What are DAOs?: The Future of Organizations
For the past two decades, centralized organizations have led the path in the development and growth of the internet. Now, as the internet transitions into Web 3.0, decentralization has become a trending topic in the tech world. In the midst of these discussions arises the question: in the future, what do organizations look like within the framework of a decentralized internet? Decentralized autonomous organizations, or more commonly known as DAOs, could be the future of organizations.
Introduction to DAOs
So, what are DAOs? Think of them basically as a digitally native group owned and managed by like–minded individuals collaborating and coordinating together, through a mutual set of rules enforced on a blockchain, for a specific purpose. Before we learn more about how DAOs are the future of organizations, let’s first look at the numbers.
In 2021, interest in DAOs and the overall DAO ecosystem have significantly flourished. According to data from DeepDAO, assets under management in DAOs’ treasuries had a 40x increase from USD$400 million to a whopping USD$16 billion. Additionally, participating members of DAOs increased 130x from 13,000 to 1.6 million. These numbers are expected to further increase in 2022.
Characteristics of a DAO
What differentiates DAOs from traditional organizations is their technological foundation: smart contracts. More specifically, the programming code and data of smart contracts define the rules of governance for the organization. Moreover, a collective proposal and a subsequent voting process determine decisions within the organization.
In the table below, you can see additional characteristics of a DAO that differentiates it from traditional organizations.
How do DAOs function?
Because smart contracts essentially govern DAOs, a central authority like CEOs are not necessary to run the organization. Therefore, in democratic fashion, group voting decides the course of action within DAOs–from authorization of payments to strategic decisions. These unique aspects show how DAOs can be the future of organizations.
Once a smart contract is written on the blockchain, the rules of the contract. can only be changed via voting. Furthermore, any actions that go against the rules of the contract will fail.
Smart contracts not only define the rules of the organization, but also regulate the treasury holding governance cryptocurrency tokens. Governance tokens are created at the inception of a DAO. The amount of tokens equal to the amount of votes a member has. Votes give tokens a price, which in turn give tokens an utility. For example, members can use tokens to vote on important issues such as salary for any employees or even use tokens as incentives for voting rights.
Lastly, it is in every member’s best interest to work diligently for the DAO because an increase in the token’s value translates to an increase in profits for the DAO.
There are two primary types of memberships for DAOs: token-based membership and share-based membership. The type of membership is important because it determines the voting system used to govern the DAO.
As the name suggests, token-based membership is based on cryptocurrency tokens. A member holding tokens also holds voting rights. Depending on the token used, a token-based membership is completely permissionless, meaning the DAO is open for anyone to join as long as they possess the DAO’s token. Members can earn governance tokens in exchange for cash or Proof of Work, then held or traded on decentralized exchanges (DEX). Ultimately, a token-based membership is useful to govern either decentralized systems or the tokens.
One of the most prominent DAOs with token-based membership is MakerDAO, whose governance token is MKR. Holders of MKR token can vote on decisions pertaining to MakerDAO’s future course of actions.
Share-based memberships are slightly different from token-based memberships. To join a DAO based on shares, one must submit a proposal that outlines their contribution–either in the form of tokens or a skill. Additionally, existing members may also vote on the acceptance of prospective members. In this sense, share-based memberships are more permissioned than token-based memberships.
By offering something of value, a prospective member earns shares, which directly represent their ownership of assets in the treasury and voting power. At any time, members are also allowed to revoke their membership and leave with their assets. Therefore, share-based memberships are useful for close, small-scale groups like charities or venture capitalist investment groups; however, this type of membership can also govern systems and tokens.
One example of a DAO with share-based membership is MolochDAO, created on the Ethereum blockchain. The purpose of MolochDAO is to improve and support infrastructure projects pertaining to Ethereum via funding, ultimately to further promote the use of Ethereum. Therefore, prospective members can only be accepted if they write a proposal demonstrating the knowledge and expertise regarding Ethereum to make informed judgments.
Different types of DAOs
The aforementioned MakerDAO and MolochDAO are considered a protocol DAO and grant DAO, respectively.
Protocol DAOs are often the backbone of decentralized finance (DeFi) protocols like MakerDAO. Lending platforms may utilize protocol DAOs as a tool for ownership and governance to promote decentralization.
Grant DAOs–like MolochDAO–are used to fund the development of blockchain-based projects such as Ethereum or DeFi protocols with grants.
Other types of DAOs include but not limited to:
- Investment DAOs (e.g. The LAO): similar to traditional VC investment groups that pool capital and invest in projects; token holders, and not a central authority, vote and decide on capital allocation
- Collector DAOs (e.g. PleasrDAO): members pool capital to invest in in collectible items like NFTs, exclusive physical artwork, and other media
- Social DAOs (e.g. Friends with Benefits): private, multi-purpose social clubs for like-minded individuals; one can gain access to a DAO via a membership fee purchased using the DAO’s tokens
- Service DAOs/DAO-related services: focus on providing DAO-related services and resources; for example, platforms like Aragon allow people to create their own DAOs
Why are DAOs important?
Foremost, creating a traditional organization requires enormous amounts of resources, and, most importantly, trust in your colleagues–especially if you met them on the internet. Furthermore, dealing with a central authority and related bureaucracy are difficult.’ Traditional organizations are also more prone to corruption and centralization of power.
Smart contracts provide a solution to the limitations of a traditional organization. Members of a DAO do not necessarily have to trust each other. They only need to trust in the code, which is the basis for governance within the DAO. This makes the decisions and processes of DAOs more transparent, auditable, and confirmable. The utility of smart contracts ultimately enable DAOs to be the future of organizations.
DAOs help solve the principal-agent problem, which refers to the problem that arises from a conflict of interests between a group (agent) and the central authority (principal) making decisions for the group. Democratic community governance, where both interests and incentives are aligned, is the solution.
Essentially, DAOs open the door for an ownership-based economy. Instead of corporations, DAOs enable people from all over the world to capture the value derived from collectively organizing and creating value. Therefore, DAOs not only significantly expand the possibilities for globalized collaboration and coordination, but also provide a lot of utilitarian value.
Example use cases for DAOs
- Digital art: according to Andrew Kang (co-founder of Mechanism Capital), “the future [of art] is community ownership.” Artists can join collectives like DAOs to learn from other artists with diverse skill sets, support each other, and create together.
- Investment: DAO members can collectively vote on which ventures to pursue and know how their funds are being allocated
- Charity: members can be from anywhere in the world and collectively decide on how to spend donations
- Freelancing: freelancers can pool their money to collectively spend on tools or services they need
Advantages of a DAO
- Transparency: the code is open-source so anyone can view or change it
- Distribution of trust: A lack of central authority means every member can vote on decisions regarding the DAO, including future plans and changes in the smart contract
- Impossible to shut down: the DAO continues to function even if a major developer leaves the project; any federal authority who wants to shut it down needs to participate in the voting process like anyone else
Disadvantages of a DAO
- Transparency: open-source code is also a disadvantage because anyone can see, analyze, and, if not secure enough, potentially hack the DAO’s code (e.g. ‘The DAO’ incident in 2016) or discover business secrets
- Inability to be completely decentralized and autonomous: although DAOs are structurally and geographically decentralized, smart contract protocols need a technical expert to design and improve the code, which can be viewed as centralized
Challenges & Limitations
The idea of a DAO is still nascent. Centralization has already proved to be effective and efficient. To become the future of organizations, DAOs have a long way to go to reach the impact that democracy and centralized governance have had on modern society.
A DAO’s legal and regulatory framework, in addition to the overall infrastructure, are underdeveloped. This is especially true when compared to corporations. Although they are similar to corporations, DAOs also do not fit into the same legal and regulatory frameworks because both entities are fundamentally different.
For example, in the U.S., debates are ongoing regarding the legal and regulatory domain of DAOs. The question of whether DAOs are an LLC or a general partnership has created a shroud of uncertainty around DAOs. It gets particularly tricky when DAOs want to also be established in the physical world. Therefore, DAOs will continue to operate in a gray area until agreements can be reached.
There’s a reason why traditional corporations with strict hierarchies have worked for so long. Decisions will be impossible to execute if every employee in a hierarchical organization had a say.
This is the same for large-scale DAOs. The majority of DAOs today have unrefined governance structures (e.g. 1 token = 1 vote). Everyone who votes has their own opinion, which makes extremely complicated in voting situations with hundreds or thousands of token holders.
The governance structure needs improvements. For example, DAOs can adopt a delegated authority model. This model allows token holders to vote in qualified leaders to make important decisions transparently. Members can also create sub-DAOs, or “bubbles” within a DAO, to improve the efficiency of assigning tasks and the organization of information flow.
As we usher in a new era of the internet, DAOs will play a vital role in shaping a truly decentralized Web 3.0. Not only are DAOs challenging the status quo of corporate governance, but they are also changing how people work together and engage with the digital world. DAOs are the future of organizations.