What is a Decentralized Autonomous Organization (DAO)?

What is a Decentralized Autonomous Organization (DAO)?

Decentralized Autonomous Organization (DAO) is a new form of legal structure. Without a central governing body, each member within a DAO usually has a common goal and tries to act in the best interest of the entity. Popularized by cryptocurrency and blockchain enthusiasts, DAOs are used to make decisions in a bottom-up governance approach.

Understanding Decentralized Autonomous Organizations (DAOs)

Inspired by the decentralization of cryptocurrencies, in 2016 a group of developers came up with the idea of creating a decentralized autonomous organization, or DAO. The concept of a DAO is to promote the oversight and governance of a corporation-like entity. However, the key to a DAO is the lack of central authority as a collective group of leaders and participants act as a governing body.

How DAOs work

DAOs rely heavily on smart contracts. Such logically coded agreements dictate decision-making based on underlying activity on the blockchain. The voting process for DAOs is published on the blockchain. Users often have to choose between mutually exclusive options. Voting power is often distributed among users based on the number of tokens they own. For example, one user who owns 100 tokens of the DAO will have twice the voting power of a user who owns 50 tokens. The theory behind this practice assumes that users who invest more money in the DAO are incentivized to act in good faith. Imagine a user who owns 25% of the total voting power. Such a user may participate in bad deeds, but by doing so, he will jeopardize the value of his 25% share.

DAOs often have treasuries that hold tokens that can be issued in exchange for fiat currencies. DAO members can vote on how to use such funds. For example, some DAOs intending to acquire rare NFTs may vote on whether to give up treasury funds in exchange for assets.

Advantages of DAO

Decentralization. Decisions that affect the organization are made by a group of individuals, unlike the central authority, which is often outnumbered by its colleagues. Instead of relying on the actions of a single individual (the CEO) or a small group of individuals (the board of directors), a DAO can decentralize authority to a significantly larger number of users. Participation. Individuals within an entity can feel more empowered and connected to the entity when they have a direct say and vote on all matters. Such individuals may not have strong voting power, but the DAO encourages token holders to vote, burn tokens, or use their tokens in ways they think are best for the entity. Publicity. Within the DAO, votes are cast via the blockchain and are publicly available. This requires users to act in the way they think is best because their voice and their decisions will be publicly visible. This encourages actions that will benefit the reputation of voters and discourages acts against the community. Community. The DAO concept encourages people from all over the world to come together seamlessly to build a unified vision. With just an internet connection, token holders can communicate with other holders wherever they live.

Limitations of the DAO

Slowness: If a public company is led by a CEO, one vote may be needed to decide on a particular action or direction the company will take. With DAO, every user has the opportunity to vote. This requires a much longer voting period, especially given the time zones and priorities outside the DAO. Lack of education: Similar to the problem of slowness, the DAO has a responsibility to educate many more people about the entity's still outstanding activities. It is much easier to keep a single CEO involved in the company's development, while DAO token holders may have different educations, understanding of initiatives, incentives or access to resources. A common challenge of DAOs is that, even though they bring together diverse groups of people, they must learn how to grow, strategize, and communicate as a unit. Inefficiency: Partially summarizing the first two points, DAOs are at high risk of being inefficient. Due to the time required to administratively educate constituents, communicate initiatives, explain strategies, and onboard new members, the DAO can easily spend far more time discussing changes than implementing them. A DAO can also get bogged down in trivial, administrative tasks due to the nature of the need to coordinate a much larger number of individuals. 

Security: An issue that all digital platforms for blockchain resources face is security. DAO requires significant technical expertise to implement. Without it, the way in which voting or decisions are made may be null and void. Trust can be broken and users leave the entity if they cannot rely on the structure of the entity. Even using multi-signature or cold wallets, DAOs can be exploited, treasury reserves stolen, and vaults emptied.