With all this buzz about web3, decentralization seems to be the future we are moving towards. Taking that into consideration, I’ve been noticing many more DAOs appearing. Whether they’re created solely to raise capital for something specific, or even if they’re incorporated into an NFT project, DAOs surely have their place in web3.
There’s a lot to unpack when it comes to DAOs. But bear with me, I’m going to take you through what a DAO is, how it works, and why DAOs are so important moving forward.
What is a DAO?
DAO stands for Decentralized Autonomous Organization. It is a virtual organization that is represented by computer-coded rules and regulations on the blockchain. A DAO is free from the influence of a central government and is instead ruled by a community, with each individual having a right to vote on what happens within the DAO.
To expand further, a DAO is an organization that is ruled by a decentralized community of members. It works with computer-coded rules and laws which are completely autonomous. DAOs run completely on blockchain protocol and are controlled via smart contracts. The whole process is transparent and you can regard it as a trustless system.
Instructions and decisions are pre-made, with cryptography. According to different conditions, you will find that the code makes different decisions. This leaves zero room for human intervention and therefore there’s no scope for corruption. With DAOs, you can achieve levels of transparency, cost savings, and decentralized decision-making that we previously thought were unachievable.
At the top of most organizations, some people make decisions. This could be the CEO or a board of stakeholders or anybody else. But whenever such a situation arises, there’s always the chance that the decision-maker would put their profits first, rather than the benefits of everyone who works there.
You can refer to this as the principal-agent dilemma. Whenever there is an agent who is in charge of making decisions on behalf of the principal their goals may diverge and their gains will be put forth ahead of the collective gain.
Since DAOs put the decision-making in the hands of automated code and computers, there’s no need for this human intervention and corruption. All your decisions are coded beforehand and the process is completely autonomous.
How does a DAO work?
A DAO works by forming a core team of community members using smart contracts. These smart contracts establish the groundwork for how the DAO will function. They are transparent, verifiable, and publicly auditable on the blockchain, allowing any potential member to fully grasp how the protocol will operate at each stage.
The specific mechanisms and systems underlying different DAOs differ on the kinds of blockchains and codes they use, however, the overall system is pretty similar. There needs to be a smart contract that defines the “laws” of the organization, there needs to be funding, and then finally there is the deployment stage.
You make each decision in a bottom-up approach. Usually, anybody who owns tokens or holds a stake in the DAO can collectively vote on what the rules are in the smart contract. The majority rules the system. Anyone with voting rights can pass proposals and you will decide on which ones pass through by voting.
This is also where most of the funding comes in. People buy tokens to get a say in the voting rights of the rules of the DAO. And these tokens are what provide the funding to run this system. Then the developers would code the smart contract based on the rules established by the community. So, the whole process is fully transparent.
The final stage is the deployment of the DAO on a blockchain. Once the DAO is deployed, all the rules are in motion. Now the developers or creators of the project have only as much control as the community does. Ultimately, stakeholders get to decide what happens in the future, or anybody who has voting rights.
Why are DAOs important?
DAOs are important because they have several advantages such as being completely autonomous and transparent, to being trustless. This decentralization allows for a level playing field for everyone involved, and certain entities do not inherently have more power than others.
Let’s take a deeper look into why DAOs are so important.
1. Trustless organization
In current organizations, there’s a need for trust. You have to trust the other parties involved to make decisions that will benefit the greater good of the organization and the community. Which isn’t always the case.
Since DAOs leave the decision-making to codes, it can be easier to form this trust. You know what will happen if certain conditions are triggered. This is why it leaves room for no corruption. You don’t have to trust anybody and the code is fully transparent and anyone can verify what’s going on.
2. No hierarchy
Even with the current World Wide Web, you can see there are only a few companies at the top that are controlling everything. The power is still very much centralized online, and many businesses are suffering from it. It is starting to look a lot like the real world, where the rich and powerful only get profits and everyone else is left to fend for themselves. DAOs aim to change that.
DAOs work on a bottom-up approach. A community of members (which can be anyone with voting rights) collectively decide on what rules everyone follows. So, there’s no hierarchy. DAOs give power back to the people.
3. Solves the principal-agent dilemma
The principal-agent dilemma has long been a problem that almost all organizational systems face. DAOs provide a sustainable solution to that problem. This is also the reason why a lot of people prefer DAOs over traditional organizational systems.
We previously thought that there were minimal solutions to this problem because there would always be the need to involve humans in the process. By taking humans out of the equation, decisions are much fairer and more logical.
DAOs are perhaps the closest thing to true democracy that we can get in our society. So it’s no wonder that people are slowly shifting to this model. While we might have to wait before this is the norm, the sooner you are on board, the better you might be able to implement it in your organizations as well.
Examples of a DAO
Even though DAOs are just beginning to come into the mainstream limelight, they have been around for a while. Most people would recognize Bitcoin as the first DAO example. However, if you consider the true definition of a DAO, Bitcoin doesn’t technically classify as a DAO since there is no organized governance system involved. So, what are some examples of a DAO?
Examples of DAOs include DASH, a cryptocurrency administered by its users, MakerDAO, a program that maintains a stablecoin, and Augur, a prediction market platform. One popular example of a DAO is a shared virtual world like Decentraland, where their DAO is a decision-making tool for MANA and LAND holders.
Even Decentralized Finance or DeFi, which is a space that allows applications to be decentralized, has launched its governance token.
Disadvantages of DAOs
Although DAOs have many advantages over traditional organizations controlled by a human entity, there are some disadvantages and concerns with DAOs as well.
Disadvantages of DAOs include:
- DAOs are a new technology and their uncertainty make people apprehensive
- DAOs lack any legal structure or governance
- The DAO hack has raised security concerns in the past
- Bugs could be exploited by hackers
- The anonymous process used to create DAOs could create an accountability gap
- Liability can’t be easily enforced
Taking all these disadvantages into consideration and addressing each one is an important step towards incorporating DAOs on a larger scale, across numerous industries. However, such as with anything new, there will always be things that need to be worked out.
Unless we continue to explore DAOs and their use-cases, we won’t be able to expose all the disadvantages, hence we won’t be able to improve DAOs and their utility. Exploring both the pros and cons of DAOs is crucial, but so is being thoughtful about every step you take.
Whether you’re creating your own DAO, or you become part of an existing DAO, you need to take into consideration all the risks and unknowns of DAOs in order to take full accountability for your actions throughout your exploration of this new technology.
Final thoughts
As the world is shifting more into a decentralized and virtual space, DAOs are not a thing of the future anymore, but rather the present. DAOs give the decision-making back to the people, while the intentions of the organization are automated and transparent thanks to blockchain technology.
I believe many more brands and businesses will utilize DAOs to help raise capital and form a strong community full of like-minded individuals. What DAO will you be a part of?
1 thought on “DAO Explained: What is it and Why is it So Important?”
Comments are closed.