DAO is a decentralized autonomous organization on a blockchain operating without central leadership using smart contracts. Decisions are made from the bottom up under the control of the community, organized around a certain set of rules (smart contracts) applied in the blockchain.
DAOs are Internet organizations that are collectively owned and operated by their members. They have built-in financial vaults that can only be accessed with the approval of their members. Decisions are made through proposals that the group votes on within a certain period.
- Decentralized Autonomous Organizations (DAOs) could replace the way we see companies and businesses today.
- DAO is a new type of organizational structure built on code and blockchains.
- They have the opportunity to become global conduits who will bring about a real digital revolution, unlocking the potential of Web 3.
DAO works without hierarchical control and can have a large number of goals. Freelance networks where contracts pool their funds to pay for software subscriptions, charities whose members approve donations, and group-owned venture capital firms are all possible with these organizations.
Before moving on, it’s important to distinguish the modern DAO, the internet organization today, from the DAO, one of the first such organizations ever created. For the first time, the DAO was a project founded in 2016 that ultimately failed and led to a dramatic split in the Ethereum network.
How does DAO work?
First of all, it is important to understand that DAO is an organization in which decisions are made from the bottom up, that is, a collective of members owns the organization. There are various ways to participate in the DAO, usually through token ownership.
DAOs work using smart contracts, which are essentially pieces of code that are automatically executed when a set of criteria is met. Currently, smart contracts are deployed on many blockchains, although Ethereum was the first to use them.
These smart contracts set the rules of the DAO. Those who have a stake in the DAO are then given voting rights and can influence how the organization operates by making decisions or creating new governance proposals.
This model prevents DAOs from spamming proposals: a proposal will only be accepted after it has been approved by a majority of stakeholders. The way this majority is determined varies from DAO to DAO and is specified in smart contracts.
DAOs are completely autonomous and transparent, since they are built on open source blockchains, anyone can view their code.
Anyone can also check their embedded treasuries as the blockchain records all financial transactions.
As a rule, the launch of a DAO occurs in three main stages
Creating a Smart Contract: First, a developer or development team must create a smart contract for the DAO. Once launched, they can only change the rules set by these contracts through the control system. This means that they must test contracts thoroughly to make sure they don’t overlook important details.
Funding: After creating DAO smart contracts, it is necessary to determine how to receive funding and how to manage. Most often, tokens are sold to raise funds; these tokens give holders the right to vote.
Deployment: Once everything is set up, the DAO needs to be deployed on the blockchain. From this point on, stakeholders decide on the future of the organization. The creators of the organization – those who wrote the smart contracts – no longer influence the project more than other stakeholders.
Understanding: is it necessary to run a DAO
There are a number of considerations to take into account before forming or transitioning to a DAO structure. To get started, potential hosts should focus on two main areas: purpose and utility. It is important to note that DAOs are not practical or suitable for all use cases, and many areas still need improvement.
If you’re interested in building a DAO, ask yourself, “Is a DAO necessary to achieve this?” If the answer is yes, move on to the question: “What benefit will our organization gain from being able to hopelessly coordinate their actions on the blockchain and align incentives through a complex system of tokenomics?”
How to start DAO today?
Today, starting a DAO project is easier than even a year ago. Given the level of maturity achieved in the blockchain industry and the growing acceptance of Web 3 and blockchain technologies, the market now offers several tools and platforms for creating DAOs that cover everything from universal toolkits like Aragon to specific tools around creating and managing a treasury.
But while the entry barrier is not difficult and quite manageable, there are still many vital decisions that need to be taken into account.
Gathering a founding team, building a community
At the heart of every successful DAO is a strong community. And at the heart of every strong community is a core DAO team. When creating this team, it is very important to find the right partners. This group should go beyond being passionate about the mission you want to accomplish. They should also be dedicated to realizing the long-term horizon in order to realize its greatest potential.
It is best to choose participants with similar views but different and complementary skill sets. You will need someone with Web3 technical know-how to become a key contributor. However, traditional areas such as economics, marketing, operations, and community management are also critical to DAO’s long-term success.
It is important to note that this guide should not be considered financial or business planning advice. As any successful DAO will probably tell you, it is highly recommended that you seek the advice of a lawyer to ensure that you comply with all legal and financial requirements, especially if you are considering issuing your own DAO token.
It’s hard to have a real DAO without community management. This is why it is important to find the proper mechanism or service for members to connect their wallets and propose, view, and vote on treasury/minutes decisions.
With gas fees rising, online voting can become expensive, which is why some DAOs (and famous projects like Doodles) rely on custom offline governance tools like Snapshot to facilitate governance proposals. Ultimately, the choice between conducting voting online or offline is a decision made by the core DAO team.
Creating and placing a token
Once you have the community, governance mechanism, and technical infrastructure in place, it’s time to tackle the tokenomics of your DAO. In many cases, tokenomics will serve as the underlying incentive structure. But be careful: if implemented incorrectly, tokenomics can damage the integrity of the community and even the overall longevity of the DAO.
Most DAOs use tokens to either reward members, vote on proposals, unlock other benefits, or a combination of the three. Before proceeding, you should consider what purpose your tokens will serve in your DAO. Will they be used to vote on the direction of the organization? Will they have intrinsic value? Can they be additionally wagered on additional income?
You will need not only the talent and knowledge of DAO members to create the token itself, but also consideration of the impact of the supply and distribution of tokens. Given the undeniable psychological impact of supply and demand on cryptocurrency pricing, finding that sweet spot is one of the hardest parts of running a DAO and has been documented by both ENS and Uniswap.
In terms of distribution, it’s critical to strike the right balance between incentivizing and rewarding your community and having enough funds in the community coffers to move towards bigger goals. Again, we cannot overemphasize the importance of communicating with a lawyer throughout the token creation process to ensure security and legal compliance.
Treasury at the DAO
Perhaps the most important decision of your DAO is where to place your treasury. While the DAO Treasury acts like any standard bank account, these funds are likely to be the lifeblood for whatever purpose your DAO pursues and should be protected with the utmost security. To limit the risk of attackers and ensure that no single person controls DAO funds, most DAOs prefer to create multi-signature (multi-sig) wallets.
Multi-signature wallets require multiple people to sign blockchain transactions before they can be executed. For this, Gnosis Safe and SafeSnap have become the industry standard. Gnosis also allows you to store multiple tokens in one wallet. For example, Gnosis can contain a mixture of both ETH and a native DAO governance or social token. Other examples of DAO Treasury management tools are Parcel and Llama.
Rules and Prohibitions: Do’s and Don’ts in DAO
While technically building a DAO is relatively easy, managing it successfully is a different story. But who better to learn about the intricacies of DAO success than those who have first-hand experience with it?
In the interest of providing both guidance and practical evidence for this guide, we spoke to a number of DAO creators and core members to get their thoughts on the most important rules and do’s and don’ts when working with the DAO.
Building a DAO – learn from the experts
The first to share wisdom was the pseudonymous Web3 developer and co-founder of Krause House, Commodore, who said that without a strong community, the DAO could never get going. And he should know because Krause House includes a DAO with a global reach that embodies the great goal of owning and managing an NBA team.
“To bring a group of people together and act in the spirit of the DAO is an incredibly powerful signal that building a DAO is worth the time,” Commodore said. “I always recommend reaching out to 100 people via Twitter, Discord, or a podcast to see if the idea has momentum. If so, explore together how to become a DAO.”
Cooper Turley, one of the most prominent players in Web3 music and founder of the Fire Eyes DAO, shares a similar sentiment. He argued that without product-to-market fit, the DAO would be short-lived and that it was critical to find a differentiated niche that would keep participants coming back every day. When launching Fire Eyes, Turley took a simple and realistic approach. “Think down-to-earth and focus on a very small number of people,” he said, suggesting a better way to keep things simple.
The same applies to the structure of tokenomics. While it can be fun to include features like staking, burning, and game theory, there’s no reason to launch things you don’t understand. It is much better to take the slow and steady path to success than to try to do it all at once.
However, the slow, steady, and simplistic spirit can also apply to the organizational structure of the DAO. Because while hierarchy is still present in all DAOs, it is important to eliminate the possibility of a single voice or authority to dictate key decisions. In fact, the aforementioned founder of Alterrage, Kacher, considers developing a simple and thoughtful leadership infrastructure in his organization a beacon of success, offering additional best practices for not locking your DAO to one leader.
- “At Alterrage, we don’t have a single leader, but rather we have seven different areas (for example, ateliers, technology, web 3 architecture, etc.) that focus on core business areas,” Kacher said.
- “Each area is led by one ‘leader’ with the additional help of three support leaders who are all equally trained. Without training or a form of leadership, members of uncertain DAO communities often get lost and leave out of frustration.”
Optimization of registration and documentation
In addition to the recommendations outlined by those involved with the DAO, there are some other best practices to consider. The first is accessibility because it should be simple and easy for people to learn more about how your DAO works and what it is for.
This discovery and adaptation process should be one of the first activities of the core team, as it is necessary for the growth of the DAO. All rules and standards should be clearly documented and linked in many places.
If this is a “serious” DAO with paid full-time members, it’s even more important to map out very precise membership requirements and install documentation now to avoid disputes in the future.
Conflict resolution standards and processes should also be put in place, as no organization, DAO or otherwise, is free from conflict.
Listen to the community
As people join your DAO, it’s especially important that your community always feels heard and understood.
This need goes far beyond governance and voting proposals and should include personal feedback, Discord conversations, Twitter discussions, and more.
Start small and invest in the right tools to grow
Because most DAOs are global communities, and growth is often the most important thing, founders must invest in scalable, accessible, and manageable communication platforms to support multiple languages and content media. Only time will tell if DAOs become mainstream organizations. But for now, the best course of action for aspiring DAO founders and the broader Web3 community, according to Commodore, is to just get started.
- “Part of the beauty of innovation and breakthroughs is that new tools are being created and people are using those tools for all kinds of different needs in their lives,” said Commodore.
- “We’re only in the early stages of learning about this powerful new tool, so it’s still too early to tell what things fit and what don’t. I’m just happy to see so many people trying to build a DAO because together we’ll quickly make more progress as we collect the winnings.”
Features and risks of DAO today
In theory, DAOs should act as a more ethical and transparent way to govern organizations. Not only do they eliminate the need for centralized hierarchical decision-making, but they successfully align incentives among all stakeholders. This turns users and members of the organization into real investors and owners. By choosing community property, DAOs allow those who are active in the organization to have a say in important decisions about its future.
But while successful DAOs create a circular ecosystem where no one person has the final say, it is important to note that all DAOs still contain the orders of authority. In most DAOs, individual contributions are often rewarded with governance tokens. Those who contribute the most also own the most governance tokens and therefore have the highest reputational voting power.
DAOs are new, so many of them still work despite operational hurdles. Collaborative decision-making takes time and requires the full participation of the community for the smooth operation of the DAO. Reaching a consensus can be a difficult task. Even getting a proposal to the voting stage can be difficult if there are too many parties involved in the early stages of DAO formation.
DAOs offer great opportunities for business growth, but with the risk of losing control without the right foundations.
Compared to corporations and official organizations, DAOs also carry significant security risks. Web3 is still the wild west, and we’ve seen even the most robust smart contracts get hacked. So, before you move forward in forming a DAO, you should have a team of experienced developers and a lot of risk mitigation plans.
Why do we need DAOs?
As Internet organizations, DAOs have a number of advantages over traditional organizations. One of the significant advantages of DAO is that there is no need for trust between the two parties. While a traditional organization requires a lot of trust in the people behind it—especially on behalf of investors—with a DAO, only the code needs to be trusted.
It is easier to trust this code because it is public and can be thoroughly tested before being run. Every action the DAO takes after launch must be community approved and fully transparent and verifiable.
Such an organization does not have a hierarchical structure. However, it can still perform tasks and grow while being controlled by stakeholders through its own token. The lack of hierarchy means that any stakeholder can come up with an innovative idea that the whole group will consider and improve on. Internal disputes are often easily resolved through a voting system according to pre-written smart contract rules.
By allowing investors to pool funds, DAOs also give them the opportunity to invest in early-stage startups and decentralized projects while sharing the risk or any profit that may be generated from them.
The Principal-Agent Dilemma
The main advantage of DAOs is that they offer a solution to the principal-agent dilemma. This dilemma is a conflict of priorities between a person or group (principal) and those who make decisions and act on their behalf (agent).
Problems can arise in some situations, most commonly between stakeholders and the CEO. The agent (CEO) may operate in a way that is not in line with the priorities and goals set by the principal (stakeholders) and instead act in their own best interest.
Another typical example of a principal-agent dilemma occurs when the agent takes on the excessive risk because the onus is on the principal. For example, a trader can use extreme leverage to get a performance bonus knowing that the organization will make up for any shortfall.
DAOs solve the principal-agent dilemma through community governance. Stakeholders are not forced to join the DAO and only do so after understanding the rules that govern it. They do not need to trust any agent to act on their behalf and instead work as part of a group whose incentives are aligned.
The interests of token holders are aligned as the nature of the DAO encourages them not to be malicious. Since they have a stake in the network, they will want it to succeed. To act against him would be an act against their self-interest.
History of DAOs
DAO was an early iteration of modern decentralized autonomous organizations. It was launched back in 2016 and conceived as an automated organization acting as a venture capital fund.
Those who held DAO tokens could profit from the organization’s investments, either by receiving dividends or benefiting from the rise in the price of the tokens. Initially, DAO was seen as a revolutionary project and raised $150 million in Ether (ETH), which became one of the largest crowdfunding projects of the time.
The DAO was launched on April 30, 2016 after Ethereum protocol engineer Christophe Jensch released open source code for an Ethereum-based investment organization. Investors bought DAO tokens by transferring ether to their smart contracts.
A few days after the start of the token sale, some developers expressed concern that a bug in The DAO smart contracts could allow attackers to withdraw its funds. While a proposal was put forward to fix the bug, the attacker took advantage of it and siphoned over $60 million worth of ETH from the DAO wallet.
At the time, about 14% of all ETH in circulation was invested in the DAO. The hack was a major blow to the DAO as a whole and to the then one-year-old Ethereum network. A debate ensued in the Ethereum community as everyone tried to figure out what to do. Initially, Ethereum co-founder Vitalik Buterin proposed a soft fork that would blacklist the attacker’s address and prevent him from moving funds.
The attacker, or someone impersonating them, then responded to this offer by claiming that the funds were obtained “legitimately” in accordance with the rules of the smart contract. They said they were ready to sue anyone who tries to take possession of the funds.
The hacker even threatened to bribe ETH miners with some of the stolen funds to thwart the soft fork attempt. In the ensuing debate, the decision was determined by the hard fork. This hard fork was implemented to roll back the history of the Ethereum network before The DAO was hacked and reallocate the stolen funds into a smart contract that allowed investors to withdraw them. Those who disagreed with the move rejected the hard fork and supported an earlier version of the network known as Ethereum Classic (ETC).
Disadvantages of DAO
Decentralized Autonomous Organizations are not perfect. This is an extremely new technology that has drawn a lot of criticism due to lingering concerns about their legality, safety and structure.
The MIT Technology Review, for example, found it a bad idea to trust the masses with important financial decisions. Although MIT shared its thoughts back in 2016, the organization never seems to change its mind about the DAO — at least not publicly. The DAO hack has also raised security concerns, as flaws in smart contracts are difficult to fix even after they are discovered.
DAOs can be distributed across multiple jurisdictions and there is no legal basis for them. Any legal issues that may arise will likely require participants to engage in complex litigation with numerous regional laws.
For example, in July 2017, the US Securities and Exchange Commission released a report that found that the DAO sold securities in the form of tokens on the Ethereum blockchain without permission, violating part of the country’s securities law.
Decentralized Autonomous Organizations have gained popularity over the past few years and are now fully incorporated into many blockchain projects. For example, the decentralized finance (DeFi) space uses DAO to allow applications to become fully decentralized.
For some, the Bitcoin (BTC) network is the earliest example of a DAO. The network is scaling by community agreement, even though most network members have never met each other. It also lacks an organized governance mechanism and instead, miners and nodes must signal support.
However, by today’s standards, Bitcoin is not considered a DAO. By current standards, Dash will be the first true DAO as the project has a governance mechanism that allows stakeholders to vote on the use of its treasury.
Other, more advanced DAOs, including decentralized networks built on top of the Ethereum blockchain, are responsible for launching cryptocurrency-backed stablecoins. In some cases, the organizations that originally launched these DAOs gradually give up control of the project, only to one day become irrelevant. Token holders can actively vote on governance proposals to recruit new contributors, add new tokens as collateral for their coins, or adjust other settings.
In 2020, the DeFi lending protocol launched its own governance token and distributed it through the liquidity mining process. Essentially, anyone who interacted with the protocol received tokens as a reward. Since then, other projects have copied and adapted the model.
Now the list of DAOs is extensive. Over time, it became a clear concept that gained momentum. Some projects are still aiming to achieve full decentralization with the DAO model, but it is worth noting that they are only a few years old and have not yet reached their final goals and objectives.
As Internet organizations, DAOs have the potential to completely change the way corporate governance is run. As the concept matures and the legal gray area they operate in clears up, more and more organizations can adopt the DAO model to help manage some of their activities.