What Is a DAO: Basic Theory & Practical Application
Can you imagine an organization governed autonomously by code without a central authority? Even though it looks like fiction to most people, a DAO (decentralized autonomous organization) makes it real.
So, what is a DAO? How does it work? We will cover these and more questions in this guide. You will learn the pros and cons of this kind of organization, its use cases, and how you can establish one to revolutionize the decision-making process in business and enable easier multinational online cooperation.
What Is a Decentralized Autonomous Organization, and How Does a DAO Work?
As DAOs are still at a nascent stage, you might be wondering what’s actually behind this concept. Indeed, what does DAO mean? There are various approaches to defining DAO’s meaning.
Cooper Turley, an expert who has successfully built several DAOs, thinks of this development as a decentralized autonomous community that shares an Ethereum or other blockchain wallet to manage blockchain-based projects or make investments.
Another DAO definition is a blockchain-based software that suggests collective organization management to the users who own DAO cryptocurrency and are able to vote on proposals and updates.
What is a DAO crypto? It is a digital asset, also known as a governance or DAO token, that is purchased to get equity in the organization. The amount of the cryptocurrency contributed to the project defines the weight of the member’s vote.
At Ergonized, we define DAO as an organization driven by blockchain programs (usually smart contracts) that functions on community-based decision-making without direct human hierarchical management through implementing DAO token rights, business logic rules, and contractual obligations. When all the pieces are put together it culminates in an autonomous, decentralized, data-driven, and transparent organization. DAOs aim at automating the managerial and administrative functions so that independent agents can make decisions without human input.
Note, we brought up the concept ‘DAO token’ in our definition. DAO is an extremely complicated concept, so it’s likely you don’t know all of this new terminology. Let us briefly clear this up for you.
So, what is a DAO token? A DAO token is a cryptocurrency that is tied to a certain project. Anyone who gets the tokens gets the right to vote on matters that are critical for the DAO. The number of tokens, not the number of token owners, defines the outcome of the voting. Thus, the more tokens you have, the more impact you have. There are several ways to obtain DAO tokens:
- Buy them;
- Receive them as a gift;
- Receive them for being involved in DAO-related tasks.
The first DAO was launched on April 30th, 2016 on the Ethereum network by a group of developers who used the open-source code written by Christoph Jentzsch. The idea behind the DAO was simple – delegate the decision-making authority to the automated system to reduce human errors and introduce a new decentralized business model where decisions are made collectively without a centralized governing body.
That decentralized autonomous organization relied on crowdfunding through token selling. Thus, those people who purchased tokens became the organization’s investors and token holders.
That idea picked up steam pretty quickly, and within a month there were more than 11,000 token holders. The funds raised in Ether reached an equivalent of $150 million.
However, there were concerns about the code the developers used in DAO. As a result, the first DAO experiment ended up being a failure. In June 2016, hackers drained $50 million from the DAO because of major vulnerabilities. Luckily, the attack was reversed, and money was restored to the DAO recovery address thanks to the hard fork of the Ethereum blockchain. This incident greatly undermined the trust in both Ethereum and DAOs in general.
Nevertheless, with the explosion of decentralized finance (DeFi), DAO has seen a new surge of interest.
How Does DAO Operate and What Makes It Different?
Moving forward from the recent history of DAOs, let’s dig a little deeper and understand the technology behind it. There are several principal differences between traditional companies and decentralized autonomous organizations.
First, as we already mentioned, DAOs are blockchain organizations ruled by smart contracts. A smart contract is a blockchain application that includes the programmed rules that trigger a certain reaction from the system when the requirements are met. This technology automates much of the decision-making process, thus reducing human errors, and eliminating the need for third parties. For example, the system can be programmed to automatically disburse funds when a specified percentage of investors agree to fund a project.
Secondly, a DAO promotes a brand new management system, one where all stakeholders have voting rights and equal access to data. Thus, the DAO’s governance is based on community, while in traditional organizations executives make all major decisions. Every person who has a DAO token gets the right to vote for any changes, which will be approved only when a certain threshold of investors votes for the change. This promotes greater input from all members and ensures an open collaboration within the organization, even when the token holders do not know or even necessarily trust each other.
All the operations and transactions are transparent. DAO members are connected to common consensus rules in an open-source software where all the transactions are tracked and recorded in a distributed network. Thus, once the new transaction happens, all the network users will see the changes with detailed information in their nodes.
Aaron Wright, a Clinical Professor of Law at Benjamin N. Cardozo School of Law, states that DAOs aim at stretching across the globe instead of operating in one or several jurisdictions. Regardless of the physical location, background, religion, or education, hundreds if not thousands of people can join the organization. He also points out that the DAO members abide by the code and software instead of adhering to legal written agreements and legal formalities.
Here is a breakdown of what makes DAO different from traditional companies:
DAO is characterized by the following features:
- Decentralization: the stakeholders make decisions instead of top management.
- Transparency: every network member has equal access to the data and can view the code, the transaction history, and other data.
- Democracy: there is no place for bureaucracy in DAO as the decisions are transparently made via open voting on the proposals or by smart contracts.
- Automation: day-to-day operations are automated with smart contracts that follow programmed rules.
Advantages & Disadvantages of DAOs
As internet-native organizations, DAOs provide significant operational efficiencies, offer more democratic management, and accommodate growth. However, they are not without their challenges. So, let’s see what is good and problematic about these decentralized autonomous organization blockchains.
Advantages of DAOs
DAOs have the potential to become the basic organization structure in a more tech-advanced Internet era due to the ability to solve the numerous vexing problems faced by companies.
Thanks to blockchain technology, organizations can create an environment for peer-to-peer collaboration between the members without the need to rely on a centralized entity. DAOs unite people using blockchain-based software and protocols without dependence on a managerial group, which allows people to achieve shared economic and social goals easier and faster.
The lack of trust between parties involved in companies is a common challenge in the modern business world. DAO reduces this trust deficit and offers a new model of setting interactions between parties – using code. In fact, with the DAO model, code is the only thing necessary to create trust. It is more credible because it is transparent and publicly available, so every member can check it. The code defines how members cooperate, what proposals are approved, and sets rigid rules that can’t be broken.
Another prominent merit of DAOs is the lack of hierarchical structure, so all the members stand on equal footing. It means that DAO members are engaged in an organization’s decision-making processes and have the right to access, manage, and transfer the resources or services that an organization controls. But any changes are controlled by the community on group consensus through voting, all with a high degree of transparency, and free of fraudulent behavior. For example, any stakeholder can put forward a proposal, which is then put to vote by other members. Smart contracts then either approve or decline the changes based on the voting results.
DAOs enable people to collaborate globally, regardless of location, race, social status, and other factors. Blockchain technology gives equal access to the company’s resources and voting process. The rules of the DAO membership are transparent and paperwork is unnecessary(contracts are executed automatically).
Disadvantages of DAOs
Since DAO is an extremely new technology, certain challenges should be addressed to reach its widespread adoption.
For example, it’s problematic to fix bugs and loopholes in the code once it is published. In fact, it is impossible to alter the code, and so it must be entirely rewritten when it goes live. Since the code is publicly available, anyone can access it, detect the issues, and hack the system.
Some institutions like MIT Sloan are convinced that it is not a good idea to give entire control to a big group of investors, especially when it comes to DAO fund-related matters. Its scientists believe that more centralized governance might be a more practical solution to some corporate issues.
Even though smart contracts and participatory governance decrease the technical cost of the organization’s management and operation, reaching the group consensus can be challenging. This management model requires DAO members to be directly involved in the company’s activities on an ongoing basis. Many participants may find it difficult to gather and process information to make a well-informed decision, which might affect the voting results and the organization’s future.
Another major concern is closely connected with the legal framework. Since DAOs can be distributed between various jurisdictions, it might be complicated to deal with regional laws.
The Legal Status of DAO
The biggest roadblocks that stand in the way of mainstream DAO adoption are the legal challenges and limitations. Due to this, DAOs might struggle with attracting members, large businesses, investors, and other commercial entities because of asset risks and the vague status of this entity.
Currently, the legal status of DAOs is unclear. At this moment, the American legal system does not recognize DAOs as legal entities, except for Wyoming state. Mark Gordon, Wyoming Governor, signed the state’s DAO-focused Bill 38 into law, which clarifies the legal status of decentralized autonomous organizations as limited liability companies (LLCs). So, since July 1, 2021, DAOs have been officially recognized as an online collective of like-minded investors who make shared decisions through the Ethereum platform and smart contract technology.
Vermont is another state that legislatively recognized DAOs under the blockchain-based limited liability company (BBLLC) entity to innovate and spur economic opportunity.
Regardless of the unclear legal standing, DAO blockchain companies can legally function in terms of a general partnership. This type of business arrangement allows two or more individuals to share the profits, assets, financial and legal liabilities of a jointly-owned business.
The newly passed laws that recognize the status of DAOs and the business structure options that support them hold the promise of rapid growth in DAO adoption soon.
Decentralized Autonomous Organization Examples
Even though DAOs are still in their infancy, there are some inspiring examples that prove the efficiency of this organizational structure.
Bitshares is the first successful example of a DAO, which was labeled as a decentralized autonomous company (DAC) by its founder Dan Larimer. This is a virtual e-commerce platform that allows merchants to exchange their digital assets (cryptocurrencies) without the need to trust the central fund.
This organization boasts of technology ahead of time. By offering self-governance with an enhanced voting system, 3-seconds processing time, and an in-built decentralized financial platform, Bitshares offers a scalable, secure, and robust ecosystem worth investing in.
DASH is an open-source, decentralized payment system that relies on blockchain to enhance the security and privacy of transactions. It is one of the most prominent alternatives to Bitcoin, with some advanced features like Masternodes (the user can transfer the funds to special nodes without the need to wait for approval from DASH blockchain) and PrivateSend (the user can send DASH crypto to a built-in mixing service, which mixes the transactions with others).
As a DAO, DASH functions without a centralized authority and relies on monetary incentives of stakeholders, called Masternodes, who become voting members once they purchase 1,000 DASH. This structure allows all members to participate and make decisions according to the set rules.
DASH DAO has a sophisticated structure in terms of block rewards. It is divided into three parts: 45% goes to miners, 45% to Masternodes, and 10% is allocated to the grant system. Masternodes decide how to spend the 10% of the system block rewards through voting.
MakerDAO is an independent financial system running on Ethereum. This software allows users to hold Dai – a stablecoin, which as the name suggests, is a cryptocurrency with a stable unit of value.
MakerDAO is part of the larger system, Maker Protocol. It is a DAO that uses a combination of crypto assets (Dai and MKR). Dai is thought of as the service provided by the Maker Protocol; this stablecoin enables transactions without any third-party involvement such as a bank or government). MKR, in its turn, is a token that gives the holder voting power.
Maker Protocol supports three types of voting. The first one is called Proposal Polling, which is the estimation of the proposal by MKR holders. The Executive Vote is the second type, where the voting on key decisions takes place. Finally, non-MKR token holders can also make suggestions through the MakerDAO forum (meaning anyone can make proposals), but only MKR token holders are allowed to vote for them.
More Decentralized Autonomous Organization Use Cases
As seen from the examples, a DAO is commonly adopted by financial companies dealing with cryptocurrencies and other financial operations. However, the application of DAOs goes far beyond finance:
- Government: DAOs will enhance auditing, voting, contract preparation and submission, contract execution monitoring, bidding, and other processes.
- Non-profit organizations: DAO allows individuals to receive donations anonymously and accept members from anywhere in the world; the members can vote on how the donated money should be spent.
- Auditing companies: DAOs improve auditing by enabling automated project management, improved tracking, and better security.
Tech Background of Decentralized Autonomous Organization Explained
DAOs have a complicated structure and require an extensive technical background to function properly. We will go over the main ‘ingredients’ that enable successful DAO operations.
Ethereum is the common choice for DAOs. This platform allows creating a safe space to collaborate with strangers through the Internet, building member-owned communities without centralized leadership, and making a secure protocol for committing funds.
Ethereum has a lot of features that make it a perfect foundation for any DAO:
- Ethereum’s consensus mechanism relies on a proof-of-stake (PoS) consensus protocol, which randomly selects validators in proportion to their general quantity, making it secure.
- The backbone of DAO, Ethereum smart contracts, are tamper-proof, meaning they can’t be altered except by a vote. For example, no one can spend the organization’s money without general approval.
- Because of the collaborative spirit of the Ethereum community, this platform allows the best solutions to emerge quickly, meaning that DAO will be implementing the best blockchain practices.
Blockchain frameworks facilitate the process of creating DAO infrastructure, so here is the list of several tools that might help developers build a robust DAO system.
Gnosis SAFE is a platform that allows for managing digital assets on Ethereum. It is a smart contract wallet that offers a simple yet robust consensus mechanism to approve transactions. Its main advantage is that it requires a minimal number of tokens to approve interactions, transactions, or any changes within the DAO. Even when three stakeholders support your DAO, you can program the smart contracts to achieve confirmation from three people before carrying out the transaction.
Moloch is an Ethereum community funding initiative that was initially designed as a minimum viable DAO with an aim to facilitate positive social coordination and enhance Ethereum development. This organization gathers grants for the common good of Ethereum, but the survey within the Moloch DAO says that its members are open to new activities that might require additional funding. Thus, Moloch is a community that works on increasing the Ethereum value and promoting its development.
Aragon is an application that enables the creation a DAO on Ethereum. It provides an open-source infrastructure, governance plugins, organization templates, and more, so you can build an Internet-native organization on a decentralized distributed ledger. This software is beneficial for non-profits, clubs, and other companies that require collaborative financial management and decision-making.
Colony is another toolkit that makes it easier to build a decentralized autonomous organization for people all over the world. It is simple and intuitive for beginners, yet powerful enough for DAO pros who need more functions. Colony promises to go from zero to DAO in around 90 seconds as it provides step-by-step guidance. You can create ERC20 tokens, use domains to group activities, establish reliable governance, award contributors, and much more.
Dao Stack helps people to get into a global collaborative network through the open-source software stack. It includes the tools for building DAOs, as well as linking these organizations together when they grow. The stack includes governance protocols, friendly interfaces, peer-to-peer decision-making modules, and other tools.
Utopia Labs is currently building a set of tools for DAOs that would enable them to operate the whole DAO infrastructure. The team of founders decided to start the development process with payment bits, including the invoice and reimbursement workflows that allow DAOs to receive, manage, and payout the requests. The company has also built an all-in-one transaction to carry payments in batches across multiple people and coins. But that’s not where they plan to stop, the team will also be working on financial analysis and accounting options to avoid manual accounting, enhance DAO ecosystem partnerships, provide flat currency services, and streamline real-world compliance workflows,.
Solidity is a primary curly-bracket language used to develop smart contracts to run on Ethereum virtual machines. It is a relatively new language, but it has advanced at a rapid pace, and as of now, it outranks any other programming language by at least twofold.
How to Create a Decentralized Autonomous Organization: Stepwise Guide
1. Get the DAO Wallet
The first step in creating a decentralized autonomous organization is getting a wallet. Usually, this is an all-in-one solution that allows DAO members to buy and sell crypto; as well as access, manage, and participate in their DAOs. It allows members to hold tokens, so they can make decisions through voting.
2. Create a Network of Peers Around Your Idea and Determine Rules and Goals
Professional networking offers numerous major benefits. Cooperating with peers will deepen your resources, generate new ideas, help you stay focused on the primary goal, open opportunities, and reach results faster.
As you already know, DAO is powered by smart contracts, which, in their turn, rely on a set of rules. You might need the help of professionals to craft these rules as they can be changed only through the governance system once the code is published. If you lack such help and would like to work with seasoned blockchain developers, the Ergonized team is always at your disposal. Our software engineers have vast experience in building DAOs and are more than happy to share their expertise with you.
3. Set a Decision-Making Approach and Encode It Into a Smart Contract
The greatest value of a DAO is that it can run entirely autonomously on the blockchain platform. There are numerous repetitive tasks and simple decisions, which under a DAO system, can be performed by code, totally without human interaction. However, some tasks and issues might require creative thinking, an innovative approach, or direct human engagement. It is also essential to define the governance rules for both assignment types from the outset.
As you establish a governance and decision-making approach, you should encode it in the smart contract app. DAO-creation frameworks, as we mentioned earlier, will be of great help at this stage.
4. Design a Token, Add Liquidity, and Supply Treasury
If you have spare resources that allow you to design a custom token to manage your DAO’s ecosystem, why not use them? Custom tokens are unique to your DAO, and they will give you complete control over the authentication process. Still, they are not obligatory, and you can do with standard digital assets.
Also, don’t forget to add liquidity for automated conversion of crypto coins into cash and supply treasury to enable members to gain voting rights.
5. Deploy the DAO on the Blockchain
Once everything is set up, it’s time to deploy the DAO on the Ethereum blockchain platform. From this point, you should realize that the DAO no longer belongs to you or the team of founders. It is a collective entity that is owned by all stakeholders holding the governance tokens.
A DAO is a programmable organization that functions in the form of an online community gathered around a shared mission. This community controls the organization’s multi-signature crypto wallet, ensuring that the objectives of the DAO are met. Thus, there is no central party, and all DAO members proactively shape the future of the organization. The governance is automated by smart contracts guided by set rules, eliminating human errors and increasing efficiency. Anyone can join the DAO, and the only requirement is the staking fund, which usually comes in the form of cryptocurrency or any other digital asset.
For all its merits, there are lingering concerns about the legality, safety, and structure of DAOs. Nevertheless, analysts and investors predict that this type of organization will become the future of online communities in around five years. Cathy Hackl even believes that DAOs will eventually replace traditional companies.
If you would like to contribute to the future of DAOs and be one of those visionaries revolutionizing the way entrepreneurs run their online businesses, you can begin today by building one of these promising organizations. Admittedly, the concepts and the implementation are complex, so you probably won’t get far without an experienced blockchain development team to guide you through the whole process.
Not to worry, Ergonized is here for you to share our expertise and skills in order to bring your ambitious ideas to life. We’ll discuss, strategize, and implement the DAO project, so you can have a beautifully functioning DAO community of your own.