Cryptocurrency’s main pull is decentralization, which allows everyone to partake. Decentralized autonomous organizations (DAOs) echo the same central principle, making them an exciting development for many crypto enthusiasts.
But what are DAOs, and how do they work? Are there any benefits or drawbacks you need to know about before diving in? Read on to find out.
What Is A Decentralized Autonomous Organization (DAO)?
Decentralized autonomous organizations, or DAOs, are internet-native organizations that operate without the need for a board of directors or management. Instead, members purchase governance tokens and make decisions based on a set of rules located on a code base on the blockchain.
Furthermore, DAOs have built-in treasuries that can only be accessed when the members vote on it. Depending on a DAO’s purpose, this can be used in various ways. For example, members of charitable organizations may vote on entities to donate ether tokens to, while venture capital firms can operate on a decentralized business model.
This makes them inherently different from a traditional organization like Apple or Google, which is one of the main reasons they’ve become a point of interest for many crypto enthusiasts.
DAOs vs The DAO: An Important Distinction
One of the biggest pitfalls when understanding DAOs is confusing them with The DAO. But what’s the difference?
The DAO is a precursor to today’s internet-native organizations. It was established as an entity that functioned as a form of venture capital fund that operated open-source code. However, since this blockchain-enabled organization was still in its infancy stages, there were many security vulnerabilities to exploits and attack vectors.
It was hacked soon after, and investors lost roughly $50 million worth of ETH.
How Does A DAO Work?
There are a few core features that all DAOs share: they’re decentralized, transparent, and fully autonomous. But how does anything get done without human intervention in its day-to-day processes?
It all comes down to smart contracts on the blockchain. These smart contracts are chunks of code that activate when set conditions are met, which establishes the rules that the broader organization has to operate under.
However, while these rules keep everything in order, members that have a stake in the organization can vote on proposals for new governance policies. But before it even gets to this point, members need to participate in a preliminary vote to determine whether the proposal will go through to this stage at all.
For the curious, individuals can purchase tokens during a DAO’s creation period or in fixed intervals post-deployment to partake in the DAO’s governance.
How A DAO Is Made
Despite being fully autonomous internet-native organizations, DAOs are still built by developers. Here’s how a DAO goes from ideation to execution:
- Creating the smart contract: This is arguably the most critical stage of making a DAO. Developers develop the smart contract and its many rules while rigorously testing them to ensure nothing is left out. After this period, these smart contracts can only be changed through the governance system.
- Obtaining funding: Next, the DAO has to build its treasury. This is usually facilitated by the sale of tokens that give buyers a “stake” in the organization, thereby giving them voting rights after deployment.
- Deploying the project: Once the first two hurdles have been conquered, the DAO is deployed on the blockchain. After this point, its developers become regular stakeholders and must vote to make any changes to the smart contracts.
The Benefits Of DAOs
DAOs are exciting because of their decentralized business model, but what exactly sets them apart from more traditional organizations? Here are some of the advantages DAOs have over traditional organizations:
- Trust: Traditional organizations are composed of people, which means there must be a certain level of trust to move forward. This can mean trust in the organization’s management from investors or co-workers. Either way, DAOs cut out the nebulous concept of trust by being transparent and openly verifiable via blockchain.
- No hierarchical structure: Because DAOs have no hierarchical structure, any member can propose and vote on changes to the smart contract. Because of the existing rules, this can happen without too much fuss.
- Risk sharing: If the organization decides to use part of its treasury to invest in blockchain projects or an upcoming business service, all stakeholders evenly share the risk. That means fewer losses overall while also making decisions that most members agree with.
Disadvantages Of DAOs
While decentralized autonomous organizations might sound like an all-around solution to the downfalls of traditional organizations, they aren’t perfect. In fact, many critics and crypto enthusiasts have a laundry list of concerns about security, legality, and how viable the structure is. Here’s a breakdown of its cons:
- Can be legally murky: As more governments attempt to regulate crypto, the legality of DAOs becomes more questionable over time. This can mean more risk for stakeholders.
- Decentralized nature can backfire: Despite being voted on by members, specific changes to smart contracts can be disadvantageous. Even if someone finds these issues early, reversing or fixing them will take a long time because of the governance system.
Decentralized autonomous organizations (DAOs) represent powerful technology that’s still in its infancy stage, so speculation can make things seem more significant than it is. However, the potential for autonomy can be beneficial for large industries worldwide, which may bring a more democratic financial future for many organizations.
That said, there’s still a lot of room for DAOs to grow. So while DAOs continue to develop and expand, potential investors will have to be diligent and do their research before trading any fiat for governance tokens. After all, everything is entirely open to the public – you just need to take a look for yourself.