You may have heard people talking about DAOs and wondered what in the world they were talking about. Especially if you know people who are interested in blockchain technology.
Or maybe you have not heard about DAOs and you are now wondering what I am talking about. Well, let me tell you.
What Are DAOs?
DAO stands for Decentralized Autonomous Organizations.
These organizations are built using blockchain technology and function differently from traditional organizations.
In a traditional organization, there is a hierarchy. There are leaders or executives who oversee the running of the organization and make the final decisions on its day-to-day running.
In a Decentralized Autonomous Organization, there is no such hierarchy. There are no leaders, and the running of the organization is democratized. Every member of the DAO has equal say in how the organization is run.
Think about how elections work in most democratic countries. Every person who is of voting age had one vote to decide who will become the next president for example. The presidential candidate with the highest number of votes wins the election.
Now imagine a company. Say Amazon, or Microsoft, or Nike. All big companies, all companies with a traditional hierarchical structure. Now imagine that instead of having a CEO who makes important decisions, these companies were run by the shareholders. Each shareholder has one vote and they vote on each decision to be made as it concerns the company. That is fundamentally the idea behind Decentralized Autonomous Organizations.
Decentralized Autonomous Organizations are referred to as trustless systems. This means that the people involved do not need to trust a third party or one another for the system to function as it is supposed to.
You are probably wondering: if the people do not have to trust each other then what will they trust? Let us look at how DAOs work.
How Do DAOs Work?
Decentralized Autonomous Organizations aim to do away with much of the hierarchy and structure of modern day organizations. The idea is for an organization that has no central authority and runs by executing certain smart contracts that are coded into the organization before its inception.
People who buy into the vision of the organization purchase a stake in the organization and become shareholders. The shareholders get paid a dividend when the organization makes a profit, and they are also directly able to alter the rules embedded in the smart contract by which the organization functions through a majority consensus.
Too much? Let me break it down. Decentralized Autonomous Organizations have two main features. Smart contracts, and decision making through a majority consensus.
Smart Contracts
First, what are smart contracts?
Smart contracts are a way to create self-executing contracts that involve two people directly without the need for any middlemen.
Smart contracts are created using code. They are coded in such a way that once certain parameters are met, the contracts are executed without the need for middlemen.
The way contracts usually work is that two people, say A and B, draw up some kind of contract which is supposed to be legally binding on both parties. However, in the case that one party does not keep their end of the agreement the case has to be taken to a third party, usually a court for resolution.
However, there are several problems with courts and middlemen generally. They are all humans and they can arrive at the wrong decisions due to several reasons. This system requires people to place their trust in a third party to settle whatever issue arises. This is the exact situation that smart contracts try to do away with.
How DAOs Use Smart Contracts
In a Decentralized Autonomous Organization, the organization is ‘governed’ by a smart contract. The smart contract executes when certain conditions are met. And the conditions can be altered only by a majority vote of all the people involved.
For example, a DAO could be set up to scan the stock exchange and invest in promising stocks according to parameters that are coded into the smart contracts of the Organization. When profits come back they are distributed to the shareholders according to how much was originally invested in the DAO.
Several different caveats can be placed in the smart contracts such as only sharing out dividends when the profit margins are above a certain threshold and so on. The parameters by which the DAO runs can be adjusted by a consensus among the shareholders of the DAO. This — DAO proponents believe — ensures a greater level of democracy in the running of a business.
The reason Decentralized Autonomous Organizations are referred to as trustless systems is due to their use of smart contracts. In a DAO you do not need to know or trust all the other people involved since the smart contract automatically executes once the conditions are met.
2. Majority Consensus
The rules governing a DAOs smart contract can be changed, but this requires a vote among members of the community.
When a DAO is first built, its smart contract parameters are set by the founders. However, in order to receive funding to function, people who are interested need to be able to buy into the DAO.
Those who are interested purchase native tokens on the DAO. These tokens are unique to the DAO and they can be spent on things such as voting. The tokens can be purchased using other cryptocurrencies. The cryptocurrencies are used to fund the DAO.
Once the DAO has received enough funding to begin to operate, it goes live. The DAO then begins to function according to the rules that have been written into its smart contract.
Once the DAO is operational the need to make decisions concerning how it is run will arise. These decisions have to be made by a majority consensus among members of the DAO.
Say a DAO wants to change the rules that govern its smart contract. The decision has to be put to a vote. Every member of the DAO can vote on the proposal using their native tokens. At the end of the day the majority wins the vote and they decide what happens to the smart contract moving forward.
Voting power in a DAO is directly proportional to the amount of native tokens you possess. So the more native tokens you possess the higher your voting power.
What Are The Advantages Of A DAO?
Like all technologies on the blockchain, the benefits of a Decentralized Autonomous Organization arises from the fact that it is decentralized.
Due to the fact that control of the organization is directly in the hands of shareholders, DAOs have some advantages over traditional organizations.
In a DAO one person cannot make decisions that affect everyone. Unlike in traditional organizations where the CEO makes the decisions and everyone else has to live with the consequences of the decision. Decisions in a DAO are made with the full involvement of everyone in the DAO.
Decision making in a DAO is also transparent and open to scrutiny by every member of the DAO. Every decision is recorded in a public ledger on the blockchain. This way everyone can see what has been decided on and how it is implemented.
DAOs also do away with the risk that comes from having to trust a free moral agent to always make the best decisions for everyone. Human CEOs can be greedy, rash, impulsive, corrupt, or any number of other things. In a DAO this risk is removed as everyone only has to trust the smart contract. The smart contract executes when its parameters are satisfied and there is no danger of human risk.
Are There Any Problems With DAOs?
Of course, as with all new technologies, there are drawbacks to Decentralized Autonomous Organizations.
1. Slower Decision Making
Most of the drawbacks have to do with the very nature of the blockchain itself. For example, the decentralized nature of DAOs leads to slower decision making.
This is because everyone has to vote and a majority consensus has to be reached to implement a decision. This makes DAOs unable to thrive in fields where decisions have to be made in real time. This decision making problem was on full display in the fall of The DAO.
The DAO was one of the first attempts at a Decentralized Autonomous Organization on the Ethereum blockchain. However, hackers were able to exploit a flaw in the smart contract code and steal $60 million worth of Ether. The democratic nature of DAOs meant that everyone had to vote before the flaw in the code could be fixed.
2. Code Vulnerabilities
DAOs are able to provide a trustless system to participants through the implementation of smart contracts. However, smart contracts are essentially a body of code written by programmers. Of course, there can be flaws in the code that can be exploited by hackers to steal funds from the DAO. And since smart contracts are unchangeable, any error in the code is also unchangeable.
3. Legal Issues
Like pretty much everything else associated with blockchain technology, DAOs face legal challenges arising from their decentralized nature.
For example, members of a DAO can be spread across several different physical locations. This means that should a legal issue arise, resolving it would require dealing with the laws governing several different countries on such issues.
Not every country has really accepted the blockchain and the advent of decentralized technology. Going forward, laws attempting to regulate decentralized technologies and their applications will likely arise in several places. These laws will vary from place to place as well and affect members of DAOs differently depending on their physical location.
Some DAOs In The Real World
The first application of this idea on the Ethereum network was for a company which was named ‘’The DAO.’’
The idea behind The DAO was for shareholders to purchase voting rights proportional to how much ether they put into the project — 1 ether gave an investor 100 DAO voting token.
Then the shareholders were to vote on which projects the Organization would invest in and get paid dividends when their investments returned a profit. The DAO failed in spectacular fashion after a hacker found a way to exploit the system.
The failure of The DAO highlighted some of the flaws with the idea of a DAO. Particularly, the idea of smart contracts which cannot be altered without a majority consensus.
Eventually the Ethereum community voted to perform a ‘’hard fork” on the Ethereum blockchain in order to reverse the transactions and return the stolen funds to their owners. This decision did not go down well with the whole Ethereum community however, and the blockchain split along two lines, with the new blockchain after the fork remaining as Ethereum, and the old blockchain becoming Ethereum Classic.
Despite the failure of The DAO, there continues to be general excitement about the possibilities of a Decentralized Autonomous Organization which transcends traditional hierarchical constraints.
Projects such as Aragon, Uniswap, and MakerDAO continue to try to realize that dream. MakerDAO and Uniswap are both cryptocurrency exchanges who are building out Decentralized Finance (DeFi) products.
MakerDAO enables loans to be taken out in cryptocurrency, while Uniswap enables a suite of products which support its peer-to-peer cryptocurrency exchange platform.
Aragon is a service on the Ethereum blockchain which enables the creation of Decentralized Autonomous Organizations. Using Aragon, anyone can build out and launch their own DAO.
These projects and several others around the globe show that the enthusiasm for the idea of a world dominated by DAOs has not waned. And while DAOs might encounter certain unique challenges right now, it must be remembered that the same has been true of every new technology in the past. However, as time goes on, and the adoption of DAOs increases, there will be improvements upon the current technology and these challenges will be surmounted.