What is a DAO?
A DAO, which is short for Decentralized Autonomous Organization, is a term that is often used in the cryptocurrency space but not always widely understood. In short, a DAO is a set of organizational rules that is triggered automatically and removes the need for intermediaries. In this guide, we will give a more detailed explanation of what they are, how they are created, and everything else you need to know about DAOs.
What Is a DAO?
A Decentralized Autonomous Organization is, as its name implies, an organization that is decentralized in that it has no central government, and autonomous. Instead of being governed by a small team of executives, a DAO’s rules are set in code and enforced by the network of computers that run this software; this means that the rules are the same for everyone, no matter who they are, and unchangeable—so there is no finding loopholes to get out of your obligations or restrictions. As the code is law, there is no need for intermediaries who will ensure that the rules are followed.
A DAO’s decentralization usually means that it is democratized instead of being hierarchical. For example, any changes that should be implemented are voted upon by all participants instead of a single group of decision-makers. All the votes are automatically tallied and carried out by the software instead of relying on human intervention. This removes the possibility of vote counts being mismanaged or tampered with, leading to transparency and full visibility.
Thanks to the removal of the need to trust other participants in the DAO, this means that it can consist of many people who don’t know each other and would otherwise not be able to coordinate their common goals. In other words, they can transcend any physical limitations and be sure that all parties are working towards the good of the project itself.
How to Create a DAO
Many projects in the crypto space have a DAO behind them, as this tends to be one of the best ways to keep the governance of the project fair, transparent, and accessible to all who want to participate. However, like any organization, a DAO still needs to be set up and funded before it reaches the wider audience it is aimed at. Here are the three key phases in creating a DAO:
- The first step is always figuring out what the smart contract underpinning the DAO needs to do—and then creating it. These sets of rules are often very extensive and cover a myriad of things; forgetting to set something up during the first developmental phase means that it can later be changed through voting alone, which can be a long and laborious process, especially if the forgotten rule is important to the health of the network itself. This code also needs to be tested and retested so that nothing slips away.
- The next phase is securing funding for the launch of the DAO, but also for its ongoing functioning. This is often achieved through token sales, which also handle the governance side of the process—most of the time, the amount of tokens you own correlates to your voting power within the organization. This is not unlike a shareholder type of relationship, which is why DAOs translate so very well into the decentralized finance (DeFi) world.
- Finally, the DAO itself needs to be launched. Once its deployed on the blockchain, there are no changes that the founding team can make without the input of the other participants, or token holders. This is when all rules go into effect, including the DAO’s governance. In other words, the DAO is then truly created.
After this, the DAO runs as predicted and any changes are voted upon by the whole network.
What Was “The DAO”?
When talking about decentralized autonomous organizations as a whole, the minds of many still go to “The DAO” that marked a turning point in the history of Ethereum (ETH). The DAO was the name of a decentralized autonomous organization that launched in 2016 with the idea of being a decentralized form of a venture fund. People could own The DAO tokens and earn dividends from them or just profit off the price appreciation, if they wanted. The DAO was one of the largest crowdfunding attempts of its time, raising around USD 150m in ETH.
Just before the attack that would mark The DAO’s end, around 14% of all ETH in circulation was invested in the project. Then, a hacker found and exploited a bug in the code that allowed them to siphon off USD 60m away. The sheer amount of ETH already tied to The DAO caused a rift in the Ethereum community on what should be done. Those who believed there should be a fork that would blacklist the attacker’s address, preventing him from moving the funds and rolling the blockchain back to a time before the hack, were led by Ethereum’s founder Vitalik Buterin and that version of the blockchain is still the official one for Ethereum. On the other hand, people who opposed this decision forked off the main Ethereum blockchain and created what is now known as Ethereum Classic (ETC).
Potential Downsides of DAOs
While DAOs aim to be improvements of existing hierarchical structures, they are far from perfect themselves. One of the most often cited issues is that many institutions from traditional finance believe that masses should not be trusted with major financial decisions.
Additionally, DAOs are mostly unregulated and tend to spread out over many jurisdictions, which makes solving potential legal issues extremely complicated at best, or even completely impossible.
Finally, as the example of The DAO proved, once a DAO is up and running (deployed on the blockchain, in other words), changing even life-threatening bugs in the code can be a slow and costly process that gives malicious actors plenty of time to act. Even the most trivial bug that would otherwise be solved in a matter of hours has to undergo the same voting process.
See also: What Is a Smart Contract?