What Is A Decentralized Autonomous Organization (DAO)?

Last updated Jun 22, 2023 | 05:05 PM UTC

The world of cryptocurrency is full of new terms and definitions. If you are still getting acquainted with the basic notions, it's high time you learn about the decentralized autonomous organization (DAO).

Decentralized autonomous organizations, or DAOs, are flexible legal entities that run without central management. They have grown in popularity among those involved in the cryptocurrency and blockchain communities because their members make decisions based on a bottom-up approach and work towards a common goal.

The bottom-up approach involves individual members or lower-level participants initiating decision-making and governance instead of a centralized authority.
 
 

DAOs, Explained 

A DAO is a particular kind of business that uses smart contracts to run on a blockchain network. It is intended to operate independently without the guidance of a centralized authority, relying on member consensus to decide what to do and how to do it.

DAOs are typically governed by a set of predefined guidelines and protocols, and all blockchain users can see and follow their operations. In a DAO, participants frequently have voting rights and can participate in decision-making based on how many tokens or shares they own in the company.

Due to their potential to build decentralized, community-driven ecosystems, DAOs have grown in popularity in the cryptocurrency and blockchain space.
 
 

History Of DAO

The phrase “decentralized autonomous organization” first appeared in the 1990s. At that time, it pointed to the multi-agent network of the Internet of Things (IoT). Today's DAO definition traces back to the concept of the decentralized autonomous company (DAC), used in initial crypto forums.

Founder of Ethereum Vitalik Buterin spoke about the DAO in his 2014’s blog post - “DAOs, DACs, DAs and More: An Incomplete Terminology Guide”. Many people believe that Bitcoin is the very first DAO in the market. However, the existing term indicates an organization located on a blockchain.

DAO History

The present form of DAO appeared in May 2016 as part of the Ethereum community. The first format of a decentralized autonomous organization was a venture capital fund. Its goal was to enable entrepreneurs to set up their business ideas for the community in return for funding. This also allowed investors to send ETH to a specified address for some tokens.
 
 

How Does A DAO Work?

When you think about digital currencies, the first thing that comes to mind is their decentralized nature. This means that third-party institutions don't control cryptocurrencies. Instead, the control is in the hands of nodes or computers, and the blockchain network. The decentralized status of cryptocurrencies keeps their security and privacy on the highest level - something that doesn't work for standard currencies. 

Here are the steps that illustrate how a DAO typically works:
 

Creation

Deploying a group of smart contracts on a blockchain platform results in the creation of a DAO. These smart contracts specify the organization's policies, governance framework, and functionalities.
 

Membership

Users who want to take part in the DAO typically have to purchase a particular cryptocurrency or token linked to the group. The ownership or voting rights this token denotes within the DAO.
 

Governance

Members can vote in DAOs to take part in the decision-making process. Members are able to submit proposals that address different topics like funding, project direction, or policy changes. Voting may be weighted, with the number of tokens held determining the voting power.
 

Consensus

To come to an agreement on proposals, consensus mechanisms like majority voting or quadratic voting are used. Depending on the DAO's design and the blockchain platform it uses to operate, the specific consensus method may change.
 

Execution

When a proposal is accepted by consensus, the smart contracts immediately carry out the suggested actions. Allocating resources, allocating funds, or starting other smart contracts are examples of this.
 

Transparency

The DAO's operations are transparent and auditable by anyone on the network because all transactions, proposals, and voting records are kept on the blockchain.
 

Rewards and incentives

DAOs frequently have mechanisms for rewarding contributors for their contributions. Tokens or other incentives may be given out as a result of a member's involvement, participation in voting, or contribution to the DAO's goals.
 

Evolution

DAOs are made to be flexible and able to change with time. The DAO can develop and adapt to changing conditions by allowing members to suggest and vote on updates or amendments to the organization's rules and governance structures.
 
 

Types of DAOs

DAOs can take various forms, as explained below:

  • Protocol DAOs: Their role is to govern decentralized protocols. MakerDAO is a perfect example of a protocol that keeps Dai stablecoin pegged to the dollar. 
  • Collector DAOs: The purpose of these DAOs is to obtain NFTs. DAO members pool money and purchase selected NFTs. An ideal example of collector DAO is PleasrDAO, which purchased the "Once Upon a Time in Shaolin'' album in 2021 as part of a government auction.
  • Social DAOs: These gather people with common interests and work like a country club. For instance, Friends with Benefits requires their members to purchase 75 FWB tokens.
  • Investment DAOs: The members pool money and vote on where and how to invest it. As a result, gains and losses are split by members according to their stake. 
  • Philanthropy DAOs: These collect funds and make decisions as to which organizations to award them to. This is similar to a community-based charity. 

 

Decentralized Autonomous Organization Examples 

DAOs continue to attract attention in the cryptosphere. Different blockchain projects have implemented decentralized governance protocols. Some of the popular blockchain projects with key DAO principles are:

  • Bitcoin: Many people consider the Bitcoin network as the original DAO project, since it works in line with an open-participation protocol. This consensus coordinates a number of participants who don't know each other. The Bitcoin network, however, doesn’t have the intricate governance mechanisms which are typical of DAO.
  • Dash: This is an open-source, P2P cryptocurrency offering instant and private transactions. Decisions are made by all participants, which is a typical characteristic of the DAO project. However, Dash coins are distributed among a small group of people, which gives them unequal voting power.
  • MakerDAO: MakerDAO is a decentralized lending platform built on the Ethereum network. The foundation has introduced several amendments in April 2020 aiming for full decentralization. The goal is to transfer the project’s ownership to a dispersed network of stakeholders.
  • Uniswap: This project announced its governance token, UNI, to turn Uniswap into a decentralized protocol. Still, the community is concerned about the level of decentralization by Uniswap's governance protocol. This is because a minimum of 1% threshold of the UNI supply is needed for suggesting governance proposals 

 

How To Start a DAO

Before thinking about starting a DAO, it is important to understand the different requirements depending on the project. Below is a step-by-step guide to creating a DAO:

  • Define the DAO structure: This includes defining objectives of creation and urgency for a decentralized structure. Other elements you have to consider are the decision-making process, benefits, and challenges.
  • Decide which type of DAO you want: After determining the structure, you need to decide which type of DAO you need. Examine different DAOs and their functionalities before you opt for one.
  • Explore DAO use cases: The next step includes thinking about DAO’s use in community governance. This process can back multiple strategic activities, including fundraising,  buy-in from the community, and supporters in the preliminary stages.
  • Consider DAO token allocation, supply, and rewards: This involves setting a token price, available supply, and rewards for the community. 
  • Create DAO: Many enterprises choose to develop their systems, while others opt for DAO templates and tools. This may help in defining the legal framework of the decentralized autonomous organization.
  • Set up the DAO Treasury and Community: This step is essential for the safe management of your DAO. Additionally, you’ll need treasury management tools to prevent unilateral decisions about ownership and capital spending.

 

What Is The Importance Of DAOs

Many people wonder what the purpose of DAOs is and why we need them. As smart contract-powered organizations, DAOs have multiple benefits over typical organizations. For example, one important advantage of DAOs is the absence of trust between the two sides. While a standard organization is based on trust in the people behind it, DAOs only require trust in code. 

Trusting the code is simpler because it is publicly available and ready to be tested at any moment. Every action taken by DAO after the launch needs approval by the community and is also transparent and attestable.

An organization like this doesn’t have a hierarchical structure. However, it is still capable of reaching certain goals, while also being under the control of stakeholders. The absence of a hierarchy also indicates any stakeholder can introduce a brand-new idea that the group will review and act upon. In addition, the resolution of internal disputes is simple, thanks to the inclusion of the voting system according to the existing rules in the smart contract.

DAOs also allow investors to pool funds by giving them the possibility to invest in startups and decentralized projects. However, this comes with a shared risk and profits. 
 
DAO Pros and Cons

Benefits Of DAOs

The benefits of decentralized autonomous organization are explained below:

  • Decentralization. All decisions within an organization are made by individuals without the interference of a central authority.
  • Participation. Individuals are part of the entity and have more voting power and direct influence on the organization. In addition, a DAO inspires token holders to vote, burn tokens, or use them according to their preferences.
  • Publicity. Votes are publicly available and executed via blockchain. This means that users should act in the best way possible. It also fosters actions that are useful for voters' reputations.
  • Community. The DAO concept also encourages people to come together and work towards a common vision. They can simply do this with an internet connection,  regardless of their location. 

 

DAO Disadvantages 

While having obvious advantages, DAO’s imperfections cannot be denied. Below you will find some of the common drawbacks of the DAO structure: 

  • Speed. Within a DAO system, every user can give their vote, which extends the voting period. This is incomparable to companies guided by a standard CEO, where only one vote can decide certain actions of the company.
  • Education. DAO has the ability to educate more people when it comes to the upcoming activity of an entity. The biggest challenge of DAOs is the way of bringing people together and connecting them in one organization that can grow and communicate as a unit. 
  • Inefficiency. The time required for educating voters and communicating initiatives could lead to inefficiency. This means that DAO could easily spend more time considering changes than implementing them. The main reason for this is the coordination of many participants.
  • Security. DAOs often require considerable technical expertise before implementation. When this is lacking, decision-making problems can occur. This could also lead to broken trust and people leaving the entity. 

 

DAO vs Traditional Organization

Decentralized autonomous organizations stand out with certain features that differentiate them from standard organizations. This includes the following:

  • Formation: Both traditional organizations and DAOs have their founders. While entrepreneurs govern both the establishment and supply of a standard entity, a community supports decentralized organizations.
  • Structure: Traditional organizations have a pyramid structure with management and employees, while DAOs give voting power to each member.
  • Funding: Capital for traditional organizations comes from their members first, but DAOs align financial contributions with administration power.
  • Legal Definition: Standard entities have a centralized legal structure, while DAOs are generic partnerships.

 

The Future Of DAOs 

DAOs have a promising future and have the potential to completely change a number of industries. More people and organizations are likely to adopt the idea of DAOs as knowledge of blockchain technology and cryptocurrencies continues to grow. An expanded selection of DAOs serving various industries and use cases will be possible thanks to this increased adoption.

Future DAOs are anticipated to improve their governance frameworks, fostering more robust and inclusive consensus-building, voting, and decision-making processes. There will be more opportunities for stakeholders to actively influence the organization's direction. By removing geographic barriers and enabling people and organizations from all over the world to work together on projects and contribute, DAOs will also promote global collaboration and cooperation.

DAOs' fundamental feature of integrating cryptocurrencies and blockchain-based tokens will not change. A dynamic token economy will be created within a DAO where tokens will stand in for ownership, voting rights, or access to services, encouraging participation and value creation. DAOs will also investigate novel use cases outside of their current applications as the technology develops, upending sectors like finance, governance, supply chain, art, and entertainment.

Nevertheless, as DAOs gain popularity, regulatory frameworks to address legal and compliance issues will probably be established. To ensure the proper operation of DAOs and safeguard the interests of participants, governments and regulatory bodies will work to define rules and regulations.
 
 

FAQs:

How to start a DAO?

Starting a DAO consists of several steps, from determining its structure to setting up a treasury for its community. I’ve already covered the main stages of the process above, so you can check it out for further reference. 
 

Why do we need DAOs?

DAOs are a perfect method for creating innovative corporate governance by helping blockchain projects to reach the ideal level of decentralization.
 

What are the benefits of a DAO? 

The main benefits of DAO are its decentralized nature, publicity, community, and participation of individuals. 
 

What are the key characteristics of a DAO?

A DAO is a completely transparent and autonomous organization led by the community. There is no central authority behind it and smart contracts set the foundational rules.
 

How can a DAO be used in business?

DAOs allow businesses to operate without relying on a centralized authority. They have multiple uses, including funding projects, creating incentives, and managing resources.
 

How is a decentralized autonomous organization different from a traditional organization?

DAOs differ from traditional organizations because no central entities stand behind them. Since code runs all the activity rather than people, businesses are more efficient and transparent.
 

How does a decentralized autonomous organization make decisions?

DAOs rely on individual members’ decisions on a set of questions, including the future of the system, possible upgrades, and treasury allotments.