DAO is actually just an acronym that stands for Decentralized Autonomous Organization. As defined by Aragon: a group of people without central management who coordinate over the internet around a shared set of rules to achieve a common mission.
Basically, this is an organizational structure has three main innovations:
- Its rules for transactions are governed by software rather than by a centralized human hierarchy, allowing a flattened organizational structure.
Because it is software-based, and utilizes smart contracts, a DAO operates automatically to execute instructions – payments, delivery of tokenized incentives, and so on – by executing the code.
2. All of the transactions are publicly recorded on the blockchain network, providing a layer of transparency unavailable to stakeholders in traditional organizations.
3. Aside from the initial set of rules, a DAO is at least partially governed by the vote of members who are token holders, making it decentralized not only in the number of mining nodes or token holders but also by a more-or-less democratic vote or at least “weighing in” on key decisions by all the stakeholders. There are innumerable ways to structure these votes: One man one vote, one token one vote, a threshold of tokens needed to propose a vote, a different threshold needed to participate in the actual vote and so on.
4. If publically traded, DAOs can also be used to raise money.
It is not a perfect democracy. DOAs can issue tokens to allow votes (governance tokens) for any kind of decision-making required, empower profit-sharing, or supply liquidity. However, most DAOs created for legitimate purposes value and honor the decentralized structure and input from token holders and consider this a key asset.
The SEC has officially designated public sales of tokens tied to shares of a company as illegal sales of securities. The legal lines remain blurred. Some argue that DAOs are closer to legal because legislation passed in some states move DAOs closer to state-approved status as a legal business entity.
There are numerous operating DAOs with billions in treasuries still flying under the radar, as many frauds and scams that make some type of legal recognition and/or regulation in the future a strong probability.
Basic criteria
Basically, anyone can create a DAO and write their own rules into the code, and DAOs can have an infinite variety of purposes.
Depending on their emphasis on decentralized voting, and automated decision making, there are two main classifications;
Protocol DAOs. Teh basic unit of a DAO is a smart contract, ie the code containing and executing the rules of the agreement. By relying solely on code to enforce rules, DAOs theoretically eliminate the need for human intervention, management structures, administration, and legal agreements. Assuming that the code itself is error-free and the choices made initially are good ones, it can reduce human error and adds efficiencies. DAOs that are primarily organized for this are considered algorithmic DAOs, or Protocol DAOs.
Membership DAOs: DAOs set up for one person one vote spread power more fully throughout the organization than DAOs which are have one token one vote, in which large token holders can accumulate power. The DAOs which fully embrace this structure as their principal use of the Dao are considered Membership DAOs, or Collective DAOs.
Most, but not all, DAOs are built on the original Ethereum network and thus share their original basic ruleset.
The Ethereum token standard ERC20 is a coding standard that allows all tokens created using the standard to be exchangeable anywhere in the vast Ethereum ecosystem. However, today DAOs can also be built on top of Solana and other blockchain networks.
History
The first DAO, confusingly named TheDAO, was created by Vitalik Buterin the founder of Ethereum to raise funds for the project.
TheDAO, as it was called, launched in April 2016. Ethereum was designed as the first open-source infrastructure, like the infrastructure in a city, or even WordPress, onto which the next generation of blockchain developers, the second wave after Bitcoin, could build their own decentralized networks, marketplaces, and an entire ecosystem of new organizations. Ethereum founders innovated in other ways, as well. They were the first to develop smart contracts, and to use Ethereum’s unique software language Solidity.
But they needed financing. TheDAO’s first ICO was a revolutionary way to raise venture capital. Aiming to raise $5 million, the company raised $150 million in token sales – billions in today’s dollars – almost overnight, but also experienced the first and still one of the largest token hacks, losing roughly $60 million before forking the blockchain to reverse the hack.
Ethereum recovered and its blockchain has not been hacked since. Although many other companies in its ecosystem have, overall Ethereum was a ground-breaking success story, inspiring a generation of developers interested in using DAO to raise capital and solidity programmers to build more companies.
By 2018, roughly 10 additional DAOs had formed on the Ethereum model. By 2020, there were nearly 200 DAO’sof various types. Today, there are just over 4832 DAOs according to DeepDAO, a Tel Aviv-based data aggregator launched in 2020. These DAO form, a small but important subset of the 14,000 plus Altcoins- any coin or token besides Bitcoin.
By 2022, the year of the DAO, the organizational format was peaking. By March Ethereum’s total DAO treasuries held $8.2 billion, while Solana DAO treasuries, the most successful copycat, held $1.3 billion in their own treasury.
DAOs, having originated from Ethereum, a non-profit, that sprung from Bitcoin’s initial innovation also have a particular ethos, different from traditional cryptocurrencies. As Fast Company put it, “Baked into the thinking behind DAOs is a mistrust of centralized human control.
“There’s no CEO who can authorize spending based on their own whims,” reads the Ethereum FAQ, “and no chance of a dodgy CFO manipulating the books.”
Fast Company goes on to describe the mistrust of hierarchical corporations baked into the DAO culture.
“There’s a school of thought that says human beings don’t misbehave in a vacuum because they’re evil, but because they act within an organization that affords them power that can be abused. They might act against the best interests of the organization because of greed, prejudice, desire for fame, or a hundred other flaws. Sometimes this happens behind closed doors (as when an executive pays $1,000 for a haircut and signs his own expense report), or in the open (as when a CEO decides to host disinformation on his company’s social network).”
This phenomenon is articulated in the Principal-Agent dilemma – see video below.
The Principal-Agent dilemma holds that an “agent” is an individual or entity that is permitted to execute actions or make decisions on behalf of another. The “principal” is the individual or entity who hires and is represented by the agent.
The agent is ultimately the decision-maker and may prioritize their personal interest above the principal’s, since the principal cannot fully track and control the agent’s moves, but bears most of the risk.
While legal contracts and the court system alleviate these moral hazards in traditional organizations, decentralized autonomous organizations drastically reduce both the risks and the costs of managing them.
Smart contracts govern and execute actions according to pre-set rules, and some form of voting is required to change course.
Most legitimate DAO creators have come to understand the purpose of a more decentralized organization and grappled with the idea of how this rewards the contributions of the various stakeholders.