majority of stakeholders approve them.
DAOs are autonomous and transparent because they are based on open-source blockchains. Anyone can view their code and audit all financial transactions.
3. Two views of DAOs
DOAs have both supporters and critics. Let’s see how their views differ.
Before joining any DAO, it makes sense to look at the various pros and cons of how they work.
3.1. Advantages
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Transparency
The code that is used for smart contracts is publicly available and can be tested frequently before launch. Later, every member of the group has a say on the direction that a DAO takes.
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No intermediaries
Blockchain technology is based on a peer-to-peer system. It does not require work from intermediaries like banks and governments.
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Lack of hierarchy
Decentralized autonomous organizations have no hierarchical structure. Any stakeholder can suggest an innovative idea that the entire community considers and improves upon through the voting system pre-written in a smart contract.
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Reduction of risk
DAOs enable crypto investors to pool funds and share risk while investing in early-stage startups and decentralized projects. However, pooling funds also means sharing any profits that may come out of such projects.
3.2. Drawbacks
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No unified legal system
As DAOs can be shared among a group of people from multiple jurisdictions, there’s no single legal framework for them. If you get involved in a legal issue, for example, you’ll need to deal with many diverse regional laws.
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Potential for illegal activity
Blockchains do add security, but decentralization also attracts criminals’ interest. It’s hard to identify fraudulent startups or crypto projects via blockchains because the transactions those companies or projects make in crypto are anonymous.
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Security concerns
If somebody spotted flaws in smart contracts, it might be very difficult to fix them because they can’t be corrected until the majority votes on them. This raises various security concerns.
4. The first DAO
In 2016, a group of developers came up with the idea for a decentralized autonomous organization acting as a venture capital fund. They were fascinated by the possibilities that the Ethereum network and the decentralization of cryptocurrencies had to offer to the world of business and finance.
The developers of the DAO wanted to end manipulation of investor funds with the help of crowdsourcing. They gave decision-making power to anyone interested in joining the organization. Fueled by ETH, the DAO invented its token granting holders voting rights on possible projects.
Crowdfunding ran through May 2016 and was a huge success. In fact, according to the U.S. Securities & Exchange Commission, it raised over $150 million USD, making it an historically lucrative example of crowdfunding success.
Two months later, a hacker managed to identify a crucial flaw in the DAO’s smart contract code and drained 3.6 million ETH (around $50 million USD at that time). The hack triggered an acrimonious dispute among DAO investors. Some of them wanted to shut it down entirely, while others were looking for ways to keep the organization and respond to the hack differently.
4.1. Hard fork
A hard fork is a major change to a network’s protocol that makes previously valid blocks and transactions invalid, or vice versa. In the event that one happens, all users (or computer nodes) have to upgrade their software to the latest version of the protocol.
To address the community concerns regarding the security of the DAO, the Ethereum Foundation implemented a hard fork. They rolled back all DAO-related transactions. According to the rules, investors were allowed to reclaim their funds, and the DAO went bankrupt.
Some members supported the move, but others decided to keep using the original Ethereum blockchain network. This resulted in the creation of two Ethereum blockchains: Ethereum Classic (ETC) and Ethereum (ETH).
4.2. ETC vs ETH
Ethereum Classic doesn’t follow the updates that Ethereum makes to its software. Ethereum Classic and Ethereum exist as distinct projects with different development teams. In addition, the two blockchains have different native cryptocurrencies: ETC and ETH.
Ethereum Classic is much cheaper because it’s not in as high demand as Ethereum. Because Ethereum is the more popular of the two, more people choose to invest in it. In addition, the Ethereum blockchain is widely used for decentralized finance (aka DeFi) and supports a larger ecosystem of decentralized applications.
5. Post-Fork DAOs
After the hard fork, the acronym “DAO” became more mainstream. It was adopted to describe any decentralized autonomous organizations that have no centralized leadership and are fully autonomous and transparent.
There are thousands of DAOs these days. They’re established for a variety of reasons such as business investment, fundraising, borrowing, charity, or buying NFTs. A key aspect that made DAOs so successful is they accept donations from anyone around the globe. Members themselves can freely submit proposals and decide how to spend donations.
A list of present-day operational DAOs will never be conclusive as they are created regularly, and not all have staying power. But you can check out some of the most promising DAOs to join in the summer of 2022 according to industry experts.
Remember that you’ll need to buy a DAO’s cryptocurrency before you can become a group member. But after, you’ll have the power to vote on proposals and updates, proportional to the amount of crypto you have.
Looking into DAOs in 2022? There are a lot of exciting projects on the horizon.
5.1. Dash (DASH)
Dash is a project whose governance and budgeting mechanism allows stakeholders to vote on the use of the group’s treasury. Released in 2014 using the principles of the Bitcoin protocol, Dash has gone through ups and downs and remains one of the most trusted coins to invest in.
5.2. Uniswap (UNI)
Uniswap is a decentralized exchange operating since 2018 on the Ethereum network. It allows investors to swap Ethereum-based currency known as ERC-20. Uniswap also offers liquidity pools, i.e. crowdsourced pools of tokens locked in a smart contract to facilitate trades between digital assets.
5.3. Maker (MKR)
Maker is a project currently focusing on introducing real-world assets into the crypto world. For example, MKR token holders have already agreed to use tokenized versions of freight-shipping invoices, agricultural real estate, and revenue-based loans for small businesses. The list is expected to grow in the upcoming years.
5.4. Aave (AAVE)
Aave is a lending protocol that allows borrowers and lenders to interact without a centralized authority. Initially, the protocol was hosted on the Ethereum blockchain, but its popularity led to its integrations with multiple other networks. AAVE can also be used as collateral within the ecosystem.
5.5. Lucky Block (LBLOCK)
Lucky Block is said to be one of the most exciting crypto projects for 2022. The platform offers a unique take on crypto gaming. Platform users can enter lucrative daily prize draws for the chance of winning jackpots. Prizes are distributed in LBLOCK. Lucky Block is built on the Binance Smart Chain (BSC).
6. Bottom line
DAOs are collective organizations owned and managed by their members, all of whom have a voice. DAOs are picking up steam with an increasing number of organizations wanting to govern their activities through the same model. In fact, industry experts say that DAOs even have the potential to replace some traditional companies altogether.
FAQs
What are DAOs in simple terms?
A DAO is a decentralized autonomous organization that is controlled by group members that agree with certain rules for a common goal. They encode those rules as transparent computer programs that are accessible to anyone.
Who makes decisions in DAO?
Decisions on how an organization’s money should be spent usually take place by vote on a proposal. Any member of the community can put forward an idea, which later the entire organization can vote on.
Essentially, DAOs are organizations that offer decentralized financial services. Decentralized finance, or DeFi for short, is a market segment that provides financial and business services through the blockchain mechanism. Services like investment and mortgages are offered without intervention from banks and other financial institutions, which cuts costs and allows for product delivery at lower costs.
How do DAO owners make money?
Typically, the owners of a DAO are community members that hold the organization’s tokens. They can benefit from a dividend or by selling their tokens to other crypto enthusiasts when the price increases.
How to join a DAO?
To become a member of a DAO, you first need to purchase its cryptocurrency. Holding the asset will give you the power to vote on proposals and updates, proportional to the amount you hold. Check out the DAOs mentioned in this article, and choose the one you like the most.
Vytautas Kundrotas
Vytautas is a content manager whose fuel is curiosity. Fascinated by how modern technologies are rocketing the finance industry, he develops copy that targets present-day topics.
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