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Decentralized Autonomous Organization (DAO) - Explained!

December 25, 2021

Decentralized Autonomous Organization (DAO) - Explained!

If you could change anything about your last place of work, what would you change? Leadership? Structure? Payment structure? What if there is an organization that handles all of these segments autonomously and with no central authority? What if you could be a part of that organization’s governance? Sounds interesting? Let’s discuss! 

Every organization operates on specific systems of leadership. Irrespective of the organization's size or the hype around it, there is a method of operation and decision-making process. Despite the attempts to make members of a group involved in the decision-making process, some people end up having the final authority as to which suggestions pass and which do not. 

What if there’s already a structure where everyone is a leader, and which is operated by an immutable system of knowing the outcome of decision making? This is where the Decentralized Autonomous Organizations gain their relevance.

Understanding the concept of DAO 

A Decentralized Autonomous Organization (DAO) helps eradicate a problem present in many conventional organizations - the . When more than one person is involved in an organization, there is bound to be some divergence of interest, priorities, and goals. This leads to parties making selfish choices. DAOs avoid this problem by creating a trustless system and removing the need for centralized leadership.

A DAO is, just as its name says, a decentralized autonomous organization, with its core features being:

  • The governing rules and policies are set up as computer code.

  • It must be present on a blockchain to avoid the need for a central authority.

  • The treasury of the organization must not be accessible without the consent of the majority of the leadership.

  • The company’s day-to-day operations must be totally independent of its creator’s influence. 

Brief History

The first application of DAOs was created in early 2016 when a few crypto enthusiasts decided to create an open-source framework on the Ethereum Blockchain. Named "The DAO," it was an investor-directed venture capital fund. Please do not confuse this with the actual term DAO. This company garnered the most prominent crowdfunding ever with an estimated $250 million worth of Ether when Ether was still trading at $20. 

This huge success was short-lived as an exploit in The DAO’s system left the site reeling from a loss of 3.6 million ETH in mid-2016. Later that year, many exchanges delisted The DAO token, leaving the project battered. Ever since then, several attempts have been made to run enterprises using the decentralized autonomous organization method. Many of them have been successful, as we will see later in the article.

How Does a DAO Work?

Any DAO's efficiency depends on three fundamental things - the smart contracts involved, the set of rules known to all members, and a token that can be spent within the system for rewards. The smart contract holds all the information of the DAO, ranging from who the majority stakeholders are, the workflow, and incentive systems. Defining and encoding the smart contract is the essential part of a DAO as editing or reviewing it would need to include the votes from every member of the decentralized organization. 

After the smart contract has been encoded, there is the need for a token as it plays a crucial role in allocating the voting rights and offering incentives to certain organization members. The holders of these tokens invariably are entitled to voting rights based on their holdings. 

Notable Advantages and Disadvantages of Using a DAO

Advantages

  1. One significant advantage of DAOs is their transparency and divisibility.  You don't need to be skeptical about the people behind the organization and if or not there's an ulterior motive. With the details encoded in a smart contract, you only need to trust the encoded rules and policies.

  2. There is no long, arduous process required to accept innovations with no central authority. When an idea is brought to the table, the stakeholders' votes determine what beliefs are implemented and which ones are not. 

  3. DAOs solve the principal-agent problem. With both parties seeing themselves as members, equally responsible for the organization's progress, issues such as the agent taking excessive risks because he doesn't bear the brunt when things go wrong or issues like ulterior motives dictating the organization's direction are nullified. 

Disadvantages

  1. Currently, getting the majority votes for a decision to be made is a time-consuming process. This means crucial issues such as a bug detected in the code will take a long time to rectify. This can give room for hackers to manipulate systems long before a decision is made. 

  2. Being highly efficient for cross-border organization building is a big plus for DAOs. Still, it comes with a high possibility of facing multiple lawsuits from different cities/countries. These legal and organizational threats to companies pose various hurdles for DAOs. 

Examples and Use Cases

The transitioning of most cryptocurrency exchanges from centralization to decentralization is not as smooth as it seems on paper. DAOs are still a new concept and will evolve with time. Let's look at two notable examples of blockchain projects that run very close to a fully decentralized system. 

MolochDAO: is an organization focused on financing new Ethereum projects. Before you can join, you will need to submit a proposal that the organization members will go through and deliberate if you'd be a good fit in expertise and capital to make sound judgments on upcoming Ethereum-based projects. MolochDAO is still one of the closest organizations to operate on a fully decentralized and autonomous system. 

Dash: Some argue that Bitcoin was the first DAO to exist. While it operates on a decentralized network, Bitcoin is nowhere near a DAO by today's standards. is a cryptocurrency company that comes close to being a DAO as its members come together to deliberate on how the treasury would be managed. 

Why are DAOs the Future of Governance?

The question of which organizations would turn into DAOs in the coming years is very valid. The stereotypical centralized organizations and projects have brought more flaws than imagined. A few of them are mentioned below.

  • Good ideas often die without reaching the people that can make things happen. 

  • Greed and personal gain has been a significant constraint for organizational growth. 

  • Lack of open and fair decision-making. The majority of the organization follows specific instructions because it was "directed from above" and not for the organization’s benefit. 

  • The bulk of the organization does not see themselves as partners when they are equally responsible for the organization’s growth. 

Because of these reasons and many more, the chasm for a decentralized, all-inclusive, and trustable system has gotten more comprehensive than could have been imagined before. The success achieved by the decentralized nature of Bitcoin can only mean one thing; DAOs are here to stay and will become the norm in coming years.

Conclusion

The concept of DAOs is still relatively new, and a lot of work still has to be done, especially concerning legal and regulatory compliance. Nonetheless, since DAOs help removes the principal-agent dilemma, it is only a matter of time before many centralized organizations (most importantly, centralized crypto exchanges) start redefining their values to be decentralized autonomous exchanges. 

Which company, exchange, or cryptocurrency project would you want to see taking the lead? Let us know, as we would love to know your thoughts!

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