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What is a decentralised autonomous organization, and how does a DAO work?

What is a decentralised autonomous organization, and how does a DAO work?

A decentralised autonomous organisation (DAO) is a non-centralized organization. Bottom-up decisions are made, governed by a community organised around a certain set of rules enforced on a blockchain. 

DAOs are internet-native organisations that are owned and governed collectively by their members. They have built-in treasuries that can only be accessed with the permission of their members. Choices are made based on recommendations that the group votes on over a set period of time.  

A DAO operates without hierarchical management and can serve a variety of objectives. These organisations enable freelancer networks where contracts combine their earnings to pay for software subscriptions, philanthropic groups whose members approve payments, and group-owned venture capital corporations. 

Before proceeding, it is necessary to distinguish between a DAO, an internet-native organisation, and The DAO, one of the first of its kind. The DAO was a 2016 project that ultimately collapsed, resulting in a catastrophic split in the Ethereum network.

How does a DAO work?

As previously stated, a DAO is an organisation in which decisions are made from the bottom up; the organisation is owned by a collective of members. There are several ways to engage in a DAO, the most common of which is through the ownership of a token. 

DAOs use smart contracts, which are simply bits of code that execute automatically when a set of criteria is met. Smart contracts are being used on many blockchains, although Ethereum was the first to use them. 

The DAO’s regulations are established by these smart contracts. Those who have a stake in a DAO can then vote and influence how the business functions by deciding on or introducing new governance ideas. 

This methodology protects DAOs from being flooded with suggestions by requiring a proposal to be approved by a majority of stakeholders. The method for determining a majority varies from DAO to DAO and is described in smart contracts. 

DAOs are completely self-sufficient and transparent. Because they are constructed on open-source blockchains, their code is accessible to everybody. Anyone can audit it as well.

Why do we need DAOs?

DAOs have significant advantages over traditional organisations because they are internet-native. The lack of trust required between two parties is a significant advantage of DAOs. While traditional organisations require a great deal of faith in the people behind them, especially on the part of investors, DAOs just require trust in the code. 

Trusting that code is easier to accomplish because it is publicly available and can be thoroughly vetted before release. Every action taken by a DAO after it has been formed must be accepted by the community and be entirely transparent and verifiable. 

There is no hierarchy in such an organization. Nonetheless, it may complete tasks and flourish while being governed by stakeholders through its native token. Because there is no hierarchy, any stakeholder can propose an original concept that the entire group will evaluate and improve upon. Internal conflicts are frequently easily resolved using the voting system in accordance with the pre-written rules in the smart contract. 

DAOs let investors pool their cash, allowing them to invest in early-stage enterprises and decentralised initiatives while sharing the risk and any gains that may result.

The principal-agent dilemma

The primary benefit of DAOs is that they provide a solution to the principal-agent problem. This quandary arises from a clash of priorities between a person or group (the primary) and those who make choices and act on their behalf (the agent). 

Problems can arise in a variety of settings, the most typical of which is the connection between stakeholders and a CEO. The agent (the CEO) may behave in their own self-interest rather than in accordance with the priorities and goals established by the principal (the stakeholders). 

Through community governance, DAOs resolve the principal-agent issue. Stakeholders are not compelled to join a DAO and do so only after thoroughly comprehending the rules that govern it. They don’t have to rely on any agent acting on their behalf and can instead work as part of a group with aligned incentives. 

The interests of token holders align because the structure of a DAO incentivizes them not to be bad. They will want to see the network flourish because they have a vested interest in it. Acting against it would be against their own best interests.

What was the DAO?

The DAO was a forerunner of today’s decentralised autonomous organizations. It was founded in 2016 with the intention of creating an automated organisation that would function as a type of venture capital fund. 

Those who held DAO tokens might profit from the organization’s investments by receiving dividends or benefiting from token price gains. The DAO was once regarded as a groundbreaking idea, and it garnered $150 million in Ether (ETH), making it one of the largest crowdfunding endeavors of the time. 

The DAO was introduced on April 30, 2016, when Ethereum protocol engineer Christoph Jentzsch published the open-source code for an Ethereum-based investment company. By sending Ether to the DAO tokens’ smart contracts, investors bought them.

Some developers raised concerns a few days into the token sale that a glitch in The DAO’s smart contracts could allow unscrupulous actors to drain its funds. While a governance plan was being developed to address the flaw, an attacker exploited it and stole more than $60 million in ETH from the DAO’s wallet. 

The DAO received approximately 14% of all ETH in circulation at the time. The attack dealt a serious blow to DAOs in general, as well as the one-year-old Ethereum network. As everyone tried to figure out what to do, a discussion erupted within the Ethereum community. Initially, Vitalik Buterin, co-founder of Ethereum, advocated a soft fork that would ban the attacker’s address and prohibit them from moving the cash. 

The attacker, or someone impersonating them, then reacted to that proposal, stating that the funds were gained in a “legitimate” manner in accordance with the smart contract’s rules. They stated that they were prepared to sue anyone who attempted to seize the money. 

The hacker even threatened to bribe ETH miners with stolen money in order to prevent a soft fork. Following the argument, a hard fork was determined to be the solution. This hard work was done to revert the Ethereum network’s history to before the DAO was hacked and reallocate the stolen cash to a smart contract that allowed investors to withdraw it. Those who opposed the move opposed the hard fork and supported an earlier version of the network known as Ethereum Classic (ETC).

Disadvantages of DAOs

Decentralized autonomous groups are not without flaws. They are a relatively new technology that has drawn much criticism because of remaining worries about its legality, security, and structure. 

For example, MIT Technology Review has stated that trusting people with critical financial decisions is a bad idea. While MIT revealed its thoughts on DAOs in 2016, the organisation does not appear to have changed its mind—at least not publicly. The DAO hack also sparked security worries, as smart contract issues can be difficult to rectify even after they are discovered.

DAOs can exist in various jurisdictions, and there is no legal framework in place to govern them. Any legal concerns that may arise will almost certainly necessitate dealing with multiple regional laws in a complex court struggle. 

For example, in July 2017, the United States Securities and Exchange Commission issued a report determining that The DAO offered securities in the form of tokens on the Ethereum blockchain without authorization, breaking elements of the country’s securities law.

Examples of DAOs

Decentralized autonomous organisations have grown in popularity in recent years and are now completely integrated into several blockchain projects. DAOs, for example, are used in the decentralised finance (DeFi) field to allow applications to become truly decentralised. 

According to some, the Bitcoin (BTC) network is the first example of a DAO. Even though most network users have never met, the network scales through community agreement. It also lacks a centralised governance framework, forcing miners and nodes to signal their support. 

However, by today’s standards, Bitcoin is not considered a DAO. Dash would be the first true DAO by current standards, as the project features a governance structure that allows stakeholders to vote on the usage of its treasury.

 Other, more sophisticated DAOs, such as decentralised networks built on the Ethereum blockchain, are in charge of developing cryptocurrency-backed stablecoins. In certain circumstances, the organisations that initially created these DAOs gradually relinquish control of the project, eventually becoming obsolete. Token holders can actively vote on governance proposals to recruit new contributors, add additional tokens as collateral for their coins, or change other parameters. 

In 2020, the DeFi lending system issued its own governance token, which was allocated via a liquidity mining procedure. Essentially, everyone who participated in the system would be rewarded with tokens. The model has now been adopted and adapted by other projects.

The list of DAOs is quite lengthy. It has evolved into a clear concept that has gained traction over time. Some projects are currently attempting complete decentralisation using the DAO model, but it’s worth noting that they are only a few years old and have yet to reach their final aims and objectives. 

DAOs, as internet-native organisations, have the ability to totally transform corporate governance. As the notion grows and the legal grey area in which they operate is clarified, an increasing number of organisations may adopt a DAO model to help manage parts of their activities.

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