What Are DAOs And Why You Should Understand it

Blockchain technology can pivot quickly, and it’s inspiring to see how far the industry has come since bitcoin’s debut about a decade ago. Before bitcoin, the financial sector was defined by its reliance on banks as trusted third parties, which ensured the safety and fungibility of our money but did so slowly and for hefty fees. Decentralized technology has demonstrated that the interests of multiple entities could be collectively aligned in a single system, instead of through banks, for example.

Less than a handful of years later, Ethereum has applied the same concept to areas outside of finance. Where bitcoin removed banks as middlemen between individuals and businesses transacting across borders, Ethereum’s smart contracts and tokenization model has disrupted intermediaries across virtually every industry. In cloud storage, for example, Ethereum smart contracts enable decentralized network participants to be paid in tokens for sharing their unused hard drive space. Participants can then use these tokens to pay for anonymous, distributed storage space from the network itself, thus cutting out cloud monopolies like Amazon Web Services or Google.

Smart contracts can even be set up for more mundane business like sending and paying invoices, but however efficient the new model is, there’s room for improvement. Unsurprisingly, blockchain innovators have already discovered a way to piggyback on the latest trend by producing its newest iteration: Decentralized Autonomous Organizations (DAO). Called DAOs, these complex smart contract structures may have the biggest impact on business of any blockchain breakthrough thus far.

Smart contracts are extremely useful for automating transactional processes, and for reducing the input that humans must supply for relatively simple tasks. The goal of a Decentralized Autonomous Organization isn’t just to reduce human inputs—it’s to eliminate them entirely. Though still largely an on-paper idea rather than one that’s been perfected in practice, a DAO is effectively a business that uses an interconnected web of smart contracts to automate all its essential and non-essential processes.

Any business can benefit from a model with DAO-like ambitions. A novelty keychain store that keeps its inventory on the ledger can create a smart contract that triggers at each item’s specific reorder point based on historical customer demand. The smart contract will autonomously create an invoice for the store’s relevant supplier, send it and specify the date of delivery. When the shipment arrives, the smart contract will be notified using scanners or IoT beacons connected to the ledger, and execute the release of a payment in cryptocurrency. It can then pull customer information from a CRM system when orders come in, automatically print labels and help accelerate shipping.

This example covers just a few processes, but would potentially help the keychain merchant save labor costs and time. Employees are needed to keep track of inventory, create and pay bills, scan incoming shipments, and more. A DAO expands upon this example by automating all processes, not just shipping or invoicing, and it does so by stringing together multiple smart contracts in a complex web of ‘if, then’ statements. The final goal is an organization that requires no human input whatsoever and can not only function well but also make thoughtful changes to its structure without prompting.

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.

While the specific underlying mechanisms powering a DAO vary across different blockchain projects, there are several general phases a DAO must undergo to launch in a sustainable manner:

Before a DAO can be deployed, the underlying rules must be defined and encoded in a series of smart contracts. Given that future changes to the DAO’s operational workflows, governance system, and incentive structures will need to be voted on in order to take effect, this phase is arguably the most important step to creating a sustainable and truly autonomous DAO, as any initial mistakes or overlooked details can potentially destabilize the project down the line.

Once the creators of a DAO have established its governing smart contracts, the DAO needs to receive funding in order to operate. The DAO’s smart contracts must entail the creation and distribution of some form of internal property, such as a native token that can be spent by the DAO, utilized in voting mechanisms, or used to incentivize certain activities. From there, individuals or entities interested in participating in the DAO’s growth can purchase or otherwise acquire the DAO’s native token, which typically results in acquiring voting rights.

Once a DAO receives enough funding to be deployed, all of its decisions are made via a consensus vote. As a result, all token holders become stakeholders who can make proposals regarding the DAO’s future and how its funds are spent. If the DAO’s token distribution policy and consensus mechanisms defined in its underlying smart contract architecture are well-designed, the DAO’s stakeholders will naturally work towards the most beneficial outcome for the entire DAO network.

The resulting DAO organization can therefore operate independently from its creators or any other central authority. Since DAOs are open source, all of their rules, transactions, and activities are recorded on the blockchain and can be reviewed by anyone, which generally ensures full transparency and immutability. In short, a DAO’s stakeholders are bound together by a common goal, which they will vote to advance through the pursuit of specific network incentives defined by the DAO’s underlying consensus policies

Because DAOs embody a marked departure from the structure of traditional organizations and how they operate, there are numerous legal and operational challenges these organizations must overcome. For instance, because DAOs can be physically distributed across multiple countries and jurisdictions, any resulting legal issues likely would require dealing with multiple regional laws and any relevant cross-border contractual relationships.

Furthermore, because changing a DAO’s code or smart contract structure requires a consensus vote, malicious actors could possibly exploit a bug or design flaw before the DAO’s stakeholders manage to collectively resolve the issue. This type of exploit crippled one of the earliest crowdfunding efforts on the Ethereum blockchain: In 2016, The DAO was hacked because of vulnerabilities in its code base, which resulted in a controversial hard fork of the Ethereum network to move funds stolen from The DAO to a new smart contract. The incident was a critical moment in blockchain, and since then avoiding another such hack has been a priority for developers.

That said, DAOs have continued to gain traction in the marketplace. At present, there are a number of promising blockchain projects that have fully incorporated decentralized governance mechanisms, particularly within the decentralized finance (DeFi) landscape. Below is a non-exhaustive list of existing blockchain projects that embody the core tenets of a DAO:

The Bitcoin network can be considered the first rudimentary DAO since it operates fully in accordance with an open-participation consensus protocol that coordinates the behavior of a vast network of participants unknown to each other. However, the Bitcoin network lacks the complex governance mechanisms typically associated with a DAO, and is rarely referred to as such.

Dash is an open-source, peer-to-peer (P2P) cryptocurrency that offers instant payments and private transactions. While the project is a DAO to the extent that all decisions are made collectively via a subset of masternodes, the degree to which the Dash network is truly decentralized remains debatable given that the network’s governance tokens were distributed in a way that concentrated wealth to a small group of stakeholders, granting them disproportionate voting power over the project.

MakerDAO is a decentralized lending network built on the Ethereum blockchain and is the protocol behind the stablecoin DAI. The MakerDAO Foundation, which has steered the development of the project since inception, initiated several moves in April 2020 to achieve full decentralization, namely giving control of the undistributed supply of the project’s governance token (MKR) to MKR holders at large, establishing a process of electing paid contributors, and improving the voter participation process to benefit smaller stakeholders. In this way, the MakerDAO Foundation hopes to make itself obsolete and pass full ownership of the project on to its distributed network of project stakeholders.

In September 2020, Uniswap released a native governance token, UNI, in order to transition Uniswap into a decentralized, community-owned protocol. However, the Uniswap community has raised concerns about the degree of decentralization granted by Uniswap’s governance model, particularly given the fact that a minimum threshold of 1% of the total UNI supply is required in order to submit governance proposals — a sum that effectively bars 99% of UNI holders (who each hold less than 1%) from introducing a proposed change to Uniswap’s protocol.

From the examples above, it’s clear that many blockchain projects built with decentralized philosophies are on a journey toward achieving the ideal of complete decentralization. To this point, it’s important to note that the more stakeholders a DAO has, the more decentralized it becomes. This is a major reason why so many existing blockchain projects allow for a certain level of centralized decision-making in the initial stages of the project prior to achieving the scale required to transition into a full-fledged DAO. And, given that most DeFi projects are only a few years old, many of these projects have yet to transition into a fully-fledged decentralization, although achieving DAO status is oftentimes a central goal of these projects.

• Transparency: voting, funding decisions, and other actions are viewable by anyone.
• More firepower: members across the world can contribute, giving DAOs lower barriers to entry than companies.
• Cheaper: the concept has firmly taken root in the DeFi, and there are many tools—which can be used like Legos, so little needs to be built from scratch.
• Collaborative: giving everyone a voice pools mass knowledge for a proposal and enables experts to invest in the ecosystem they are building.

• Flat structure: by not having a clear authority figure, or chain of command, decentralized organizations are slower to operate as decisions take longer to make.
• Disagreements: when the community disagrees strongly, it could split the organization into two.
• No change: in some DAOs, those with the most tokens call the shots, so governance looks very similar to traditional organizations.
• Legality: minefields abound in relation to token projects that might be deemed to be securities.

Companies using DAO platforms to compartmentalize and automate certain parts of their business can achieve fast scalability and be leaner without sacrificing quality of service. However, there are a few obstacles that make a true DAO difficult to achieve, for now. Access to technology like IoT beacons is still limited, meaning that an organization dealing with physical products will always require human labor until robots become cheaper and more accessible. Additionally, the idea of a self-governing system requires increasing degrees of complexity with each passing day. Businesses are not getting any simpler, and so a properly self-governing DAO has much more to consider when it comes to smooth, fair operation. The onset of more accessible artificial intelligence will also be a tailwind for DAOs. While DAOs are still years away from complete autonomy, savvy businesses can already identify areas where inputs are excessive before applying DAO-component technology to streamline operations without fear.