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What is a decentralised autonomous organisation (DAO)? How does it work?

10 minutes 2 months ago

Decentralised autonomous organisations (DAOs) have become increasingly prominent in recent years, finding integration into various blockchain projects. The decentralised finance (DeFi) sector, for instance, utilises DAOs to enable fully decentralised applications. This article will guide you through all the fundamental concepts of DAOs, along with their implications and disadvantages. You will also find examples of DAOs and sections to distinguish between a DAO and The DAO.

What Is a Decentralised Autonomous Organisation (DAO)?

A decentralised autonomous organisation (DAO) is an emerging form of legal structure with no central leadership. Instead, power is distributed across all tokenholders of a DAO, often based on the number of tokens they hold. These members of a DAO can cast votes and participate in the management and decision-making through a bottom-up approach, following a specific set of rules enforced on a blockchain.

What Is the Purpose of Decentralised Autonomous Organisations (DAOs)?

One significant feature of digital currencies is that they are decentralised, meaning that there is no single institution or board of directors controlling them. Instead, these tokens are distributed among a variety of computers, networks, or nodes. This characteristic, in many cases, is deployed to attain levels of privacy and security that are typically not obtainable to standard currencies and their transactions.

Similarly, a DAO is designed to promote oversight and administration of an entity akin to a corporation. The crucial part of a DAO, however, is the lack of central authority – the collective group of individuals acts as the governing body. This has a number of advantages, such as making collective decisions democratically, and allowing for those invested in the DAO to be active participants in its future. By allowing for this, DAO’s tend to create engaged and passionate communities of like-minded individuals.

How DAOs Work

DAOs operate through smart contracts (chunks of code that automatically execute when a set of criteria and conditions are satisfied). Smart contracts dictate decision-making upon underlying activity on a blockchain. To illustrate, based on the outcome of a decision, certain code may be executed to raise the circulating supply, burn a selected amount of reserve tokens, or issue select rewards to existing tokenholders.

The voting procedure for DAOs is recorded on a blockchain, where users typically need to choose between mutually exclusive options. Voting influence is frequently allocated to users based on the quantity of tokens they possess. For instance, a user holding 100 tokens in the DAO will wield double the voting power of a user with 50 tokens.

The underlying principle behind this approach is to incentivise users with a higher monetary stake in the DAO to act with integrity. Consider a user holding 25% of the total voting power; while they could engage in malicious activities, doing so would jeopardise the value of their 25% ownership.

DAOs commonly maintain treasuries containing tokens that can be exchanged for fiat currency. DAO members can collectively decide on how to allocate these funds. For instance, DAOs with the goal of acquiring rare NFTs may vote on whether to utilise treasury funds to obtain such assets.

Benefits of DAOs

Decentralisation: Decisions are made by a collection of individuals instead of relying on one person (a CEO) or an elite group (a board of directors). For a proposal to be approved, it must receive support from the majority of tokenholders. However, how that majority is determined varies from DAO to DAO and is specified in the smart contracts.

Participation: DAO offers all members the feeling of being appreciated. They may feel more empowered and connected to the entity when they have a direct say and voting power on all matters.

Publicity: Transparency is a key aspect of DAOs, where votes are conducted on the blockchain and are visible to the public. This compels users to make choices aligned with their judgement, knowing that their votes and decisions will be openly accessible. This dynamic encourages actions that enhance users' reputations and deters actions that go against the interests of the community.

Limitations of DAOs

Speed: In contrast to a public company where a CEO can swiftly make decisions with a single vote, a DAO involves every user in the voting process, leading to a more prolonged decision-making period. This is especially true when considering diverse time zones and individuals' priorities beyond the DAO.

Educational Challenge: A DAO faces the challenge of educating a larger number of people about ongoing entity activities. Managing a single CEO is simpler in terms of overseeing company developments, while DAO tokenholders may have varying educational backgrounds, understandings of initiatives, incentives, or resource accessibility. A common hurdle for DAOs is the need for a diverse group of individuals to learn how to collaborate, strategize, and communicate effectively.

Examples of DAOs

The earliest semblance of a DAO is often perceived in the Bitcoin network, where scalability is achieved through community consensus, despite many participants being unfamiliar with each other. Bitcoin lacks a formalised governance mechanism, relying instead on miners and nodes to signal support. However, current standards do not categorise Bitcoin as a DAO. Dash is considered the first true DAO, boasting a governance mechanism allowing stakeholders to vote on treasury use.

Advanced DAOs, notably those built on the Ethereum blockchain, play a pivotal role in launching cryptocurrency-backed stablecoins. Some of these organisations gradually relinquish control to token holders who actively vote on governance proposals for contributor hiring, collateral addition, and parameter adjustments.

In 2020, a DeFi lending protocol introduced its governance token through a liquidity mining process, a model later adopted by numerous projects. The DAO landscape is now extensive, with projects aiming for complete decentralisation through this model, though many are relatively young and yet to attain their ultimate goals.

As internet-native entities, DAOs have the potential to revolutionise corporate governance. While the concept matures and navigates the legal grey areas, more organisations may adopt the DAO model to govern their activities.

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