What are DAOs?

5 mins read March 09, 2022

What are DAOs?

A decentralised autonomous organisation (DAO) operates without the need for hierarchical management and can serve a variety of objectives. DAOs are software models that run on the blockchain and allow its users to collectively manage its code and protocol. It is built on a smart contract that enforces specific rules which are embedded in its code on members, therefore, creating a trustless organisation.

What does Trustless mean in Blockchain?

Trustless simply means that you do not have to place trust in an institution or person to complete negotiations or payments. Participating parties within a blockchain are incentivized to cooperate with the rules defined by their protocol to ensure compliance.

DAOs Vs. The DAO

The DAO launched in 2016 was the first model of a decentralised autonomous organisation created as a form of venture capital fund. That is, its members collaborated and provided funds for projects that they considered highly profitable and benefitted by receiving dividends.

Some developers expressed concerns a few days into the token sale that a glitch in The DAO's smart contracts may allow unscrupulous actors to drain its cash. While a governance plan was being developed to address the flaw, an attacker exploited it and stole approximately $60 million in ETH from The DAO's wallet. In response to the hack, there was a hard fork in which the Ethereum Blockchain was returned to its previous state before the introduction of The DAO to allow investors to withdraw their stolen tokens.

Even though “The DAO” failed, there have been several successful DAO projects since then. Some of these projects include Bitshares (aka DAC), PleasrDAO, Herstory DAO, MetaCartel venture (DAO).

How do DAOs work?

DAOs are built on blockchain technology and use smart contracts to enforce laws such that no member of the organisation can bypass the laws or cheat others. Smart contracts are agreements between parties that are automated and executed once certain conditions are met.

The rules guiding the organisations are decided by DAO stakeholders, and once completed, the organisation can begin to raise funds and add more members.

For a DAO to begin its operation, there are certain processes it goes through.

The setting of rules and Encoding: DAOs are structured differently, but they all possess a unique code that users agree to adhere to when they join the organisation. The codes establish voting rights, membership policies and the mechanism through which proposals are filed.

Governance: DAOs do not have a central authority. The governance rules are ideally encoded in the smart contracts and cannot be changed except members of the DAO agree otherwise.

Autonomous and transparent: Ethereum co-founder, Vitalik Buterin proposed that DAOs should be automated and the smart contract contracts should be supported by a Turing-complete platform. Ethereum is considered a Turing-complete platform which explains why most DAOs are built on the ethereum blockchain. DAOs are most successful when they are autonomous and transparent such that anyone can view its codes, audit its treasuries, and the records cannot be duplicated or manipulated.

Funding: The DAO's funds can be gotten from the sale of the DAO’s governance tokens. The governance tokens can be sold at bids or on crypto exchange platforms. Dividends from the organisation's investments are typically how a DAO makes money and they are distributed to the members.

DAO Membership Policies

DAOs have different policies concerning their membership which is embedded in the smart contracts. As such, a DAO may have:

Open membership: Membership is fully open, and it is easy to join

Governance token/ Token gated membership: Members are limited via tokens, and an interested member must authenticate that they possess the required tokens before they can join the DAO. These tokens are equivalent to shares in a traditional corporation.

When considering joining a DAO, find out what kind of membership policies they have in place, the participation rate of the members and how they respond to proposals to see if they are fully participatory.

Challenges of DAOs

Although DAOs are vastly growing, certain limitations have discouraged many from setting up DAOs even though they can revolutionise the existing organisational and business models. Some of the limitations include:

DAOs although largely automated may be unsuccessful in the long term such as “The DAO.”

Investors or members of the DAO may experience losses if the governance token’s value drops or hits zero.

The legal framework of DAOs remains unclear and may vary according to jurisdiction Wyoming is the first state to recognise DAO as a legal entity. However, DAOs can exist without legal status as a corporation as long as participants in the DAOare in compliance with the law.

DAOs code is encoded and difficult to alter once the system is up and running. As such it may pose a significant danger if there are bugs like in the case of “The DAO.” Modifications to the code would require the consensus of all members and may still be difficult to repair as the process of modifications may open risk of exploitation or hacking.

Should you join a DAO?

The decision to join a DAO is personal. The main thing to consider is if a DAO represents an idea you believe in and if it is worth your investment. Here are some of the benefits of DAOs to keep in mind when considering it as a potentially profitable venture to invest in:

Trustless and transparent
Global and local business models can be created among individuals on a trustless basis with no one above the rules and regulations as the smart contract automatically enforces set codes.

Non-hierarchical structure
In traditional institutions, the CEO or board of directors may pursue selfish interests, which may not be in the best interest of the organisation or in line with the goals and members would not have the power to change this as the board of directors act in their favour. However, DAOs remove this conflict since power is decentralised.

Conclusion

DAOs have potential, and their broad adoption would aid in the management of financial initiatives by providing transparency and decentralisation. As DAOs become more widely used, they will adapt to overcome their limits and cover the inadequacies within the traditional financial system. Before investing in a DAO, you should undertake thorough research to ensure that you are investing in a viable project.

Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.

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