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What is a Decentralized Autonomous Organization and how does it work?

What is a Decentralized Autonomous Organization and how does it work?

What is Decentralized Autonomous Organization?

A decentralized autonomous organization (DAO) is an entity with no central leadership. Decisions get made from the bottom-up, governed by a community organized around a specific set of rules enforced on a blockchain.

DAOs are internet-native organizations collectively owned and managed by their members. They have built-in treasuries that are only accessible with the approval of their members. Decisions are made via proposals the group votes on during a specified period.

A DAO works without hierarchical management and can have a large number of purposes. Freelancer networks where contracts pool their funds to pay for software subscriptions, charitable organizations where members approve donations and venture capital firms owned by a group are all possible with these organizations.

Before moving on, it’s important to distinguish a DAO, an internet-native organization, from The DAO, one of the first such organizations ever created. The DAO was a project founded in 2016 that ultimately failed and led to a dramatic split of the Ethereum network.

How do DAOs work?

A community can adapt a DAO and program it according to its own goals.

a.Code is written in the form of smart contracts, which provides some sort of governance mechanism.

b.Members typically use governance tokens to vote on decisions made by the DAO, such as the allocation of funds.

c.In the case of many DAOs, the impact of a member's vote can increase based on the amount they have contributed to the project.

d.The outcome can be based on the degree of participation as well as voting preference.


Advantages of Daos

- 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 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.

Disadvantages of Daos

- 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.

Three major steps for launching a Dao

Smart contract creation: First, a developer or group of developers must create the smart contract behind the DAO. After launch, they can only change the rules set by these contracts through the governance system. That means they must extensively test the contracts to ensure they don’t overlook important details.

Funding: After the smart contracts have been created, the DAO needs to determine a way to receive funding and how to enact governance. More often than not, tokens are sold to raise funds; these tokens give holders voting rights.

Deployment: Once everything is set up, the DAO needs to be deployed on blockchain. From this point on, stakeholders decide on the future of the organization. The organization’s creators — those who wrote the smart contracts — no longer influence the project any more than other stakeholders.


What was The Dao?

The DAO was an early iteration of modern decentralized autonomous organizations. It was launched back in 2016 and designed to be an automated organization that acted as a form of venture capital fund. Those who owned DAO tokens could profit from the organization’s investments by either reaping dividends or benefitting from price appreciation of the tokens. The DAO was initially seen as a revolutionary project and raised $150 million in Ether (ETH), one of the greatest crowdfunding efforts of the time.

The DAO launched on April 30, 2016, after Ethereum protocol engineer Christoph Jentzsch released the open-source code for an Ethereum-based investment organization. Investors bought DAO tokens by moving Ether to its smart contracts. A few days into the token sale, some developers expressed concerns that a bug in The DAO’s smart contracts could allow malicious actors to drain its funds. While a governance proposal was set forth to fix the bug, an attacker took advantage of it and siphoned over $60 million worth of ETH from The DAO’s wallet.

At the time, around 14% of all ETH in circulation was invested in The DAO. The hack was a significant blow to DAOs in general and the then one-year-old Ethereum network. A debate within the Ethereum community ensued as everyone scrambled to figure out what to do. Initially, Ethereum co-founder Vitalik Buterin proposed a soft fork that would blacklist the attacker’s address and prevent them from moving the funds.

The attacker or someone posing as them then responded to that proposal, claiming the funds had been obtained in a “legal” way according to the smart contract’s rules. They claimed they were ready to take legal action against anyone who tried to seize the funds. The hacker even threatened to bribe ETH miners with some of the stolen funds to thwart a soft fork attempt. In the debate that ensued, a hard fork was determined to be the solution. That hard fork was implemented to roll back the Ethereum network’s history to before The DAO was hacked and reallocate the stolen funds to a smart contract that allowed investors to withdraw them. Those who disagreed with the move rejected the hard fork and supported an earlier version of the network, known as Ethereum Classic (ETC).

The future of DAOs

DAOs have seen a big revival of interest in the last few years, with hundreds of developers working on technical innovations, improvements to governance mechanisms, and voting solutions.

Decentralized autonomous organisations have been particularly active in the creative industries, with DAOs forming to create "headless" fashion brands, perfumes and filmmaking communities. In many cases, these creative DAOs retain an element of centralization; for example, while filmmaking DAO Decentralized Pictures allows token holders to vote for a shortlist of film projects to win funding, the final decision on which project receives the award is made by a board of judges.

A wave of "investment DAOs" has also sprung up, in which token holders vote on which projects to invest in. While some, such as Neptune DAO, are aiming to provide conventional venture capital funding to Web 3 projects, others are so-called "collector DAOs" that focus on acquiring high-value items such as NFTs at auction.

Will DAOs start to change the way that companies operate and raise money? Soon you too might be a member of a DAO, voting on the right way for your business to move forward, without having a boss telling you what to do.

DAOs are also moving towards official recognition; in April 2021, landmark legislation in Wyoming recognized DAOs as a new form of company, with the first DAO approved mere months later. However, it hasn't all been plain sailing. In November 2021, the SEC halted token registration for the first legally recognized DAO, alleging that it put out "misleading information" to would-be investors.