Contributed by Ishan Shahzad
Follow him on Medium
Decentralized Autonomous Organization
As the name suggests, DAOs have three core features:
- Decentralization: Not governed by one single, centralized entity.
- Autonomous: The DAO can automatically execute operations on its own without any intervention.
- Organization: The DAO is governed by its own predetermined rules, like an organization.
A decentralized autonomous organization (DAO) is exactly what the name says; a group of people who come together without a central leader or company dictating any of the decisions. They are built on a blockchain using smart contracts (digital one-of-one agreements). Members of DAOs often buy their way in, most of the time purchasing a governance token specifically for the DAO which gives them the ability to vote on proposals made around how the pool of money is spent and managed. These groups can be made up of people from around the world, who often communicate on Discord channels.
A DAO has a “completely flat hierarchy,” according to Jason Yanowitz, co-founder of crypto trade publication Blockworks. “It’s a way to govern people differently around a shared balance sheet.”
Why Do We Need DAOs?
Starting an organization with someone involving funding and money requires a lot of trust in the people you’re working with, but it’s hard to trust someone you’ve only ever interacted with on the internet. With DAOs you don’t need to trust anyone else in the group, just the DAO’s code, which is 100% transparent and verifiable by anyone.
This opens up so many new opportunities for global collaboration and coordination.
Usually flat, and fully democratized.
Voting is required by members for any changes to be implemented.
Votes tallied, and outcomes were implemented automatically without a trusted intermediary.
Services offered are handled automatically in a decentralized manner (for example distribution of philanthropic funds).
All activity is transparent and fully public.
A traditional organization
Depending on the structure, changes can be demanded from a sole party, or voting may be offered.
If voting is allowed, votes are tallied internally, and the outcome of voting must be handled manually.
Requires human handling, or centrally controlled automation, prone to manipulation.
Activity is typically private and limited to the public.
Examples of DAO
To help this make more sense, here are a few examples of how you could use a DAO:
- A charity — You can accept membership and donations from anyone in the world, and the group can decide how they want to spend donations.
- A freelancer network — You could create a network of contractors who pool their funds for office spaces and software subscriptions.
- Ventures and grants — You could create a venture fund which pools investment capital and votes on ventures to back. Repaid money could later be redistributed amongst DAO members.
How can the DAO help here?
DAOs work using smart contacts, which are automated, self-executing contracts binding two individuals to each other. In a decentralized environment, people interact with each other via an open-source protocol. They are responsible for overall network upkeep and are rewarded with native tokens for successfully finishing various tasks.
So, what does this mean?
Individual behavior isn’t enforced upon by a legal contract. Instead, economic incentivization automatically makes individual nodes act in the best interest of the network. Unlike traditional companies with a complicated top-down structure with several layers of management, the DAO’s governance is much more refined and ruled by a predefined code.
Plus, once deployed, the DAO can grow by itself without depending on its creator(s).
How do DAOs work?
Step 1: Putting down the rules
The first step in building the DAO is to establish and define the rules which will govern the entire ecosystem. These rules are written in and stored in a smart contract. There are two things that you must keep in mind about smart contracts:
- They are open and transparent. Everything chronicled inside a smart contract is visible for everyone to see.
- Smart contracts are immutable. Once recorded, no one can change the content defined inside them.
Step 2: The funding
The next stage is the funding phase. This is very important for the following reasons:
- Decentralization is critical for the success of DAOs. During the funding phase, it will have the opportunity to distribute its tokens as far and wide as possible.
- Secondly, by acquiring these tokens, the users get several rights and privileges within the environment. One of these privileges happens to be the right to vote on certain matters.
Step 3: Becoming autonomous
Following deployment, the DAO becomes completely autonomous, aka, free from external control. Everyone who holds the DAO’s native tokens owns a stake within the network. As such, they get voting powers in the ecosystem that are directly proportional to their stake. The approval percentage required to reach a majority may vary from proposal to proposal.
Now, this system of majority voting has both its advantages and disadvantages.
The most significant advantage is that the interests of the majority dictate all the decision-making and funding. On the flip side, this also makes decision-making a prolonged and drawn-out process.
Imagine someone discovers a fatal vulnerability on the DAO’s attack surface. Instead of fixing it immediately with an emergency hard fork, you will have to wait for the majority to vote on fixing it. This can be a big time waster since you would ideally want to fix up these bugs ASAP.
DAOs benefit in the real world
Currently, DAO crypto tokens are being used for many purposes like investment, charity, buying and creating NFTs, fundraising and many more. For example, the Decentraland DAO includes a decentralized city-planning committee in the metaverse, where they decide moderation of content, LAND policy and auctions, among others.
Below are outlined the top three benefits of DAOs and their native tokens in the real world:
Decentralized, automated and transparent
The decentralized and transparent nature of DAOs gives its members full ownership to maintain the protocol. Moreover, DAOs are automated — thanks to smart contracts — so decisions are executed automatically. Compared to traditional companies, DAOs eliminate all third-party transaction costs and the organization only “pays” for existing on the blockchain, thereby increasing their profit margins.
Decision-making power in the organization is given to each token holder. This power is proportional to the amount of tokens held by a member, but it doesn’t give them more rights or privileges. Token holders have the right to effect changes that further develop the protocol, which makes it a rewarding and truly democratized space.
Potential investment returns
Owning a governance token in a DAO is a bit like holding equity in an early-stage start-up — if it becomes successful later on, that equity will be extremely valuable. The DAO members who are also token holders are rewarded with a fixed percentage of the transaction volumes on the exchange. This helps create a more stable token user base with a long-term investment mentality. All in all, this reward mechanism is what differentiates these tokens from those launched by other non-DAO projects.
Largest DAO tokens
- Uniswap (UNI): Uniswap is the governance token for the decentralized exchange (DEX) with the same name. Uniswap is the 2nd largest DEX on Ethereum with more than $10 billion of crypto in total value locked (TVL). UNI holders can vote on various proposals including whether the DEX should be ported to other networks like Polygon. The platform is not completely decentralized, as its developers still have significant control over it. For example, it has removed a few tokens it deemed problematic for regulators like stablecoins pegged to stock prices.
- Maker (MKR): Maker is the governance token for the largest decentralized finance (DeFi) application on Ethereum, MakerDAO, with a massive TVL of almost US$20 billion. MakerDAO is also the largest lending platform in DeFi, facilitating crypto loans for its own stablecoin called DAI. MKR holders can vote on various important parameters of the MakerDAO lending platform such as its risk management and business logic.
- Aave (AAVE): AAVE is the governance token of the 2nd largest lending protocol on Ethereum and the 3rd largest decentralized application (dApp) overall with a $13 billion TVL. It provides similar services as MakerDAO but has many more options in terms of cryptos to lend and borrow. It is an extremely popular dApp for users who want to leverage their crypto holdings. AAVE holders vote on new token listings and other important parameters just like Maker.
- Curve DAO Token (CRV): Curve DAO Token is the governance token for another giant DeFi application, Curve Finance. Curve Finance is the largest DEX in the world and the 2nd largest dApp on Ethereum with a TVL of $16 billion. It specializes in liquidity pools with stablecoins pegged to the price of fiat currencies like the US dollar and large cryptos such as bitcoin and ether. CRV is used to vote on whether to add more pools, the number of rewards each pool earns and much more.
DAOs help create a new world of corporate governance by assisting many blockchain projects to achieve the ideal decentralization. By carrying out corporate operations autonomously through smart contracts, DAOs have many benefits for their stakeholders — by providing full ownership on decision making that can be rewarded accordingly on the growth of the DAO. As DAO’s legal challenges are clarified and managed, more and more organizations will look to adopt DAO platforms for their businesses, to automate certain aspects of their core business activities.