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What is a DAO (Decentralised Autonomous Organisation), and How Does It Work?

What is a DAO (Decentralised Autonomous Organisation), and How Does It Work?

What exactly is a decentralized autonomous organization (DAO), and how does it function in practice?

A decentralized autonomous organization (DAO) is a type of organization that does not have a central leadership structure like traditional boards of directors.

It is decided from the bottom up, regulated by a community organized around a certain set of rules enforced on a blockchain, and decisions are taken from there.

DAOs (Decentralized Autonomous Organizations) are internet-based organizations that are collaboratively owned and governed by their members. These organizations have built-in treasuries that may only be accessed with the permission of their members. Decisions are made by ideas that are voted on by the group over a certain period of time.

A decentralized autonomous organization (DAO) operates without the use of hierarchical management and can be used for a wide variety of purposes. These groups make it feasible to form freelancer networks where contracts combine their earnings to pay for software subscriptions, philanthropic organizations where members approve payments, and venture capital businesses run by a group.

An important distinction to make before moving on is between a DAO, an organization that was born on the internet, and The DAO, a pioneering internet-native organization. The DAO (Decentralized Autonomous Organization) was a project that began in 2016 and ended in failure, causing a major rift in the Ethereum network.

What is the operation of a DAO?

As previously stated, a decentralized autonomous organization (or DAO) is an organization in which decisions are made from the bottom up; the organization is owned by a collective of members. Participation in a DAO can be accomplished in a variety of ways, the most common of which is through the ownership of a token.

Digital autonomous organizations (DAOs) operate through the use of smart contracts, which are simply bits of code that are automatically executed if a set of criteria is met. Smart contracts are already being used on a wide range of blockchains, but Ethereum was the first to implement them in this way.

The DAO's regulations are established through the use of smart contract technology. The holders of DAO stakes, therefore, have the ability to vote and may have an impact on the organization's operations by voting on or proposing new governance proposals.

DAOs will not be inundated with proposals under this paradigm because a proposal will only pass if it has the approval of a majority of stakeholders. In each DAO, the method by which that majority is chosen is described in its smart contracts.

Decentralized autonomous organizations (DAOs) are completely independent and transparent. Everyone has access to their code because they are constructed on open-source blockchains. In addition, because the blockchain records all money transactions, anyone may conduct an audit of their own built-in treasuries.

Typically, the introduction of a DAO is divided into three primary parts.

1. Smart contract creation

It is comprised of the following steps: To begin, a developer or group of developers must write the smart contract that will serve as the foundation for the DAO. Following the launch, they will only be able to modify the rules established by these contracts through the governance system. They must therefore thoroughly test the contracts to verify that no crucial aspects are overlooked.

2. Financing and governance:

Once the smart contracts have been developed, the DAO must decide on a method of receiving financing and how to implement governance. To raise cash, tokens are frequently sold, and the holders of these tokens have the ability to vote on the monies raised.

3. Stakeholders

It is necessary to deploy the DAO on the blockchain after everything has been set up and verified by the community. From this point on, stakeholders will make decisions about the organization's future. The organization’s founders — those responsible for establishing the smart contracts — now have no more authority over the initiative than any other stakeholder.

What is the purpose of DAOs?

DAOs offer a number of benefits over traditional organizations due to the fact that they were founded on the internet. One key advantage of decentralized autonomous organizations (DAOs) is the lack of trust required between two parties. DAOs are different from typical organizations in that they require simply faith in the code, rather than trust in the people behind them — especially on the part of investors — whereas traditional organizations require trust in the people behind them.

Because the code is publicly available and can be thoroughly tested before being released, it is easy to put your faith in it. After a DAO is founded, all of its actions must be approved by the community and must be completely public and verifiable by anybody.

What does The DAO really mean?

A precursor to today's decentralized autonomous organizations was the DAO. An automated venture capital fund, was created in 2016 and is still going strong.

DAO token holders stood to gain from the organization's investments in the form of dividends or an increase in the token's value. When the DAO was first launched, it was hailed as a game-changer and raised $150 million in Ether (ETH).

Engineer Christoph Jentzsch of Ethereum's protocol revealed open-source code for an investment firm with Ethereum blockchain-based on April 30th, 2016. To purchase DAO tokens, investors have to move their Ether into the DAO's smart contracts.

Some engineers expressed concerns a few days into the token sale that a flaw in The DAO's smart contracts could allow malicious actors to drain the organization's funds. A hacker exploited a security flaw in The DAO's wallet and stole over $60 million in ETH while a governance proposal was being considered to remedy it.

14 percent of all Ethereum in circulation was invested in The DAO at the time of its launch DAOs in general, as well as the one-year-old Ethereum network, took a serious hit as a result of the breach.

As everyone tried to find out what to do, a dispute erupted in the Ethereum community. To begin, Vitalik Buterin, co-founder of Ethereum, suggested a soft fork that would block the attacker's address and prohibit them from moving the funds in question.

As a response to that proposition, the attacker or someone posing as them claimed that the monies had been obtained in a "legitimate" manner according to the conditions of the smart contract. There was a claim that they were prepared to take legal action against anyone who tried to take the funds.

To avoid a soft fork, the hacker even threatened to bribe ETH miners with some of the stolen assets. After much debate, it was decided that a hard fork was the best option. The Ethereum network's history was rolled back to before The DAO was hacked, and the stolen assets were reallocated to a smart contract that allowed investors to withdraw them. Those that disagreed with the decision opposed the hard fork and supported Ethereum Classic, an older version of the network (ETC).

Disadvantages of DAOs

Autonomous decentralized groups aren't without flaws. They are a relatively new technology that has drawn a lot of criticism because of unanswered questions about its legality, security, and structure.

The MIT Technology Review, for example, has stated that entrusting crucial financial choices to the masses is a bad idea. While MIT expressed its views on DAOs in June 2016, it does not appear that the organization has changed its opinion — at least not publicly. Security worries arose as a result of the DAO hack, as smart contract issues might be difficult to rectify even after they are discovered.

The US Securities and Exchange Commission, for example, issued a report in July 2017 determining that The DAO offered securities in the form of tokens on the Ethereum blockchain without authorization, violating elements of US securities legislation.

Examples of DAOs

Over the previous few years, decentralized autonomous organizations have gained pace and are now completely integrated into many blockchain initiatives. DAOs are used in the decentralized finance (DeFi) arena to allow applications to become fully decentralized.

A DeFi lending system launched its own governance token in 2020, which was allocated via a liquidity mining mechanism. To put it another way, everybody who interacted with the protocol would be rewarded with tokens in the real world like digital currency. The model has now been adopted and adapted by other projects.