If you follow the events in the world of blockchain and cryptocurrencies, then you might often come across the term DAO (Decentralized Autonomous Organization)? What is a DAO? What technologies do DAOs use, and are there examples of DAO? Can a DAO make a positive difference in businesses, governments, and society at large? Why should you know about DAOs? Read on, as we address these questions.
What is a DAO (Decentralized Autonomous Organization)?
A DAO is an organization without central leadership. Instead, a DAO has a community that governs it. The governance happens in a democratic manner. Community members have voting rights, which they exercise. The decision-making happens by voting. A DAO has a set of transparent rules, which take effect autonomously.
The fully democratic decision-making process makes the organization “decentralized”. Community members don’t need to trust each other explicitly. The autonomous and transparent rules do the “heavy-lifting”, which eliminated the need for explicit trust. These rules make the organization “autonomous”.
How a DAO works: Technologies and Practices
In the centralized world, organizations have a central leadership. The systems, structures, technologies, and processes cater to a centralized model of management. You need to explicitly trust a decision-making authority, and you agree to that authority having certain powers. All aren’t equal in such a system.
DAOs needed a new generation of technologies and practices. These technologies and practices should offer equal authority to all community members. They should also provide a way to autonomously implement transparent rules, which eliminates the need to explicitly trust a central authority.
The importance of blockchain for a DAO
Creators of DAOs use blockchain to create such organizations. A decentralized blockchain network is a peer-to-peer (P2P) network. “Nodes”, i.e., computers on this network have equal authority.
A “protocol program” on this blockchain network manages its functioning. The protocol program is open-source, and all users on the network abide by its rules.
In a limited way, Bitcoin is the first example of a DAO. This popular cryptocurrency uses its blockchain network. All nodes on this network can interact with each other without any central administrator. Bitcoin has only one use case though, i.e., transferring digital currencies from one public wallet address to another. That makes it a limited-purpose DAO.
Ethereum: The choice of platform for many DAOs
Most DAOs cater to more complex use cases than Bitcoin. E.g., a DAO might review different blockchain development projects. It might choose to invest in one or more such projects.
The DAO makes this investment decision by voting. Members of the DAO hold cryptographic tokens that allow them to participate in voting. Based on the voting, the DAO commits funds to the above-mentioned blockchain projects. These funds might be in the form of cryptocurrencies like Ether (ETH).
The Ethereum blockchain platform offers the EVM (Ethereum Virtual Machine) to developers. Blockchain developers can code smart contracts and DApps (Decentralized Apps) using it.
Smart contracts are pieces of code with the following characteristics:
• They are open-source.
• You store smart contracts on a decentralized blockchain. That makes them immutable. You can’t modify smart contracts after you deploy them.
• Smart contracts contain “If-Then-Else” statements.
• They transfer cryptographic tokens based on predefined conditions.
• Smart contracts execute autonomously.
• The execution results of smart contracts are recorded in a decentralized blockchain. That makes the execution results immutable, therefore, you can’t reverse the execution of a smart contract.
DAOs use the transparency, autonomy, and immutability of smart contracts to implement rules of governance. This is why Ethereum is a popular choice of platform for DAOs.
Examples of DAO
Broadly, there are two types of DAOs. We now explain each of them with examples.
1. DAOs with token-based membership
Anyone can join a DAO with a token-based membership. The new participant only needs to buy the governance token of the DAO from a decentralized crypto exchange.
By holding governance tokens, the new participant can participate in voting. MakerDAO is an example of this type of DAOs, and MKR is its governance token.
MakerDAO is based on Ethereum. This DAO regulates and maintains Dai, a stablecoin based on Ethereum. Dai is designed to maintain a 1:1 parity with USD.
2. DAOs with share-based membership
You can’t join DAOs of this type by only buying governance tokens. You need to submit a membership proposal. The membership proposal should demonstrate value in the form of cryptographic tokens and/or expertise in the field of decentralized blockchain networks.
Aspiring members should be able to objectively review blockchain projects. They need the ability to make informed judgments about such projects. The membership proposal should demonstrate that.
MolochDAO is an example of this type of DAOs. This DAO funds Ethereum blockchain projects after reviewing and evaluating them.
Advantages of DAOs: The differences that DAOs can make to governments, businesses, and society
DAOs have demonstrated the following key advantages:
1. DAOs have demonstrated that organizations can make decisions democratically and transparently
DAOs have shown the following:
• Organizations can operate by transparent rules.
• They can make decisions by democratic means like voting.
• Organizations can operate without central leadership.
• Governance in organizations can be automated using transparent rules.
2. DAOs have demonstrated that there are now technology solutions to run decentralized organizations
After observing DAOs, we know that decentralized blockchain networks can support such organizations. DAOs demonstrate that you can codify rules of governance using smart contracts.
Smart contracts operate autonomously. This proves that we now have technologies to execute rules-based governance processes autonomously.
3. DAOs fund important blockchain projects
To a certain extent, DAOs operate like venture capital (VC) funds. They fund promising blockchain projects after evaluating them.
Limitations of DAOs
DAOs have the following limitations:
1. Legal uncertainties
DAOs aren’t legally-registered organizations under the jurisdiction of any country. They operate like VC funds, and they fund important blockchain projects. They deal in substantive funds.
The lack of legal backing can create challenges for them in the future. E.g., one or more DAO participants might not want to accept the liability of decisions made in the DAO.
To take another example, consider the status of governance tokens sold by a DAO. Financial regulators in a country might categorize them as securities investment contracts. DAOs don’t register themselves with financial regulators though, which can create regulatory challenges.
2. Smart contract bugs
You can’t modify a smart contract after deploying it. Smart contracts with bugs will continue to operate with vulnerabilities. Hackers can exploit these bugs.
DAOs deal with considerable funds, and hackers can make off with them. The immutability of smart contracts will make it very hard to recover from such attacks. This is a key limitation of DAOs.
The 2016 hack of the Ethereum DAO is an example. The Ethereum blockchain network is very secure. However, the Ethereum DAO built on it was using a faulty smart contract. Hackers exploited bugs in the smart contracts to put large sums of Ethers at risk. The Ethereum community went through a complex and contentious recovery process, which resulted in a split in the community.
Conclusion: Why you should know about DAOs
DAOs demonstrate that organizations can make important decisions democratically. They also demonstrate that organizations can operate without central leadership, and they can work transparently. Legal and security-related challenges exist. If experts working in the blockchain-crypto space can solve these challenges, then DAOs can transform the way organizations work. This is why you should watch DAOs closely.
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