In this section, we’ll walk you through the advantages and disadvantages of forming a DAO, compared to other forms of organization.
Advantages of DAOs
Decentralization: As mentioned, the whole idea of a DAO is to create a self-governing group, where control is created via software protocols and members vote on the way sto achieving common goals. For many investors, this is a bonus in itself, since spreading control among stakeholders can prevent collusion by a few.
Efficiency: Unlike lengthy and costly legal agreements or organizations that support a team of middle managers, smart contracts in a DAO are typically shorter than legal ones and automatically executed within a flattened structure, so few hundred lines of code can execute both voting and transfer of funds at much lower cost, even assuming Ethereum’s gas fees.
Flat organizational structure: Once deployed, stakeholders have more participation in decision-making, which harnesses their expertise and passion. Flat companies have a variety of advantages. If set up correctly, this can cut out expensive layers of management, improve input and participation and keep the top-level nimble and lean.
Transparency: The code is open source, meaning anyone can look at it. On the blockchain, anyone can scan through a DAO’s history to see what and how decisions were made. All activities performed within and by the DAO are recorded on an immutable public blockchain.
Attractive for raising money: Stakeholders may be attracted to buy tokens or participate in other ways if they value the way the organization rewards them, how they stand to reap the benefits if the organization thrives due to their participation, and the ability to vote on key decisions.
International collaboration simplified: DAOs are a great way to collaborate globally and still incentivize all concerned. The technology makes DAOs borderless and allows everyone to work with each other.
Accountability: Software governance is harder to change, and thus harder for a small group to “hack the mission” for a different purpose, without all involved weighing in and reacting to the proposal. Even at Ethereum, this has happened multiple times, slowing down the edicts of the top leaders, including Buterin, himself.
Use Cases: The success of huge financial DAOs like AAVE, a $15 billion grants-based DAO has provided proof of the concept that DAOs are not just collectives intended for progressive idealists.
Disadvantages of DAOs
The Pareto principle: This principle states that 80% of consequences are derived from 20% of causes.
In organizational terms, 20% — the “vital few” — of decisions are responsible for a successful outcome, or an unsuccessful one.
So what happens if the crowd’s decision is not better than one that a smaller faction or brilliant leader would have made? In short, imagine Apple’s stakeholders voting on a new iteration without Steve Jobs.
Because of large token holders, DAOs are not actually totally decentralized: In spite of claims about decentralized decision making, it is possible a few people can have more tokens than the majority, which diminishes decentralization. This could still allow for bad decisions by a small group. Theoretically, for example, founders could hold 51% and control not only the decisions but also orchestrate a pump and dump or rug pull.
One person one vote may not work either: To fix this issue, some models allow that every participant that owns or stakes crypto – no matter the amount – is issued a single token, signifying one vote to cast in future decisions.
However, this model may be unfair to those who contributed more to earn their tokens but do not get more say.
The original set of rules was already decided by a small central team: Ironically founders of DAOs hoping to create decentralized organizations often need to be superior leaders with superior judgment about creating governance, protocols around liability, and assembling a community that trusts their vision – all-be-it of trustless protocols that enable democratic decision-making. Much rides on the wisdom and competence of this initial group.
Legal issues: If a problem occurs that cannot be rectified through token voting, members of the DAO may have to engage in protracted and convoluted legal cases across states or countries without clear laws regarding DAOs.
Subsequent actions by DAO operators if consider fraud may not pierce the corporate veil and put members at risk, even if the appropriate legal structures have been formed.
Human coding error: In the development of the DAO’s complex, autonomous decision-making framework, one which is responsible for the management of large amounts of money, risks of code error or allowance of a hack or exploit can be massive. There are more than 50 companies that offer blockchain security auditing, according to OpenZeppelin. However, even BadgerDAO, a 24,000-member organization that lets people earn interest on their bitcoin, lost $120 million in a cyberattack in 2021, so this risk is real.
It may be difficult to change the rules of the DAO once deployed, even in an emergency: The same framework that prevents a person or entity from altering the organization without consensus from the community can also cause problems if there is a need to act more nimbly. These situations include gaps in the coding that could have been easily closed by programmers and speedy responses to competitive or market conditions.
Whiff of scandal
From an investment standpoint, there are still numerous “rug pulls” in which, DAO creators collect the money from the initial offering and disappear. Since there are so many unsophisticated investors in the market, this has given the emerging industry a hint of scandal. These rug pulls will not be the last.
In summary, if your team is planning to start a DAO, you should have a clear reason related to the organizational mission and values, decide how much control you are willing to relinquish to obtain legitimacy in the eyes of token holders that will buy-in, and commit to a risk management policy and legal strategy.
Next up: Types of DAOs