Centralized companies and government institutions are directed by leadership that decides the organization’s course of action, this also applies to non-profit foundations and institutions.
Blockchain has laid the groundwork for a new type of autonomous organization governed by the community through voting. In this article, we’ll explore what a DAO is in the context of cryptocurrency, how it works, and what its advantages and drawbacks are. We will also highlight some of the most well-known DAOs and explain how to create your own.
What is a Decentralized Autonomous Organization (DAO)?
A DAO meaning – blockchain-based automated system that does not require any human intervention for the protocol to function. What characterizes a DAO is that no central authority is in command, and that the system operates without hearing the voice of the other parties involved.
In other words, DAOs have no hierarchical structure; every participant in the ecosystem has equal rights and can vote on protocol changes just like any other member.
How Does a DAO Work?
Decentralized Autonomous Organizations have their origins in the arrival of Ethereum. Smart contracts enabled the creation of autonomous systems ruled by code rather than by people, removing the possibility of data manipulation.
The invention of smart contracts made it possible to develop many decentralized systems that enable users to make operations without intermediaries. These may be DeFi protocols, decentralized exchanges (DEXes), applications (DApps), autonomous organizations (DAOs), etc.
The first DAO, the instantiation of these principles, was the DAO protocol in 2016.
What types of DAOs already exist?
Let's look at the main types of DAO:
- Grant DAOs: The world's first DAO, where users simply contributed their assets to vote and make proposals for the platform. The first management tokens could not be transferred to other users.
- Protocol DAOs: These are decentralized financial protocols. With the help of smart contracts, they help users freely exchange cryptocurrencies and also help other DAO platforms launch new tokens.
- Investment DAOs: The first commercial DAO projects, the purpose of which is to make a profit. They allow any private investor to assemble a team of like-minded people to invest together in a large project with a high entry threshold.
DAO example: In 2018, during the ICO of the blockchain from the creators of Telegram, the minimum check for participation in sales was $1 million. In this case, an investment DAO can bypass this threshold and divide the profit proportionally to the share of each participant.
There are also DAOs created to serve other projects:
- Service DAOs: These DAOs support other projects by using blockchain technology to redistribute labor across different DAO ecosystems. They’re designed to find new contributors who support the crypto space and get paid in digital assets.
- Operational DAOs: Essentially blockchain-based operating systems, these DAOs make it possible to create and manage new DAOs. They allow even non-technical users to launch their own projects using templates and smart contracts.
What are the Key Components of a DAO?
A DAO operates without a centralized leadership structure. Instead, its core processes are governed by smart contracts, community input, and governance tokens. These components work together to create a system where decisions are transparent, rules are enforced automatically, and members participate directly in the organization’s evolution.
Governance Token
For most DAOs, to vote, the stakeholders are required to hold some governance tokens. These tokens are a claim to ownership of the organization, and more importantly, they grant holders the right to vote on proposals. Users can also earn tokens through contributing to the organization in other ways, such as a service offering or through digital asset staking.
Smart Contracts
A DAO is constructed by using smart contracts, which are self-executing contracts with the terms of the agreement between a buyer and a seller being written into lines of code, hosted by a blockchain DAO to which they were deployed. So that smart contracts self-execute, hence are binding, transparent and secure, and hack-proof.
No Centralized Legal Entity (Decentralization)
In a DAO, decisions are community-based. All users are free to submit suggestions for how the decentralized protocol could be improved. And if they are voted in by the wider community, they become accepted and adopted. Developers aren't allowed to change things unilaterally; new code is added only when the community has reached consensus on proposed improvements.
In this way, a DAO operates under the control of software, but the software doesn’t decide on its own.
The Benefits of Decentralized Autonomous Organizations
The benefits of Decentralized Autonomous Organizations are listed below.
- Decentralization and Transparency: A DAO is decentralized and doesn’t require trust in intermediaries or the protocol itself, thanks to its open-source code.
- Autonomy: Once launched, the protocol operates without intervention from its creators. Users interact with the system, and smart contracts enforce the terms of agreements between parties. If either party can’t fulfill the terms, the transaction just won’t happen.
- Speed of Decision-Making: Blockchain technology not only reduces costs by removing intermediaries, but also speeds up the process of reaching consensus.
The Challenges of Decentralized Autonomous Organizations
Despite their benefits, decentralized autonomous organizations (DAOs) also have some challenges:
- Regulatory Challenges: One of the main issues facing decentralized autonomous organizations is legal uncertainty, which prevents many companies from adopting them. This problem is made worse by the fact that once a DAO system is integrated into a private or public organization, it becomes difficult or impossible to regain centralized control over it.
- Partial Centralization: The initial rules of a DAO protocol are hardcoded by its creators and often cannot be changed. This limitation, however, can be addressed if the smart contract is designed to allow for the modification of the original rules. Moreover, voting power is usually based on the number of tokens held rather than the number of participants. This gives whale users who control large amounts of capital the ability to manipulate decisions and potentially take control of the platform.
- Risk of Vulnerabilities: The vulnerability of DAOs stems from the nature of decentralized open platforms - hackers can monitor contracts not only to identify errors, but also to exploit them.
What are Real-World DAO Use Cases?
The most well-known DAO to date is The DAO, which was launched in April 2016 as a decentralized venture fund.
In return for contributing ETH, participants would receive DAO tokens, which could be used for voting on which projects to fund. The fund took in $150 million in ETH and was later hacked, losing $60 million.
Unfortunately, the DAO hack left many people with a negative or skeptical view of the term "DAO" at the time. However, DAOs are an extremely powerful form of organization, and it didn’t take long for activity to experience a resurgence across the DAO crypto world.
Decentralized Finance (DeFi)
MakerDAO is a popular DeFi project running on the Ethereum blockchain, and the project is governed by holders of the MKR token. The DAO governance structure is set up to vote on all project operations, including interest rates, types of collateral, and token issuance.
This organization was one of the first platforms to launch the DAI stablecoin, whose value is pegged to the price of the US dollar.
Another DeFi project that is fully governed by a DAO is Compound. The platform allows users to lend and borrow cryptocurrencies, earning interest on their holdings. The Compound community governs the platform with its own token, COMP, and holders can vote on proposals to add new assets or change interest rates.
NFT Projects and DAOs
The NFT space has also been influenced by DAOs. In 2020, Yield Guild Games was established, a gaming guild that turns gamers into investors by purchasing NFTs in games such as Axie Infinity, League of Kingdoms, and The Sandbox.
Another popular DAO, Flamingo DAO, invested a colossal sum in NFTs. Flamingo DAO is a commercial DAO focused on NFT investments. They made headlines when they paid $762,000 in ETH for a rare CryptoPunk NFT.
How to create a Decentralized Autonomous Organization (DAO)
To create a Decentralized Autonomous Organization (DAO), follow the provided steps.
- Define the purpose of the DAO. Discuss with co-founders why you are creating the DAO, what problem it solves, how it will function, and which processes can be automated through smart contracts.
- Prepare a wallet and tools. Create a cryptocurrency wallet. It is necessary for storing tokens, voting, and interacting with the DAO.
- Choose a platform to launch the DAO. Use ready-made tools to create a DAO without programming. For example, Aragon allows you to create a DAO with a voting system, treasury, and participant management.
- Decide how the DAO will earn. Think about where the income will come from, such as dividends from investments or participation in profitable projects.
- Determine who will own the DAO. Plan how participants will receive a share through airdrops (distribution of tokens for activity) or rewards (payment for contribution to the project).
- Set up a governance system. Select how to vote. The most widespread is token-based voting. This will help make decisions through voting.
- Implement a reward system. Configure the distribution of tokens for participation, work, and support.
Conclusion
The concepts behind DAOs provide firms with a framework to establish cost-effective problem-solving models and more. Additionally, legacy institutions can eliminate hierarchical structures in favor of decentralized protocols, to money costs, and remove trust concerns of centralized systems.
At present, Decentralized Autonomous Organizations (DAOs) are still in their stages of development, but in the future, productive platforms are likely to emerge that could partially or completely replace many structures and apply trustless autonomy in various fields such as government administration, transport logistics, banking, automation, e-commerce, and many others.
FAQs
What is the purpose of DAO in the context of blockchain?
The purpose of DAO is to set up an organization that makes decisions in a decentralized way without a central authority.
Is My Privacy Ensured in a DAO?
Yes, your privacy can be ensured in a DAO. Although the transactions and voting processes are recorded on the blockchain and are publicly accessible, the identities and other personal information about the participants are hidden.
Can you trust a DAO protocol for the safety of funds?
Yes, you can trust a DAO protocol for fund security, but with some care. As always, do your homework on the DAO’s security before depositing funds; the protocol's security depends very much on the design, security audits, and community vigilance.
Abimbola Adu
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