The crypto space is advancing at an incredible speed that we are beginning to see a rise of new ecosystems within the crypto space. One of such ecosystems is the decentralized autonomous organization (DAO). For starters, a decentralized autonomous organization is a unique entity that has no central leadership. Within this type of entity, decisions are made from the bottom up. Plus, the entity is governed by a community that is organized around a specific set of rules and enforced on a blockchain network.
To get a hang of what we are trying to say, we want you to see DAOs as internet native organizations that are collectively owned and managed by their members. These types of organizations have specially designed built-in treasuries that can only be accessed after members’ approval. Decisions within DOAs are made via proposals and members have to vote during a specified period.
DOAs are not like any other ecosystem we have seen in the crypto space. Plus, they operate without hierarchical management. And yes, they can have a large number of purposes including functioning as a freelance network where contracts pool their funds for software subscriptions, venture capital companies owned by a group of charitable organizations where members approve funds. There are a whole lot of areas where DOAs can operate seamlessly.
Before we delve any further, we would like to take a minute to state categorically that there is a difference between DAO, an internet-native organization, and The DAO, one of the first crypto projects to explore the brilliance of DOA. Just so you know, The DAO was a unique project launched in 2016. Unfortunately, the project failed and led to a split across the Ethereum network.
DOA: How does it work?
Just like we mentioned right from the get-go, a DAO is an organization that is governed by its robust community. Within such organizations, decisions are made from the bottom up. While there are tons of ways to participate in a DAO, the most popular one is through the ownership of a token.
DAO operates via uniquely designed smart contracts, which are basically groups of code that automatically execute once certain criteria are met. Even though the Ethereum network was the first to deploy the concept of smart contracts, many projects deploy smart contracts on their indigenous blockchain nowadays.
These smart contracts usually hold the DAO’s rules. And members with a stake in a DAO, have voting rights, which allows them to influence how the organization operates by simply deciding or creating new governance proposals.
This brilliant feature prevents DOAs from being spammed with proposals. A proposal will only be approved once the majority of stakeholders agree on it. However, how the majority is determined differs from DAO to DAO and is clearly specified in the smart contracts.
One thing we love about DAOs is that they are fully autonomous and transparent. And this doesn’t come to us as a surprise, especially considering that they are built on open-source blockchain, making it possible for anyone to view their code. Also, anyone can audit the organization’s built-in treasuries, since the blockchain records all financial transactions.
DAO lunch and the three major steps
Before a DAO is launched, it has to go through three major steps and we will look at them shortly.
Smart contract creation: The first step involves smart contract creation, which can either be done by a developer or a group of developers behind the DAO. Once the smart contract has been launched, the rules can only be changed through the governance system. What this means is that the developers must carry out extensive tests on the smart contracts to ensure they don’t overlook any important detail.
Funding: After the team must have created its smart contract, the DAO has to clearly determine how it is going to receive funds as well as how the governance will be enacted. Most times, DAOs sell their native tokens to raise funds. On the flip side, these tokens give holders voting rights.
Deployment: After everything is up and ready, the next thing to do is deploy the DAO on the blockchain. This point is also where stakeholders decide on the future of the organization. Also, the team behind this project i.e. the creators behind the smart contracts no longer have an influence on the project more than other stakeholders.
Why are DAOs important?
Since DAOs are internet-native organizations, they have a lot of advantages over traditional organizations and you’ll learn about some of them shortly. One of the most significant advantages of DOA is the lack of trust needed between two entities. While your typical traditional organization heavily relies on the trust of people behind it, especially as it concerns investors, with DOAs, members only have to trust the codes.
Trusting a code isn’t all that difficult especially considering that the code is publicly available and can be tested before it is launched. More so, every action executed on a DAO after it has been launched is subject to approval by the community. More so, DOAs are governed by complete transparency.
Even though DOAs has no hierarchical structure, the organization can seamlessly accomplish tasks and grow even though it is being controlled by stakeholders holding its native token. The absence of hierarchy means that any stakeholder can share an innovative idea that the entire community can consider and improve upon. With DAOs, internal disputes are easily resolved via a robust voting system that is in line with the pre-written rules set in the smart contracts.
By giving investors an opportunity to poll funds, DAOs make it possible for investors to invest in early-stage startups and decentralized projects. With DOAs, every investor shares in the risks of profits that may come out of the project.
Understanding the principal-agent dilemma
One of the biggest upsides of DOAs is that they provide a robust solution to the principal-agent dilemma. For those who are new to DOAs, the principal-agent dilemma relates to the conflict of priorities between a person or group and others making the decisions and executing those decisions.
Problems are bound to occur, especially when it concerns the relationship between stakeholders and a CEO. The agent, who is the CEO, may work outside the expectations of stakeholders instead of acting in the interest of the principal.
Another very good example of the principal-agent dilemma plays out when the agent takes incredible risks because the principal bears the burden of the risk. For instance, a trader can decide to use excessive leverage to chase a performance bonus, because he knows that the organization will make up for any downside.
Thanks to DOAs, you never have to worry about the principal-agent dilemma as the community governance protocols prevent that scenario from ever playing out. More so, stakeholders join a DAO without any type of cajoling or coercion. Also, they do their due diligence to understand the rules governing the DAO. With DAO, investors don’t have to trust any agent acting on their behalf, instead, they work as a team since they have a common goal to achieve.
Also, since token holders have a unified interest, you can kiss goodbye to any type of malicious behavior or attempt to circumvent the system as they want the network to succeed so they don’t lose their stake. Acting against a DAO will mean acting against their self-interest.
An overview of The DAO?
The DOA was the very first real-life example of modern autonomous organizations. This project was launched in 2016 and was intended to be an automated organization that functioned as a form of venture capital fund.
Investors who had DOA tokens enjoyed several benefits including profiting from the organization’s investments either through token appreciation or dividends. When DOA kicked off in 2016, it was dubbed a revolutionary project. Plus the team behind this project was able to raise nearly $150 million in Ethereum. At that time, The DAO was one of the greatest crowdfunding efforts of its time.
The DOA was officially launched on April 30, 2016, after Christoph Jentzsch, who was the Ethereum protocol engineer then, released the open-source code for an Ethereum powered investment organization. Investors were able to invest in DAO tokens by simply transferring ETH to the project’s smart contracts.
A few days after the project went live, some developers expressed serious concerns over a bug in The DAO smart contract, which could be used as a loophole to siphon funds. While the team behind the project put in place a governance proposal to fix the bug, they didn’t act fast enough as a malicious hacker took advantage of the loophole and siphoned $60 million worth of ETH from The DAOs wallet.
Between 2016, when the project launched, nearly 14% of the Ethereum in circulation was invested in the DAO project. So the malicious attack was a significant blow to DAOs and the Ethereum network, which was one year old at the time. The hack spurred a serious debate within the Ethereum community as members pondered on what to do. Initially, Ethreum’s co-founder Vitalik Buterin suggested a soft fork to blacklist the attacker’s address and prevent the funds from being moved. But the attacker or at least someone posing as them responded to the suggestion of Vitalik Buterin by stating that the funds were legally obtained according to the rules of The DAO smart contract. The attackers also claimed they will institute legal actions against anyone who tried to seize the funds.
The team behind the attack also threatened that they will bribe miners using the stolen funds in an attempt to thwart any attempted soft fork attempt. At the end of the day, a hard fork was chosen as the answer to the problem. The hard fork was eventually implemented to roll back the Ethereum network’s history before the DAO was hacked. Eventually, the stolen funds were reallocated to a smart contract that allowed investors to withdraw them. Some people disagreed with the move, rejecting the hard fork in its entirety. Subsequently, this group threw its weight behind an earlier version of the network, dubbed Ethereum Classic.
What we don’t like about DAOs
While decentralized autonomous organizations look great on paper, they aren’t perfect. They are a pretty new technology within the crypto space and have attracted a lot of criticism, due to lingering issues regarding their structure, security, and legality.
An MIT technology review for examples stated that it considers it a pretty bad idea to trust the masses with important financial decisions. While this was its position in 2016, they don’t seem to have changed their thoughts about DAOs. Also, the DAO hack put a nail to the coffin as people raised serious concerns about the security and flaws in the smart contract that can be hard to fix, even if they are spotted.
More so, DOAs can be distributed across multiple jurisdictions. Plus, there is no legal framework for them. Any legal problems that may eventually occur will most likely require those involved to slug it out with numerous regional laws.
In July 2017 for instance, the United States Securities and Exchange Commission issued a report on The DAO, claiming that the project sold securities in the form of tokens on the Ethereum network with any form of authorization. By this move, the agency held that the project violated a portion of the country’s security laws.
Top examples of DAOs
Decentralized autonomous organizations have generated a lot of buzz and traction over the last couple of years and have now fully been incorporated into many blockchain projects. Today, the decentralized finance (DeFi) ecosystem leverages DAOs to allow applications to become fully decentralized. Let’s give you some examples so you understand what we are trying to say.
To a lot of experts in the crypto space, the Bitcoin (BTC) network is the earliest example of a DAO. And this doesn’t come to us as a surprise, especially considering that the bitcoin network scales via community agreement, even though most of the participants on the network have never met each other. Also, the bitcoin network doesn’t have an organized governance mechanism, instead, nodes and miners have to signal support.
However, by today’s standard, Bitcoin isn’t considered a DAO. If we are to go by current measures, then Dash would be the very first true representation of a DAO and that’s because the project has a governance protocol that makes it possible for investors to vote on the use of its treasury.
Other more advanced and complicated DOA including the likes of decentralized networks built on the Ethereum blockchain is responsible for some of the crypto-backed stablecoins projects we have seen in the last couple of years. In some scenarios, organizations that initially launched these DOAs eventually give up control of the project to the community. With this move, token holders can actively vote on governance proposals to hire new contributors, adjust parameters or add tokens as collateral for their native coins.
In 2020, a leading DeFi protocol kicked off its very own governance token. This token was distributed via a liquidity mining process. Based on this design, anyone who interacted with the protocol gets rewarded with native tokens. Other projects in the crypto space have also replicated the same model.
To be honest, the list of DAOs is extensive. More so, the brilliant concept of DAO has been gaining traction over the years. While some projects are still on the path of achieving full decentralization through the DAO model, let us quickly let you know that the DAO model is only a few years old. Given this singular fact, the model is still yet to achieve its full objective.
Given the fact that internet native organizations have the potential to change how organizations work completely, the concept still has a lot of legal grey areas it needs to address. Eventually, we expect more and more projects within the crypto space to adopt the DAO model.