What are decentralized autonomous organizations (DAOs)?
17 May 2022 by Catherine Woods
Reading time 12 min
Blockchain technology has created the digital currency world as you see it now. This is a space with various digital funds, transparent and secure transactions, and specific companies, more commonly known as DAOs. In the Web 3.0 Era, if an organization doesn't have a Chief Executive Officer or any central governance but has collective management, we can talk about a DAO company. This system of organizing the activities of people in the company is more consistent with the DeFi space.
What makes DAOs different?
So what's a DAO? This is a new type of company built on a blockchain network, realizing principles of democracy. In decentralized autonomous organizations, members share not only ownership but also governance. So community participants work together on goals. Status and rewards are distributed depending on the contribution of each member. Smart contracts come into effect as bylaws or company rules when particular terms are met on a network. It can be said that management is built on smart contracts. There is easy and clear cost control of funds in DAOs. Without banks, their funds are kept in treasuries.
Furthermore, some notice that a DAO project is a computer program or a software solution on a chain that allows integrating a set of rules for a community in code. This code provides the security and safety of the decentralized autonomous organization on a network. Simply put, a DAO runs thanks to smart contracts and blockchain technology. Thus, there is no need for bureaucracy or hierarchy. This seems to raise interest in decentralized autonomous organizations.
Here everyone will be able to make a personal proposal that can be voted on. It means that members have a voice as a lever of governance. They have a chance to make a positive change in the decentralized autonomous organization. With equal power by default, DAO community participants achieve their purpose and mission more effectively than a traditional organization with a central body. The weight of the investor's vote is determined by the number of governance tokens in his possession.
How are DAOs used?
- In general, there are non-commercial and commercial DAOs. The non-commercial DAO landscape:
- Grants DAOs growing a blockchain network and startups,
- Social DAOs to connect people,
- Collector DAOs for collective creating collections of NFTs,
- Media DAOs building blockchain-based information platforms.
- The commercial DAO landscape:
- Investment DAOs generating income from finance projects,
- DAO Operating Systems to create other DAOs,
- Protocol DAOs managing DeFi applications,
- Service DAOs producing expert groups on a blockchain.
So, the possibilities of using a decentralized autonomous organization as a general partnership are almost limitless, although it is not a legal entity.
The filter from DeFi Watch allows you to select only liquidity pools of well-known Protocol DAOs.
What about Protocol DAOs?
At the moment, it is very popular to use a DAO for the control and governance of decentralized applications. It is important to understand that the trust to a DeFi platform is attached to the DAO structure. The Protocol DAO allows the transfer of power and control from the hands of the development team to the community. It is worth noting this type of decentralized autonomous organization first released tokens such as transmittable ERC20 to a network. So a new way of spawning digital currency into the market was discovered.
Each token of the community not only generates the funds for the full function of the organization but is also a management tool. Who holds a DAO token gets all the rights fixed in the community.
There are many lending platforms and exchanges among Protocol DAOs. In the context of DeFi, examples of the best DAO projects comprise the following: Uniswap, Aave, Compound.
Uniswap is a marketplace where investors can trade tokens with the Ethereum base using a web 3.0 wallet for this purpose. This platform has its own token, UNI, that enables owners to control protocol and join the voting system. Among powerful competitors, Uniswap still keeps its position.
Aave takes the leading position in the total value of blocked funds. This DeFi lending protocol allows users to easily credit crypto funds with different interest rates. AAVE as a governance token can belong to users for management decisions. Compound also eventually released its own token called COMP. The governance system of this lending platform differs from others: the opportunity to transfer tokens, the ability of proposals only to holders with 1% and more of supply. Equally popular platforms are Curve, Balancer, and SushiSwap. Here, as in any DAO, a governance token is in the spotlight. All things considered, decentralized autonomous organizations built the basis for the simple manner of spreading tokens with a secondary market value on any network. Moreover, participants in Protocol DAOs take a vote on how to disburse those tokens, enabling launches, liquidity mining, and yield farming. This is the significance of such projects for the DeFi industry.
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Stages of DAO formation
Before these projects became known, they passed through a series of stages. So, as soon as members of the community have defined a set of rules, this is fixed in the code by a smart contract. The latter distributes income among the participants, also notes voting results among them, and publishes them.
Next comes the financing stage, when the internal capital is formed. Like in a traditional company, funds are used for the needs of the organization and to stimulate participants. Income in stablecoins or other tokens is usually generated by DAO members. Issuance of new tokens, earning interest from them, and successful activity of the company bring an increase in revenue.
On the governance stage, all discussions happen inside the DAO, and questions or problems are solved by voting. The latter is a tool for resolving any issues and making any suggestions to the community. A discussant can get extra rewards. Each team member has the right to vote, the ability to propose decisions and receive rewards. This stage marks the full functioning of the decentralized autonomous organization.
How do you join the DAO?
Anyone can become a member of decentralized autonomous organizations, but it is not so easy: projects have various conditions for partnership. After joining the DAO discord, the user must be very active for other community members to notice and invite him. Some decentralized autonomous organizations make it possible to get the DAO token for past contributions to the project overall. In addition, when they are issued and distributed on many platforms such as exchanges, any investor can buy a token. DAOs can require the performance of other criteria for entering the community.
Criticisms of DAOs
Everything has another side like a coin, so a decentralized autonomous organization consists of not only benefits. A critical attitude is explained by some outstanding problems.
The first big problem is obtaining legal status for the functioning of such organizations. They do not conform to the existing legal framework. This is exactly why it is very difficult for DAOs to work with non-crypto organizations. In addition, bias can still be expected from the leaders of various countries regarding the crypto world. It makes registration difficult. In other words, it is not enough to be just a DAO to become a legal entity. Thus, any DAO is forced to have dual status to exist: a special organization to be in the crypto world and a legal entity to stay in the legal field.
The second huge problem comes from the voting system and coordination mechanisms. This system allows everyone to govern with a slowdown in decision-making speed. Moreover, when considering a challenging issue, ordinary users may not have the qualifications and spirit to make advanced management decisions. And important things can be left without attention. In many ways, such a system also depends on the responsiveness of its members.
Security is another great problem. Why? Code written by beginners or without an in-depth audit may have weaknesses. Furthermore, hackers consider a smart contract that is so essential to the DAO as a key to cracking. Financial resources and the genius of the developers can help figure out this problem, but the anonymity of the users limits the solution options. By the way, this group of threats also includes legal risks, where a legal defense may be limited beyond the DAO. It should also be added that the nature of such organizations gives more reason for fragmentation. There are many examples where good projects broke up because of the impossibility to agree on what to do in one case or another. Besides, every new thing in any industry takes solving a lot of problems and building infrastructure all over again.
The Future of DAOs
At the moment, as we know, any decentralized autonomous organization needs several things to function: a set of rules, a governance token, and a voting system. And now, these organizations have become a hot trend in the DeFi space. But what should we expect from the DAO in the future?
It can be assumed that the evolution of working groups and subcommittees will provide a new stimulus to the improvement of governance systems. It will make the decision process more experimental and faster. For this purpose, prediction markets can be used as an innovative management tool by moving the debate about possible events to a network.
As for management in general, we should expect the appearance of new combinations of management styles that are realized on the platforms of DeFi. So Metagovernance will allow leaving far behind traditional organizations. Moreover, DAOs will support a few different protocols.
As the DAO picks up the scale, it would be good to find new ways for all members of the community to form and replenish funds. Integrating treasury with liquidity providers and lenders makes sense. Its further diversification is the next step for DAO growth.
And we can also look forward to a shift in focus from the financial to the non-commercial sector. In the future, there will be more and more exclusive clubs that will be governed through Social DAOs. This tendency will be based on benefits that will be provided to participants of these organizations.
We are probably going to see that the desire for individuality will be encouraged by the Collector DAOs. Unique artworks with various characteristics will be generated by voting here. We will keep seeing more unique uses of a DAO. Furthermore, solving the problems that provide grounds for criticism will give a new boost to development of decentralized autonomous organizations.
Since more and more projects keep seeing the value in sharing governance among their community, it seems possible that many new DAOs will be created in the future.