What is a DAO and Why Should You Care?

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2 Dec 2022

Introduction

When we think of what an 'organisation' might look like, some of us might have the image of a hierarchical structure where the entire organisation is governed by a central body of management. This is the most common organisational structure shared by companies, governments and public bodies.

The concept of a 'DAO' is radically different in this regard. Rather than having a hierarchy of actors in an organisational structure, authority is decentralised and there isn't any central oversight. DAOs are becoming increasingly popular in the Web 3.0 space and represent a paradigm shift in how organisations are structured.

In this article, we'll explore the concept of a ‘DAO’, why DAOs are important in the Web 3.0 space, and some emerging use cases in the ‘real world’.

Let's dive in!

What is a DAO?

A decentralised autonomous organisation (‘DAO’) is an organisational structure where there is no central authority that dictates the rules and operation of the entity. Rather, the DAO’s governance comes down to the actions of each participating person, all of whom share the common goal of acting in the best interests of the DAO.

Another way of thinking about a DAO is this: Let’s say you’re working in a small business. Typically you would have the small business owner (‘the boss’), perhaps a handful of other managerial figures and employees. Employees would answer to their managers while the managers would answer to the small business owner, with the ‘higher ups’ being primarily responsible for making decisions in the business.

A DAO removes the ‘higher ups’. Rather than having a boss and a manager, all participants have the same status in the organisation. Everyone would collectively be in charge of running the business. All people would have an equal vote in key matters and are responsible for leading the business.

"A DAO removes the ‘higher ups’. Rather than having a boss and a manager, all participants have the same status in the organisation. Everyone would collectively be in charge of running the business. All people would have an equal vote in key matters and are responsible for leading the business."

How do DAOs Work?

DAOs heavily rely on blockchain technology to function. The reason for this is that blockchain technology best facilitates decentralisation because technological infrastructure is not controlled by one entity. The blockchain network operates through a decentralised system of nodes and validators operating the system, thereby making the blockchain less prone to attack and also less prone to manipulation by a central entity.

With blockchain technology comes smart contracts; another feature that DAOs heavily rely upon. Smart contracts are self-executing agreements that are coded onto the blockchain. These agreements embody all the rules of a DAO. Once made, the rules encoded on the smart contract cannot be changed without a majority of the users voting for an amendment.

Smart contracts are also instrumental in implementing decisions that users collectively make. How does this work? Let’s look at a hypothetical example.

Let’s say that a DAO is voting on whether to circulate more crypto tokens in the ecosystem. If the users vote “yes”, this decision will be recorded on the blockchain and a smart contract will automatically circulate the agreed quantum of tokens. Another example: A DAO might be voting on whether to remove a bad actor from the organisation. If they vote yes, the smart contract will execute the decision by taking pre-coded steps to remove the person from the platform.

In terms of how users vote, this will heavily depend on the DAO's tokenomics. DAOs typically have crypto tokens that can be like ‘money’ in the sense that they can be spent. For instance users might be given ‘governance tokens’ that can be spent on voting.

Alternatively, tokens can simply represent ownership and status in the sense that more tokens might indicate more authority and involvement in the DAO. This is because tokens are often an indicator of personal investment and commitment in the DAO itself. Some DAOs may make it the case that those who have more tokens will have more voting power, the incentive here being that the more invested someone is in the DAO, the more privileges they should get. Alternatively, it is equally possible for DAOs to grant equal voting power to everyone irrespective of how many tokens they have. This might make voting more democratic as everyone can have a voice irrespective of their perceived status in the DAO.

DAOs On the Rise

As Web 3.0 starts to gain more traction, entities need to think of how they will govern their platforms in a way that promotes the essence of Web 3.0 - Decentralisation, democracy and inclusion. A DAO is a suitable organisational structure in this regard because decision-making is decentralised, user participation is heavily encouraged, and votes made within a DAO are transparent in that they are publicly viewable on the blockchain. All of this contributes to a sense of community.

The most famous example of a DAO is of course Bitcoin. Here, Bitcoin has pre-programmed rules that function automatically depending on decisions reached through the network’s consensus mechanisms (i.e. decision-making systems).

In saying this, we are now starting to see use cases for DAOs arise outside of crypto and finance. LexDAO is an example of a DAO whose aim is to code smart contracts capable of providing legal services. In the charity space, we have also seen UkraineDAO function as a fundraising platform to raise money for those who have been affected by the Russian-Ukrainian conflict.

These use cases of DAOs are just the beginning. In fact, some have gone on to suggest that DAOs could disrupt traditional corporate structures when it comes to financing because people can simply get funding through a DAO and build a community around a project as opposed to having to go through companies for equity.

"...some have gone on to suggest that DAOs could disrupt traditional corporate structures when it comes to financing because people can simply get funding through a DAO and build a community around a project as opposed to having to go through companies for equity."

Therefore, it can be said that DAOs have significant potential. In contrast to centralised corporate structures or governance systems, DAOs are more democratic, transparent and community based. The use cases are endless.

The Challenges Ahead

Although DAOs have potential, there are still a number of issues that need to be addressed. Namely:

DAOs can still be vulnerable to hackers. For instance, “The DAO” is an example of a decentralised organisation that was formed on the Ethereum network. It was hacked in 2016, resulting in the organisation losing $60 million.

Decentralisation may also give rise to inefficiencies if everyone is required to vote. In theory, centralised organisations may at least have the capacity to make decisions faster because the vote of a CEO or manager might be decisive. Decentralised organisations relying on everyone’s vote may take longer to implement key decisions because everyone needs time to vote. Now, this may not be true practically in all circumstances as the rules of DAOs could be designed to mitigate these issues. We also know that centralised institutions can be subject to inefficiencies through stifling bureaucracies and decision-making bottlenecks within the organisation; issues that decentralised organisations might not have. In saying this, decentralisation should not always be synonymised with "efficiency".

DAOs also face significant problems with user behaviour. Of course there is the risk of bad actors hijacking the system by forming groups and voting in a way that best aligns with their personal interests as opposed to the interests of the DAO. There may also be issues with user disengagement, where users simply lose interest in voting on the platform. Ultimately these issues will come down to platform design and governance mechanisms.

Final Thoughts

DAOs are instrumental to carrying out the Web 3.0 mission of having a decentralised, community-based internet where all internet participants can be included. This represents a seismic shift in how organisations have typically been thought because we are deviating from the idea of having centralised oversight.

Although DAOs promise a bright new future, there are still a number of issues with security, potential inefficiency and user behaviour that need to be resolved along the way. Ultimately this will come down to Web 3.0 enthusiasts and innovators working collectively to design DAOs that are better than the last.

Constant iteration and improvement will determine the future of DAOs.