Key aspects
Blockchain technology has allowed the creation of new types of organizational structures. Decentralized Autonomous Organizations (DAOs) are the best example.
As distributed networks, blockchains allow DAOs to operate autonomously without the need for a central authority.
DAOs represent an organizational model focused on community-driven development and management.
Introduction
The emergence of blockchain technology has enabled new types of organizational structures. Decentralized Autonomous Organizations (DAOs) are the prime example of innovative organizations that can function autonomously and without a central authority.
The first DAO was launched in 2016 with the vision of all its members acting collectively as a governing body. DAOs can serve various purposes, from pooling members' funds for venture investment to validating the integrity of off-chain data.
What is a DAO?
DAO stands for Decentralized Autonomous Organization. It is a concept rooted in blockchain technology that allows the creation of organizations governed by code rather than by centralized authorities or individuals.
In other words, a DAO is a community-run entity that is governed by computer code. Because the rules that determine the organization's behavior are built into its design, it can function autonomously without the need for central leadership.
Unlike traditional organizations, DAOs do not allow a single person or group to enforce decisions unilaterally. Instead, all community members can suggest ideas and vote on them. This ensures that decisions are made by the entire group, not just a few powerful people.
Cryptocurrency enthusiasts like DAOs because they make teamwork fairer. Instead of a few bigwigs making all the decisions, everyone gets a say in how to do things. This is a big change from traditional companies, where top executives and large shareholders often have all the power.
How do DAOs work?
In a DAO, the rules and guidelines for how the organization operates are written in code, usually through smart contracts on a blockchain. These smart contracts automatically execute actions based on predefined conditions, ensuring that the organization operates according to agreed rules without the need for human intervention.
Typically, members of a DAO participate in decision-making by owning tokens or shares in the organization. These tokens represent voting power, and each member's influence on the decision-making process is proportional to the number of tokens they hold.
When a decision needs to be made, such as approving a proposal or allocating funds, members can vote on these matters using their tokens. This democratic process ensures that decisions reflect the collective will of the community.
DAOs often have treasuries or pools of funds that are managed collectively by members. These funds can be used to finance projects, invest in startups, or support community initiatives.
Proposals for how to use these funds are submitted by members and voted on by the community. Once a proposal is approved, smart contracts automatically execute the necessary actions, such as transferring funds or minting new tokens.
Transparency and accountability are key principles of DAOs. All transactions and decisions are recorded on the blockchain, and are 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 DAOs operate on a decentralized network, they are resistant to censorship and manipulation, further enhancing trust and reliability. In some respects, a DAO functions similarly to a corporation or nation-state, but does so in a more decentralized manner.
DAOs and the principal-agent problem
DAOs address a problem in economics called the principal-agent dilemma. Occurs when one person or entity (the "agent") has the ability to make decisions and take actions on behalf of another person or entity (the "principal"). If the agent is motivated to act out of personal interest, he would ignore the interests of the principal.
What compounds the problem is that there may also be information asymmetry between the principal and the agent. The principal may never know that he is being taken advantage of and has no way of ensuring that the agent is acting in his best interest.
Typical examples of this problem occur with elected officials representing citizens, stockbrokers representing investors, or administrators representing shareholders.
By enabling a greater degree of transparency thanks to blockchain technology, well-designed DAOs can eliminate some of this problem, especially if the DAO manages to avoid information asymmetry and align incentives within the community. Since all transactions are recorded on a blockchain, the operation of DAOs is completely transparent and more resistant to fraud.
Benefits of DAOs
Decentralized
In a traditional organization, the most important decisions are made by a central authority. In a DAO, decisions that affect the entity are made jointly by the community.
Transparent
Transparency requires accountability from all DAO members. Voting within a DAO is done through the blockchain system and is publicly visible. Anyone can view transaction logs. This motivates community members to act in good faith and discourages acts against the community.
Community based
A DAO can bring together people from around the world to work towards a shared goal. Each member has the opportunity to contribute to the project. Unlike traditional corporate structures, everyone can express their ideas and propose courses of organizational action through decentralized governance mechanisms.
DAO Examples
MakerDAO: MakerDAO is a DeFi project with a cryptocurrency-collateralized stablecoin called DAI, which is pegged to the US dollar.
Aave: Aave is an Ethereum-based money market where users can borrow and lend a wide 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 functions as a DAO, allowing users to exchange various cryptocurrencies without the need for intermediaries.
Yearn.Finance: Yearn.Finance (YFI) is a DeFi platform that automates yield farming strategies and other DeFi opportunities. It operates as a DAO where community members govern protocol updates and decisions.
Is Bitcoin a DAO?
The Bitcoin network is considered by some to be an early example of a DAO. It operates in a decentralized manner and is coordinated through a consensus protocol without hierarchy between participants.
The Bitcoin protocol defines the rules of the system, while bitcoin (BTC) as a currency provides an incentive for users to secure the network. This ensures that different participants can work together to keep Bitcoin running as a decentralized autonomous network. The common goal in the case of Bitcoin is to store and transfer value without a central entity coordinating the system.
However, it is worth noting that there is no single way to define DAOs. Today, the term is commonly used to describe organizations that run on top of an existing blockchain and are governed by their community through smart contracts. Such a definition differentiates them from Bitcoin.
What else could DAOs be used for?
More complex DAOs can be implemented for different use cases, such as decentralized venture funds or social media platforms. DAOs could also coordinate the operation of devices connected to the Internet of Things (IoT).
A subset of DAOs called Decentralized Autonomous Corporations (DACs) have emerged. A DAC can provide services similar to a traditional company, such as a ride-sharing service. The difference is that it works without the corporate governance structure found in traditional companies.
For example, a car that is its own owner and provides ride-sharing services as part of a DAC could operate autonomously and transact with humans and other smart devices. Through the use of blockchain oracles, you could even activate smart contracts and perform certain tasks yourself.
Ethereum y "The DAO"
One of the first examples of a DAO was the aptly named “The DAO.” It was made up of complex smart contracts that ran on the Ethereum blockchain and were supposed to act as an autonomous risk pool.
In May 2016, DAO tokens were sold in an Initial Coin Offering (ICO) and provided an ownership stake and voting rights in this decentralized fund. However, shortly after launch, approximately a third of the 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, the fraudulent transactions were effectively reversed, as if the hack had never occurred. This chain is what is now called the Ethereum blockchain. The other chain, faithful to the principle “the code is law”, left fraudulent transactions intact. This blockchain is now known as Ethereum Classic.
Limitations of DAOs
Legal
The regulatory environment around DAOs remains highly uncertain, as most jurisdictions have not yet defined their approach to this new type of entity. A consistently uncertain legal status could become a significant barrier to DAO adoption.
Coordinated attacks
The desirable properties of DAOs (decentralization, immutability, trustless quality) inherently carry some performance and security risks. The DAO example demonstrated that this new form of organization can introduce significant risks if not designed properly.
Centralization points
It can be argued that decentralization is not a state, but a range, with each level being suitable for a different type of use case. In some cases, full autonomy or decentralization might not even be possible or make sense.
DAOs may allow a broader range of participants to collaborate more than ever before, but depending on how the DAO is designed, the governance rules established in the protocol could become a point of centralization.
Conclusions
Overall, DAOs represent a novel approach to organizational governance, leveraging blockchain technology to create inclusive, democratic, and transparent communities.
DAOs allow organizations to free themselves from dependence on traditional hierarchies and structures. Instead of a central entity coordinating the actions of participants, governance rules are automated and guide members toward the most beneficial outcome for the network.
The key to designing good DAOs is to use an efficient set of consensus rules that solve complex participant coordination problems. The real challenge facing DAO implementation may be more technological than social.
Further reading
What are smart contracts and how do they work?
Blockchain system use cases: Governance
Guide to Blockchain Oracles
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