What Is a Decentralized Autonomous Organization (DAO)?
A decentralized autonomous organization (DAO) is an emerging form of legal structure that has no central governing body and whose members share a common goal to act in the best interest of the entity. Popularized through cryptocurrency enthusiasts and blockchain technology, DAOs are used to make decisions in a bottom-up management approach.
KEY TAKEAWAYS
A decentralized autonomous organization is an entity structure in which tokenholders participate in the management and decision-making of an entity.
There is no central authority of a DAO; instead, power is distributed across token holders who collectively cast votes.
All votes and activity through the DAO are posted on a blockchain, making all actions of users publicly viewable.
One of the first DAOs named The DAO was an organization created by developers to automate decisions and facilitate cryptocurrency transactions.
A DAO must ensure security is prioritized, as exploits can leave a DAO drained of millions of dollars of its treasury savings.
What Is the Purpose of Decentralized Autonomous Organizations (DAOs)?
One of the major features of digital currencies is that they are decentralized. This means they are not controlled by a single institution like a government or central bank, but instead are divided among a variety of computers, networks, and nodes. In many cases, virtual currencies make use of this decentralized status to attain levels of privacy and security that are typically unavailable to standard currencies and their transactions.
Inspired by the decentralization of cryptocurrencies, a group of developers came up with the idea for a decentralized autonomous organization, or DAO, in 2016. The concept of a DAO is to promote oversight and management of an entity similar to a corporation. However, the key to a DAO is the lack of central authority; the collective group of leaders and participants act as the governing body.
How DAOs Work
DAOs rely heavily on smart contracts. These logically coded agreements dictate decision-making based on underlying activity on a blockchain. For example, based on the outcome of a decision, certain code may be implemented to increase the circulating supply, burn of a select amount of reserve tokens, or issue select rewards to existing token holders.
The voting process for DAOs is posted on a blockchain. Users must often select between mutually-exclusive options. Voting power is often distributed across users based on the number of tokens they hold. For example, one user that owns 100 tokens of the DAO will have twice the weight of voting power over a user that owns 50 tokens.
The theory behind this practice is users who are more monetarily invested in the DAO are incentivized to act in good faith. Imagine a user who owns 25% overall voting power. This user can participate in bad acts; however, by doing so, the user will jeopardize the value of their 25% holding.
DAOs often have treasuries that house tokens that can be issued in exchange for fiat. Members of the DAO can vote on how to use those funds; for example, some DAOs with the intention of acquiring rare NFTs can vote on whether to relinquish treasury funds in exchange for assets.
In 2021, ConstitutionDAO was formed in an attempt to buy a copy of the U.S. Constitution. Though the DAO failed at acquiring the asset, the DAO proved a collection of like-minded individuals could form and pursue such endeavors.
Benefits of DAOs
There are several reasons why an entity or collective group of individuals may want to pursue a DAO structure. Some of the benefits of this form of management include:
Decentralization. Decisions impacting the organization are made by a collection of individuals as opposed to a central authority that is often vastly outnumbered by their peers. Instead of relying on the actions of one individual (CEO) or a small collection of individuals (Board of Directors), a DAO can decentralize authority across a vastly larger range of users.
Participation.Individuals within an entity may feel more empowered and connected to the entity when they have a direct say and voting power on all matters. These individuals may not have strong voting power, but a DAO encourages token holders to cast votes, burn tokens, or use their tokens in ways they think is best for the entity.
Publicity. Within a DAO, votes are cast via blockchain and made publicly viewable. This requires users to act in ways they feel is best, as their vote and their decisions will be made publicly viewable. This incentivizes actions that will benefit voters' reputations and discourage acts against the community.
Community. The concept of a DAO encourages people from all over the world to seamlessly come together to build a single vision. With just an internet connection, tokenholders can interact with other owners wherever they may live.
Limitations of DAOs
Not everything is perfect regarding DAOS, though. There are severe consequences to improperly setting up or maintaining a DAO. Here are some limitations to the DAO structure:
Speed. If a public company is guided by a CEO, a single vote may be needed to decide a specific action or course for the company to take. With a DAO, every user is given an opportunity to vote. This requires a much longer voting period, especially considering time zones and priorities outside of the DAO.
Education. Similar to the issue of speed, a DAO has the responsibility of educating a lot more people in regards to pending entity activity. A single CEO is much easier to keep in charge of company developments, while token holders of a DAO may have ranging educational backgrounds, understanding of initiatives, incentives, or accessibility to resources. A common challenge of DAOs is that while they bring a diverse set of people together, that diverse set of people must learn how to grow, strategize, and communicate as a single unit.
Inefficiency. Partially summarizing the first two bullets, DAOs run a major risk of being inefficient. Because of the time needed to educate voters, communicate initiatives, explain strategies, and onboard new members, it is easy for a DAO to spend much more time discussing change than implementing it. A DAO may get bogged down in trivial, administrative tasks due to the nature of needing to coordinate much more individuals.
Security. An issue facing all digital platforms for blockchain resources is security. A DAO requires significant technical expertise to implement; without it, there may be invalidity to how votes are cast or decisions are made. Trust may be broken and users leave the entity if they can't rely on the structure of the entity. Even through the use of multi-sig or cold wallets, DAOs can be exploited, treasury reserves stolen, and vaults emptied.
DAOs
Pros
A variety of individuals can collectively come together from around the work to act as a single entity. More individuals have a voice in the planning, strategy, and operations of the entity.
As votes on the blockchain are publicly-viewable, tokenholders are naturally incentivized to act more responsibly. Members of a DAO may feel empowered to collaborate with like-minded individuals with similar goals within a single community.
Cons
It often takes longer for decisions to be made as there are more voting participants
There is often more burden to educate users as the collective voting population are diverse with varying ranges of education and knowledge. More time is needed to cast votes or gather users due to the decentralized nature of the entity, Severe exploits such as theft of treasury reserves are possible if the DAO's security is not properly established and maintained.
