What is a Decentralized Autonomous Organization (DAO)?

  • Decentralized Autonomous Organizations (DAOs) are non-hierarchical community organizations that can come together for a number of reasons.
  • Most DAOs are joined by purchasing the DAO’s governance token, which allows them to vote on what actions the DAO will take.
  • Believers in DAO say it will be essential to web3 while skeptics point to its potential to exacerbate inequality.

The underlying philosophy of Decentralized Autonomous Organizations (DAOs) is that our current democracy does not work. Thus, the DAOs provide a means for their members to participate directly in the development of the DAO. As a key part of the web3 ecosystem, DAOs come with a lot of promise and just as much criticism.

What is a DAO?

We can break down the term DAO (Decentralized Autonomous Organization) into its individual letters. As a decentralized organization, a DAO is community driven. In theory, there would be no central hierarchical structure within a DAO.

As an autonomous organization, DAOs operate on an open source blockchain protocol. They are powered by cryptocurrencies called governance tokens, which act like membership cards. These tokens also play a role in the upkeep and maintenance of these organizations, which we will focus on in a moment.

You can think of a DAO – as it currently exists – as a way for people with similar interests to come together without a central direction. The function of a DAO depends on the community. The purpose of most current DAOs revolves around investing or socializing.

However, like many aspects of decentralized finance, much of the focus of DAOs is on what it might be in the future. So for many proponents, this “could be” is an overhaul of democracy as we know it.

“This form of representative democracy that we find ourselves in does not work adequately for the kinds of challenges facing humanity today,” says Rebecca Rachmany, the founder of Direction of the DAO. “I mean the inspiration behind the DAOs is maybe how we could invent new forms of governance and new forms of democracy that would be appropriate to govern the things that belong to all of us, like the oceans, the planet and the health of the planet.”

DAO vs traditional governance

The main difference between DAOs and traditional governance is where decision-making takes place and who can make those decisions.

How does a DAO work?

The specifics of how a DAO works vary with each organization, but generally, to participate in a DAO, you need to own the DAO’s governance token. These tokens allow you to participate in the governance of the DAO, which comes in the form of proposals submitted by members.

Proposals can relate to a number of things. Some proposals relate to actions the DAO will take, such as deciding which NFT a DAO should buy or selecting a venue to host a party. Others may address the function of the DAO itself, such as changes in DAO code and protocol.

With smaller DAOs, the process of creating a proposal can be relatively simple. But as a DAO grows and more members join, the number of proposals the community faces can become overwhelming. “Voter fatigue is a huge problem,” says Rachmany. She says some DAOs are lucky to have 10% of their members vote.

To avoid too many proposals, larger DAOs will require members to stake governance tokens to submit a proposal or charge an entry fee. If a proposal asks members to stake tokens, the creator of the proposal will work to ensure that the proposal passes.

Once someone has put forward a proposal, the community will vote on it. A member’s number of votes will be proportional to the number of governance tokens they own. If a proposal is accepted, it will be executed automatically via a smart contract.

Types of CAD

DAOs are formed for a multitude of reasons, often – but not necessarily – for monetary gain. Here are some ways DAOs are currently being used.

Protocol CAD: One of the primary uses of DAOs today, protocol DAOs govern decentralized protocols. For example, MakerDAO keeps stablecoin Dai pegged to the dollar.

Collector CAD: The purpose of a DAO collector is to acquire NFTs. Members of a DAO will pool their money and buy the NFTs chosen by the members of the DAO. PleasrDAO might be the most prominent DAO collector, buying the Wu-Tang Clan’s “Once Upon a Time in Shaolin” album in 2021 at a government auction.

Another Collector DAO named ConstitutionDAO attempted to buy a copy of the US Constitution at auction, raising $47 million in Ether to do so.

Social DAOs: Most DAOs have some kind of social aspect, but Social DAOs are purely created for the explicit purpose of bringing people with similar interests together.

Since most DAOs require ownership of governance tokens, social DAOs can start to look like a country club. For example, Friends with Benefits requires full members to purchase 75 FWB tokens. Famously, the Bored Ape NFT Collection gives owners access to the Bored Ape Yacht Club discord channel and members-only events.

Investment CAD: Also called venture DAOs, members of investment DAOs pool their money and vote on how and where to invest it using governance tokens. Profits and losses are shared by all members in proportion to their stake.

DAO philanthropy: These DAOs raise funds and collectively decide which organizations to give them to, acting as a community-led charity. These work similarly to DAOs, which choose which DeFi projects to support.

Reviews of DAOs

Like DeFi and blockchain technology, DAOs come with their critics. One of the most important criticisms is that if votes can be bought, then all the power within a DAO goes to the wealthiest members of the community and this supposedly non-hierarchical structure breaks down.

Even without exacerbating inequalities, the DAO’s proposals are not always accepted in the interest of the DAO. Rachmany says proposals often become popularity contests, with voting results based on the person behind the proposal as opposed to the proposal itself. A DAO called Cordana got around this problem by appointing a board of experts that evaluates proposals on a five-star system. Yet appointing a board that evaluates every proposal defeats the purpose of a decentralized organization.

As mentioned earlier, the code for a DAO is open source, which means anyone can see it. This opens them up to bad actors who could exploit weaknesses in a DAO’s code. This is exactly what happened in 2016 when a DAO named The DAO was hacked. Pirates stole $11 billion in ether, forcing the cryptocurrency to fork. The old hacked ethereum is now sold as ethereum classic (ETC) while ethereum (ETH) is the newly forked and unhacked ethereum.

The future of DAOs

Supposedly, DAOs are supposed to play a major role in the web3 ecosystem. To understand this relationship between DAOs and web3, we can go back to the history of the web. In Web 1.0, web pages were static and users could not interact with the content. It is also known as read-only web. In Web 2.0, users can read and write, interact with content instead of just consuming it. This is the version of the web we know today. The latest iteration of the Web, Web3, includes reading, writing, and ownership. “That’s really where DAOs come in, having an organizational structure to align people around a common goal,” says Rene Reinsberg, co-founder of Celo, a financial tools development company. The governance token model theoretically allows users to own part of the business they interact with.

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