What Is a DAO? All The Basics Covered

If you're into blockchain and crypto (hard escape to headlines about the recent meltdown, right?), you’ll surely have come across the word DAO.

DAOs, or Decentralized Autonomous Organizations, are an increasingly important part of the blockchain world and a great share of crypto projects implement it as part of their roadmap. But what is it all really about?

Let’s take a look at what is a DAO and how one such organization works.

What Is A DAO?

A DAO is short for decentralized autonomous organization. What it means in reality - and yes, the name sort of gives it all away - is that a DAO brings together a group of people in an entity where there is no central authority. This way, the structure of a DAO is collectively owned and managed by all its members. Decisions get made by all members of a community organized around a specific set of rules enforced on a blockchain. These rules are specified in smart contracts, which are basically digital agreements that contain all terms and conditions of a given transaction or decision. Decisions are approved or rejected based on new proposals voted on during a specific time period.

A simple way to think of it is imagining a company without a CEO and where all workers have an equal say and equal shares, and where all decisions are made by taking into account the opinions of the whole group. And since there isn’t a governing authority to manage the company, a computer software becomes responsible for implementing changes based on what the employees have decided. A DAO is pretty much this except that operations run on a blockchain like the Ethereum blockchain.

Internet users can become DAO members by purchasing governance tokens (of whatever crypto token the DAO is written to run on), which will let them have a say in community decisions and vote on them. Because of this flat hierarchy approach, a decentralized autonomous organization can have many useful applications where removing a central authority leads to more efficient and transparent governance and outcomes.

DAOs are fully autonomous and transparent since they’re built on top of open-source blockchains, meaning that all participants can access and view their code.

The Basics of How a DAO Works

When a DAO is first created, the rules of the organization are written (or established) in the form of smart contracts, whose code establishes the rules and policies of the community and how certain actions will take place. When a smart contract is activated, it enforces the execution of rules programmed in it, while also ensuring that all parties involved abide by them.

The main idea is that this process eliminates the participation of a centralized authority when managing processes. This can relate to people, money and many other organizational structures. Smart contracts are now commonplace across many blockchains, but they first appeared on the Ethereum blockchain, which remains the platform of choice for the majority of DAOs.

As we alluded to before, anyone can become a DAO member by having participation tokens, which allow you to have an active say and hold voting rights on key decisions like how to spend donations and implement the DAO's rules. Smart contracts help automatically count votes and, if a predefined level of consensus is reached, enforce whatever decisions or proposals have been approved like investments, changes to products, salary expenditures, and much more.

Decentralized autonomous organizations typically have built-in treasuries to store digital currency. Members can access it upon approval by the group and all related decisions are made collectively.

How Is a DAO Created?

There are three steps to creating and launching a DAO:

Creating a smart contract

Establishing the foundation of a DAO is the first step and it consists in creating a smart contract with all the rules, policies and objectives that will be applicable to the organization. It’s worth noting that this step requires an extensive testing phase of the code as, once developers are done creating and launching the DAOs, the rules they set can only be changed through a group voting system. Attention to detail is key.

Raising Funds

DAOs rely on a shared pool of virtual currency that is raised among its members. When you buy into the organization, you’re agreeing to purchasing a number of tokens in exchange for a stake in the group and the decision-making process. It’s also during this phase that governance rules can be established.

Launch

Once all the foundations are in place, the DAO should be ready to be deployed on the blockchain. From here, stakeholders take over and start deciding on the future of the organization.

What Are The Benefits of a DAO - And Why Do We Need Them?

By now you might have started realizing some of the advantages of adopting a model like a DAO. Let’s take a look at what makes an internet-native structure DAO better than a traditional organization.

For starters, DAOs are built to be 100% percent transparent. As we explained earlier, the smart contract that rules such an organization can be publicly audited by any of its participants, which removes the need for trust between parties. Unlike, say, a traditional corporation, it’s virtually impossible to commit a fraud or tamper with data in this ecosystem. That’s because the only element that needs to be trusted is the DAO's code. Also, as all stakeholders have an equal say, there won’t be an entity working against the overall interests of the group. Smart contracts can only be changed when a consensus is reached through voting.

Any member of a DAO can submit a proposal, be it a new project idea, a proposed investment, or anything else. The entire group then considers the proposal and votes on whether the organization should pursue it and make funds and resources available, instead of having to rely on a sole party. And since everyone shares the risk of the group, all members gave vested interest in making sure it runs as effectively as possible, removing conflicts from the structure. They also benefit from whatever rewards are associated with a DAO’s decision.

Another positive aspect is that this type of decentralized organization can help reduce the costs associated with running a structure as smart contracts ensure that tasks are handled automatically, bypassing the need for administrative or management departments. Lastly, DAOs are based on the idea of ensuring autonomy across all aspects of the organization.

For all these reasons, decentralized autonomous organizations can be a valuable way of approaching, for example, investment into early startups, emerging projects and other exciting opportunities.

In fact, because of its structure without hierarchical management, a decentralized autonomous organization is meant to function as a type of venture capital fund, benefiting from a system to pool funds and vote to manage DAO tokens in a way that reduces costs and gives crypto investors more control and access.

The Disadvantages of DAOs

While DAOs might seem like an ideal organizational structure, they aren’t without some drawbacks.

To begin with, there’s the fact that the technology is still fairly new and untested at a large scale. That has attracted some concerns regarding issues like security and legality. One issue in particular has to do with smart contracts, as they’re publicly available, being also accessible to hackers who can discover and exploit any vulnerabilities. And as with any other form of computer code, bugs and errors also pose a challenge. Once an error is detected, there must be a vote between all stakeholders to agree on a fix to flaws and that can take time to happen.

Another con of a DAO is that this type of flat hierarchy might not be the answer for all types of companies or projects. Some companies do require a centralized leadership in order to be better managed.

As a novel concept, there is very little legal recognition of an entity like a DAO. Its members might be wary of being involved with an illegal entity and breaking the law as a result.

Examples of DAOs

Decentralized autonomous organizations have gained traction over the last few years and are now fully incorporated into many blockchain projects. The decentralized finance (DeFi) space uses DAOs to allow applications to become fully decentralized, for example:

Uniswap

One of the largest and most popular DAOs is Unisawap, which operates as a cryptocurrency exchange on the Ethereum blockchain. Its mission is to “solve the liquidity problem faced by decentralized exchanges by creating these token swap markets automatically”. This DAO also aims to broaden access to financial services to anyone in the world, without fear of discrimination or counterparty risk, and based on the following values: permissionless access, security and immutability. You can become a Uniswap member by holding a UNI token, granting you access to the organization and how it’s run.

Decentraland

This metaverse-like platform is governed by a DAO, meaning that all decisions related to the online virtual world are taken by its stakeholders instead of the developers behind the project. MANA is the governance token. Decentraland has become popular for its highly sought-after plots of virtual land and the brands it has attracted, like Adidas and Coca Cola.

LexDAO

LexDAO gathers legal engineering professionals with the aim of creating smart contracts capable of carrying out legal services. The main idea behind it is that people should have access to justice that is provided in a quick and efficient manner. That way, legal services would be easier to use and the world could become a fairer world. This DAO is headquartered in the Cryptovoxels metaverse platform.

ConstitutionDAO

This DAO became quite famous when it used crowdfunding to try and purchase a rare edition of the US constitution that was up for auction last year. It failed to win the bid, despite raising over $40 million from 15,000 contributors, and the project was eventually shut down. However, ConstitutionDao was an example of how these types of organizations can be a valuable tool when it comes to raising crowdsourced funds.

DAOs are, for course, being used for a wide range of projects. The metaverse in particular has become a platform where many decentralized organizations are emerging as is the case with Sensorium Galaxy. This metaverse’s DAO is structured as a token-based membership based on the SENSO token. This means that users holding this token have the voting power to weigh in on different plans and product-related decisions, as well as freely submit proposals.

Bottom Line

Implementing a DAO structure can prove to be a successful strategy that can address problems like inefficiencies and conflicts in an organization. And as blockchain technology becomes more widespread, it could lead to more positive outcomes that can bring even greater benefits to all types of structures member owned communities and projects.

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