What Is a Decentralized Autonomous Organization (DAO)?

A Decentralized Autonomous Organization (DAO) is an emerging form of legal structure that lacks a central governing body and whose members share the common goal of acting in the best interests of the entity. Popularized by cryptocurrency and blockchain technology enthusiasts, DAOs use a top-down approach to decision-making.

KEY TAKEAWAYS

• A decentralized autonomous organization is an entity structure where token holders participate in management and decision-making.

 • The DAO has no central authority; instead, power is shared among token holders who vote collectively.

 • All votes and actions across the DAO are published on the blockchain, making all user actions publicly visible.

 • One of the first DAOs called The DAO was an organization created by programmers to automate decisions and facilitate crypto transactions.

 • The DAO must ensure that security is a priority because an exploit can leave the DAO without spending millions of dollars in its cash savings.

Understanding Decentralized Autonomous Organizations (DAOs)

One of the most important features of digital currencies is that they are decentralized. This means that they are not controlled by a single institution, such as a government or central bank, but are distributed across many computers, networks, and nodes. In many cases, virtual currencies take advantage of this decentralized space to achieve a level of privacy and security not usually available to traditional currencies and their transactions.

Inspired by the decentralization of cryptocurrencies, a group of developers came up with the idea of ​​a Decentralized Autonomous Organization, or DAO, in 2016. (1) The idea behind the DAO is to advance the control and management of cryptocurrencies. corporate-like entity. However, the key to DAO is the lack of central authority; a collective group of leaders and participants acts as the governing body.

How DAOs Work

DAO relies heavily on smart contracts. These logically coded contracts dictate decision-making based on the core business of the blockchain. For example, based on the outcome of the decision, certain codes can be used to increase the circulating supply, burn a selected number of reserve tokens or provide selected rewards to existing token holders. The voting of

DAO was published on the blockchain. Users often have to choose between mutually exclusive options. Voting power is often distributed among users based on the number of tokens they hold. For example, a single user with 100 DAO tokens has twice the voting power of a user with 50 tokens.

This practice is based on the theory that users who have invested money in the DAO are encouraged to act in good faith. Imagine a user who owns 25% of all voting rights. This user can do bad things; however, the user risks the value of his 25 percent investment.

DAOs often have tokenized inventory that can be given in exchange for fiat. DAO members can vote on the use of these funds. For example, to acquire rare NFTs, some DAOs may vote on whether to give up vaults for assets.

In 2021, the Constitution DAO was formed to try to buy a copy of the US Constitution. Although the DAO failed to acquire assets, the DAO showed that a group of like-minded people can form and execute such an effort. (2)

Benefits of DAOs

There are several reasons why an entity or group of individuals might want to follow a DAO structure. Some of the advantages of this form of governance are:

Decentralization. Decisions affecting the organization are made by a group of individuals, not a central authority, who often greatly outnumber their peers. Instead of relying on the actions of one person (the CEO) or a small group of people (the board), a DAO can decentralize authority to a much wider range of users.

participations. Individuals in a community can feel connected to a greater power and whole when they have a direct say and vote in all matters. These individuals may not have strong voting rights, but the DAO encourages token holders to vote, burn tokens, or spend their tokens however they see fit for the entity.

Advertising. In The DAO, votes are cast via the blockchain and publicly visible. It requires users to act accordingly, as their votes and decisions are publicly visible. It encourages actions that benefit the reputation of constituents and discourages anti-community activities. 

The DAO concept encourages people from all over the world to come together seamlessly to create a unified vision. With just an internet connection, token holders can communicate with other holders wherever they live.

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Limitations of DAOs

However, not everything is perfect with DAOS. Improperly setting up or maintaining a DAO has serious consequences. Here are some limitations of the DAO structure.

speed. When a public company is controlled by a CEO, a single vote may be required to decide on a particular course of action or direction the company will take. With a DAO, every user can vote. This requires a much longer polling time, especially considering the time zones and priorities outside the DAO.

Education. As with the fast thing, DAO's job is to educate a lot more people about the entity in question. It is much easier for a single CEO to maintain an interest in the development of the company. At the same time, DAO token holders may have different educational backgrounds, and understanding of initiatives, incentives, or access to resources. A common challenge with DAOs is that as they bring other people together, those different people must learn to grow, strategize and communicate as one.

Inefficiency. Partially summarizing the first two points, DAOs have a high risk of being inefficient. Because of the time required to administratively educate constituents, communicate initiatives, explain strategies, and recruit new members, it is easy for the DAO to spend far more time discussing change than implementing it. A DAO can get bogged down in mundane administrative tasks because it has to coordinate many more people.

Security. The problem with all blockchain resource digital platforms is security. The implementation of DAO requires considerable technical expertise; without it, voting or decision-making can be meaningless. Trust can be broken and users will leave an entity if they cannot trust the structure of the entity. While using multiple sigs or cold wallets is possible, DAOs can be exploited, vaults can be stolen, and vaults can be emptied.

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Pros

• Many different individuals can come together from different work areas to work as a single unit.
• More and more people have a voice in the planning, strategy, and operations of the unit.
• Since blockchain votes are publicly viewable, token holders are naturally incentivized to act more responsibly.
• DAO members can feel empowered to collaborate with like-minded people with similar goals in a single community.

Cons

•      The decisions often take longer because there are more voters.

•      User education is often a greater burden because the voting population is diverse and has different levels of education and knowledge.

•      Voting or collecting users takes longer due to the decentralized nature of the unit.

•      Serious exploits, such as stealing cash reserves, are possible if DAO security is not properly designed and maintained.

DAO Example: The DAO

The DAO was an organization designed for automation and decentralization. It operated as a type of venture capital fund based on open-source code and without a typical management structure or board. For complete decentralization, The DAO was not tied to any particular nation-state, although it used the Ethereum network.

DAO launched at the end of April 2016 thanks to a month-long sale that raised more than $150 million. (3) At the time, the launch was the largest crowdfunding campaign ever.

DAO Operations 

By May 2016, The DAO held a huge share of all ether tokens issued to date (up to 1%, according to a report by The Economist).

However, around the same time, an article was published that discussed several potential security holes and warned investors not to vote on future investment projects until these issues were resolved.

Later, in June 2016, hackers attacked the DAO based on these vulnerabilities. Hackers gained access to 3.6 million ETHS, which was worth about $50 million at the time. (5) This led to extensive and controversial debate among DAO investors, with some people proposing different ways to deal with the hack and others demanding that the DAO be shut down for good. This incident also featured prominently in the Ethereum hard fork that occurred shortly thereafter.

Criticism of the DAO

According to IEEE Spectrum, the DAO was vulnerable to programming errors and attack vectors. (6) The fact that the organization mapped new areas of regulatory and corporate law probably did not make the process easier. The implications of the organizational structure were potentially many: investors were concerned that they would be held responsible for the actions of the DAO as a larger organization.

In July 2017, the Securities and Exchange Commission (SEC) issued a report stating that The DAO sold securities on the Ethereum blockchain in the form of tokens, in violation of parts of the US Securities Act. (7) The

DAO also operated in the murky territory to investigate whether or not it sold securities. In addition, the DAO's performance in the real world has been plagued by long-term problems. Both investors and entrepreneurs had to convert ETH into fiat currencies and this could have affected the value of Ether.

After a dispute over the future of the DAO and a large-scale hacking incident in the summer and fall of 2016, several major digital currency exchanges such as Kraken removed the DAO token, marking the end of the DAO. it was originally intended. (8)

frequently asked questions

What Is a DAO?

The DAO is a decentralized autonomous organization, a kind of bottom-up entity without a central authority. DAO members own DAO tokens and members can vote on entity initiatives. Smart contracts are implemented for the DAO and the code that controls the operation of the DAO is exposed.

What Is the Purpose of a DAO?

The DAO aims to improve the traditional governance structure of many companies. Instead of relying on one person or a small group of people to run the whole thing, the DAO intends to give each member a voice, the right to vote, and the ability to make suggestions. The DAO also strives for strict governance dictated by blockchain code.

How Does a DAO Make Money?

The DAO initially raises capital by exchanging fiat for its original token. This token represents the voting and ownership rights of members. If the DAO succeeds, the value of the original token increases.

The DAO can then issue issued tokens with a higher value to raise more capital. The DAO can also invest in funds if members choose to accept such initiatives. For example, the DAO can acquire companies, NFTs or other tokens. Should these assets appreciate a DAO raise?

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