Decentralized Autonomous Organizations (DAOs) are a type of blockchain-based organization that operates on smart contracts and is governed by its stakeholders, rather than a central authority, eliminating the need for intermediaries.
These organizations have the potential to revolutionize the way that businesses, non-profits, and other types of organizations operate by enabling decision-making, with the DAO governance being decentralized and transparent. Let's explore what DAOs are, how they work, and some of the potential use cases for this technology.
What is a DAO?
A DAO operates on the blockchain, using smart contracts to facilitate decision-making and governance. Instead of a traditional hierarchy, a DAO is governed by its stakeholders. Members of a DAO hold governance tokens in a cryptocurrency wallet and have voting rights proportional to their stake in the organization. These tokens are often distributed through crowdfunding or other means, and can represent equity in the organization or other incentives.
In 1977, Wyoming invented the LLC, which protects entrepreneurs and limits their liability. They pioneered the DAO law that establishes legal status for DAOs and became the first US state to recognize DAOs as a legal entity. The legal status of this type of organization may vary by jurisdiction and is generally unclear.
One of the most well-known DAOs is The DAO, which was launched by German startup slock.it on the Ethereum blockchain in 2016. The DAO was a decentralized venture capital fund that allowed token holders to propose and vote on investments. However, hackers attacked the DAO, gained access to $50M USD worth of ETH, eventually leading to a hard fork of the Ethereum network, resulting in the creation of Ethereum Classic. Crypto exchanges such as Kraken de-listed the DAO token, marking the end of the DAO as it had been envisionned.
Although Bitcoin (BTC) isn't considered a DAO by current standards, it is to many the earliest example of a functional DAO: it has programmed rules, functions autonomously, and is coordinated through a consensual protocol.
How do DAOs work?
DAOs operate on the blockchain and use smart contracts to facilitate decision-making and governance. A DAO's code is open-source and transparent, allowing all stakeholders to see the inner workings of the organization and anyone to read the code.
A DAO initially raises capital by trading fiat currency for its native token. This native token represents voting power and ownership proportion across members of the DAO. In other words, when decisions need to be made, token holders cast their votes proportional to their stake in the organization. Because inactive holders of governance tokens can be problematic for DAO governance, implementations have been made to allow voting power to be delegated to other parties. These tokens can often be traded permissionlessly on a decentralized exchange, but others must be earned through providing liquidity.
DAOs can be used for a variety of purposes, including crowdfunding projects, managing assets, and operating as a traditional business or non-profit. Some DAOs, like MakerDAO which revolutionized the DeFi space with its DAI stablecoin, and Uniswap, have become major players in the decentralized finance (DeFi) ecosystem, offering lending, borrowing, and trading services.
Why use a DAO?
DAOs offer a number of benefits over traditional organizations, including increased transparency, decentralization, and automation through blockchain technology. Because DAOs are operated through smart contracts, many of their processes can be automated, making them more efficient and cost-effective.
DAOs are a promising technology, which could revolutionize the way that organizations are structured and governed. For example, ConstitutionDAO is a DAO that implemented governance mechanisms inspired by the U.S. Constitution, aiming to create a decentralized version of the U.S. government.
However, there are also potential vulnerabilities to consider when using DAOs. For example, if the code of a DAO is not properly audited, it may be susceptible to hacking or other security issues. As mentioned above, they may also be subject to real-world challenges, as it is not always clear which laws and regulations apply to them.
DAOs have many possible use cases, from charities, where token holders could vote on which causes to fund, to collective ownership, where members could vote on how to use physical or digital assets such as NFTs.