What Is a DAO?

A decentralized autonomous organization (DAO) is an emerging legal structure with no central governing body whose members share a common goal to act in the entity's best interest. DAO is popularized through cryptocurrency enthusiasts and blockchain technology, so DAOs are used to make decisions in a bottom-up management approach.

Understanding DAO

One of the major features of digital currencies is that they are decentralized. This means they are not controlled by a single institution like a government or central bank but are divided among various computers, networks, and nodes. In many cases, virtual currencies use this decentralized status to attain levels of privacy and security that are typically unavailable to standard currencies and their transactions.

Inspired by the decentralization of cryptocurrencies, a group of developers came up with the idea for a decentralized autonomous organization, or DAO, in 2016. The concept of a DAO is to promote oversight and management of an entity similar to a corporation. However, the key to a DAO is the need for central authority; the collective group of leaders and participants acts as the governing body.

How DAOs work?

DAOs rely heavily on smart contracts. These logically coded agreements dictate decision-making based on underlying activity on a blockchain. For example, based on the outcome of a decision, a specific code may be implemented to increase the circulating supply, burn a select amount of reserve tokens, or issue rewards to existing token holders.

The voting process for DAOs is posted on a blockchain. Users must often select between mutually-exclusive options. Voting power is often distributed across users based on the number of tokens they hold. For example, one user that owns 100 tokens of the DAO will have twice the weight of voting power over a user that owns 50 tokens.

The theory behind this practice is users who are more monetarily invested in the DAO are incentivized to act in good faith. Imagine a user who owns 25% of the overall voting power. This user can participate in harmful acts; however, by doing so, the user will jeopardize the value of their 25% holding.

DAOs often have treasuries that house tokens that can be issued in exchange for fiat. Members of the DAO can vote on how to use those funds; for example, some DAOs to acquire rare NFTs can vote on whether to relinquish treasury funds in exchange for assets.

Benefits of DAOs

Several reasons why an entity or collective group of individuals may want to pursue a DAO structure. Some of the help of this form of management include.

• Decentralization: A collection makes decisions impacting the organization of individuals as opposed to a central authority often vastly outnumbered by its peers. Instead of relying on the actions of one individual (CEO) or a small collection of individuals (Board of Directors), a DAO can decentralize authority across a more extensive range of users.
• Participation: Individuals within an entity may feel more empowered and connected to the entity when they have a direct say and voting power on all matters. These individuals may not have strong voting power, but a DAO encourages token holders to cast votes, burn tokens, or use their tokens in ways they think is best for the entity.
• Publicity: Within a DAO, votes are cast via blockchain and made publicly viewable. This requires users to act in the best way, as their votes and decisions will be publicly viewable. This incentivizes actions that benefit voters' reputations and discourage acts against the community.
• Community: The concept of a DAO encourages people worldwide to come together to build a single vision seamlessly. With just an internet connection, token holders can interact with other owners wherever they may live.

Limitations of DAOs

Only some things are perfect regarding DAOS, though. There are severe consequences to improperly setting up or maintaining a DAO. Here are some rules for the DAO structure.

• Speed: If a CEO guides a public company, a single vote may be needed to decide a specific action or course for the company. With a DAO, every user is allowed to vote. This requires a much-extended voting period, especially considering time zones and priorities outside the DAO.
• Education: Similar to the speed issue, a DAO is responsible for educating many more people regarding pending entity activity. A single CEO is much easier to keep comprised of company developments. At the same time, a DAO's token holders may have various educational backgrounds, understanding of initiatives, incentives, or accessibility to resources. A common challenge of DAOs is that while they bring a diverse set of people together, that diverse set of people must learn how to grow, strategize, and communicate as a single unit.
• Inefficiency: Partially summarizing the first two bullets, DAOs run a significant risk of being inefficient. Because of the time needed to administratively educate voters, communicate initiatives, explain strategies, and onboard new members, it is easy for a DAO to spend much more time discussing change than implementing it. A DAO may get bogged down in trivial, administrative tasks due to needing to coordinate many more individuals.
• Security: Security is an issue facing all digital platforms for blockchain resources. A DAO requires significant technical expertise to implement; without it, there may be invalidity in how votes are cast or decisions made. Trust may be broken, and users leave the entity if they need help to rely on the structure of the entity. Even though the use of multi-sig or cold wallets, DAOs can be exploited, treasury reserves stolen, and vaults emptied.

Pros

• A range of individuals can collectively come together from around the work to act as a single entity.
• More individuals have a voice in the entity's planning, strategy, and operations.
• As votes on the blockchain are publicly-viewable, token holders are naturally incentivized to act more responsibly.
• Members of a DAO may feel empowered to collaborate with like-minded individuals with similar goals within a single community.

Cons

• It often takes longer for decisions to be made as there are more voting participants.
• There is often more burden to educate users as the collective voting population is diverse with varying ranges of education and knowledge.
• More time is needed to cast votes or gather users due to the decentralized nature of the entity.
• Severe exploits, such as theft of treasury reserves, are possible if the DAO's security needs to be adequately established and maintained.
  

DAO Example: The DAO

The DAO was an organization that was designed to be automated and decentralized. It acted as a venture capital fund, based on open-source code and without a typical management structure or board of directors. The DAO was unaffiliated with any particular nation-state to be fully decentralized, though it used the Ethereum network.

The DAO launched in late April 2016 thanks to a month-long crowd sale of tokens that raised more than $150 million in funds. At the time, the launch was the most prominent crowdfunding fundraising campaign.

Frequently Asked Questions

What Is a DAO?

A DAO is a decentralized autonomous organization, a bottom-up entity structure with no central authority. Members of a DAO own tokens of the DAO, and members can vote on initiatives for the entity. Smart contracts are implemented for the DAO, and the code governing the DAO's operations is publicly disclosed.

What Is the Purpose of a DAO?

A DAO is intended to improve the traditional management structure of many companies. Instead of relying on a single individual or a small collection of individuals to guide the entity's direction, a DAO intends to give every member a voice, vote, and opportunity to propose initiatives. A DAO also strives to have strict governance that is dictated by code on a blockchain.

How Does a DAO Make Money?

A DAO initially raises capital by trading fiat for its native token. This native token represents voting power and ownership proportion across members. If a DAO is successful, the value of the native token will increase.

The DAO can then issue future tokens at a more excellent value to raise capital. A DAO can also invest in assets if the members approve such measures. For example, a DAO can acquire companies, NFTs, or other tokens. Should those assets appreciate, the value of the DAO will increase.