A Decentralised Autonomous Organisation (”DAO”) is an important concept to understand in the blockchain space.

They are one of the rawest forms of protocols in the context of what the cryptocurrency and blockchain communities value so much; decentralisation.

Definition

What is a DAO?

A DAO is a digital organisation that is created and run by rules encoded as smart contracts. These smart contracts are stored on a blockchain (it could be Ethereum, Fantom, Cardano, Polygon, etc.)

DAOs are created by a founding team and set up on an online platform from which all members can participate by creating proposals and voting on proposals. A DAO is subsequently managed by its members through transparent and democratic voting mechanisms.

In its purest form, DAOs are run entirely by their members and are programmed in a way that allows the members to vote on important decisions such as how funds are allocated, how the DAO operates, and who can join the organisation.

In this model, nobody has an upper hand, and decisions are implemented based on what had the highest vote.

How is it different from a traditional organisation?

DAOs stand on 4 pillars that distinguish themselves from traditional organisations, these being:

• Decentralisation
  A DAO is decentralised, meaning that it is not controlled by a single entity or individual, but rather by the members who have voting power.
  
  In contrast, traditional organizations are usually governed by a centralized authority such as a board of directors or a CEO.
  

• Autonomous
  A DAO is autonomous, meaning that it operates based on pre-programmed rules in smart contracts on a blockchain, which executes automatically without the need for human intervention.
  
  In contrast, traditional organisations often require human input and decision-making at every level.
  

• Transparency
  A DAO is transparent, meaning that all of its operations and decisions are visible and recorded on a blockchain.
  
  As opposed to traditional organisations which are often centralized with a hierarchical structure.
  

• Trustless
  A DAO is trustless, meaning that it operates based on code and predetermined rules.
  
  As opposed to having trust in individuals or organisations themselves.

All 4 pillars can be interpreted as major benefits in the context of running an organisation. When compared to traditional organisations, they give DAOs a unique advantage in terms of efficiency, flexibility, and accountability.

How do DAOs work?

When looking at how DAOs work, there are two main components one should consider.

1. Tokenomics

Define “Tokenomics”
Combining “token” and “economics”, tokenomics for our purposes refers broadly to the critical thinking that goes behind a protocol’s digital currency. When we refer to the ‘tokenomics’ of a project, we are speaking about the principles and design of that protocol’s token.

This might include the total supply of the token, how it’s distributed, how it can be used, and the benefits or limitations associated with holding the token.

In essence, tokenomics refers to the economics and mechanics of tokens used in a blockchain-based ecosystem, including their creation, distribution, and value.

Relevance
In the context of DAOs, tokenomics is very important to be considered.

Tokens in a DAO can represent ownership, voting power, rewards, and other functions. This means that the tokenomics behind a DAO can influence the behaviour of its token holders and ultimately dictate the success of the DAO.

For instance, a DAO can only exist if it has members to operate it. We can use tokenomics to help incentivize participation in the DAO by offering rewards when users interact with vital components of the DAO, such as voting on decisions or contributing to the development of the protocol.

2. Governance

Define “Governance”
In the context of DAOs, governance refers to the decision-making process and mechanisms through which members of the organisation collectively manage and control the operations, resources, and strategic direction of the DAO.

Relevance
The governance process for any DAO is vital to its success.

A DAOs founding team may integrate into the community a certain voting platform such as Snapshot, Aragon, or Safe at the beginning of the protocol.

It is on these platforms that the DAO’s token holders can create proposals for the community to consider and vote on proposals that the community has put forward.

Proposals can cover anything to do with the DAO. A proposal may very well shut down the entire protocol, or it could lead the development of the protocol in a completely different direction.

For instance, this Snapshot proposal within the RomeDAO community mid-last year was a nearly unanimous vote to fully liquidate the protocol’s treasury, redistribute what was left to the remaining token holders, and shut down development.

Or the Ethereum Improvement Proposal 1559 (covered in our newsletter here), which led to a redesign of Ethereum’s transaction fee mechanism and made fees more predictable and affordable, among other benefits.

Challenges

DAOs face many of the same challenges that arise across all blockchain protocols, these include:

1. Technical complexity

2. Legal and Regulatory uncertainty

3. Security risks

4. Scalability

We’ll leave the above challenges to a broader discussion associated with blockchain adoption. For now, let’s look at issues more specific to a DAO.

• Low voter turnout
  A DAO may have heavy financial backing, but without an actively engaged community participating in proposals that come forward, the DAO cannot thrive.
  
  Low voter turnout leads to a lack of legitimacy and representativeness in the organisation’s decision-making. More importantly, it can become easier for bad actors to manipulate the outcome of a vote because there are fewer members to manipulate or to out-vote.
  

• Polarisation
  In this context, we refer to a situation where the community becomes deeply divided between an issue and different groups arise having opposing views, resulting in it becoming more difficult to move proposals forward.
  
  This often leads to a split in the community, where one group may decide to create a new blockchain or protocol to pursue their vision.
  
  A good example of this is Ethereum Classic, which spawned from a controversial decision to reverse transactions on the Ethereum blockchain that occurred after a major hack in 2016 (read more here). The Ethereum community was split between those who believed in the immutable nature of the blockchain and those who believed that the decision was necessary to protect its members and investors.
  

• Centralised voting
  Depending on how the tokenomics of a project are set up, a select few members of the community may end up having a significant amount of voting power. This ultimately results in a faux-DAO wherein a select few members, often the founding team, are dictating the direction of the protocol without allowing the community enough power to influence decisions.
  
  Take this Index Coop proposal for example, wherein there are 30 votes for the proposal which are represented by 430,000 $INDEX tokens. However, 4 of the 30 votes represent 339,000 of those 430,000 tokens.

Future

According to DeepDAO, a platform for all data related to DAOs in the Web3 space, there were 181 DAOs at the end of 2021. Today, there are 12,616 with a profile on the platform, 2,363 of which are valued at >$1M. This is pretty significant growth, and the more DAOs that come about, the more success they see, the further this organisational structure becomes legitimised.

DAOs are fascinating because, in a way, they embody entrepreneurship at scale. At every instance, a community of designers, engineers, legal and business people come together online to build something that works and provides value to the Web3 community, and whichever way you look at it, it’s pretty cool.

DAOs are a promising model for decentralised decision-making and have the potential to transform traditional organisational structures as we know them.

Will they replace traditional structures entirely? Probably not. But there could be a place for DAOs in more companies than you might think.