With cryptocurrency’s rapid development, many developers are now decentralizing other areas in the real world. The blockchain continues to revolutionize our future -from finance, investment, work, and gaming to the internet, commerce, and art.
But, one crucial area is considered the final frontier before the mass adoption of cryptocurrency – governance. This is where a DAO comes in.
What is a DAO?
A Decentralized Autonomous Organization (DAO) is a group of people enabled by a smart contract to govern a certain community, cryptocurrency, crypto exchange, decentralized application, etc. With a code in place, the organization is self-sustainable because the smart contract defines and enforces the requirements for tabling, passing, and rejecting proposed improvements.
How Does a DAO Work?
A DAO can propose changes or upgrades, which can be implemented based on the vote of the majority.
This governance structure often features a community treasury formed from a portion of staking rewards from newly minted tokens or from transaction fees. The most basic setup of a DAO gives each member one vote for each coin/token they hold. A proposal is then passed if 51% of the participating coins/tokens vote in favor of the proposal.
A portion of treasury funds is allocated to whatever improvements or initiatives the proposal seeks to bring about. And hopefully, the upgrade goes live without any issues.
How Does a DAO Deal with Corruption?
The members of a DAO are incentivized through governance tokens. With so much money involved, it’s highly prone to fraudulent activities. Therefore, the checks-and-balances system is employed in some governance structures to discourage corruption.
One of the best examples of this is Polkadot’s DAO. Before a proposal is tabled, the members should stake DOT coins. Whether a proposal gets passed or not depends on the number of DOT coins participating. The level of consensus required is inversely proportional to the number of participating DOT coins. Also, the number of votes equals the length of time the DOT coins have been staked. 32 months is equal to a 6x vote multiplier.
If a proposal is passed, it can still be vetoed by the community-elected Polkadot council. A technical committee could also veto the proposal if it's deemed a threat to the blockchain. The staked DOT coins representing the proposal will be burned when a proposal is vetoed.
What are the Types of DAOs?
DAOs can be categorized based on their use cases. While there are many other types of DAOs, these are the most popular ones today:
Protocol DAOs
These are crypto protocols governed by a community of developers and token holders. The DAO is governed by rules embedded in its smart contract. However, token holders can create proposals on how the protocol can be improved or changed. Users can also propose and vote on marketing initiatives, the development of dApps, or new ways to manage treasury funds.
Examples: Aave, Uniswap, MakerDAO, PolkaDAO
Investment DAOs
This group of people joins a capital pool to invest in specific assets. The members can vote on how the capital is spent or invested. DAO tokens representing each member's share will be issued if the investment or ventures are profitable. The value of the DAO tokens will represent how much is in the treasury.
Examples: MetaCartel, bitDAO, Flamingo DAO
Social DAOs
It works like a club but with crypto involved. A group of people decided to pool their crypto holdings, which would serve as their allegiance. The main goal of a community DAO is to bring together like-minded individuals with a common interest or goal. Becoming a member of this type of DAO gives a member access to an exclusive online community, offers, incentives, merchandise, and even additional ways to earn.
Examples: ApeCoin DAO, Friends With Benefits, Krause House
Service DAOs
It’s a talent-on-demand organization that brings together talented individuals who can provide clients with products or services. Basically, it's an agency that caters to clients who will pay fees to the DAO treasury and the service/product provider. Governance tokens are issued to each member to represent their voting power. Token holders can vote on the policies in the organization, including the fees for specific services, upgrades on the system, and fund management.
Examples: MetaverseDAO, LexDAO, Tracer DAO
Media DAOs
With the emergence of Web3 versions of social media, content creators and consumers can now be rewarded without relying on ads. With ownership tokens issued to members, they can be incentivized by researching and producing content, designing graphics, providing video assets, translating articles, and even marketing the content produced in a given outlet.
Examples: Decrypt, Bankless DAO, Mirror
Philanthropy DAOs
As you might have imagined, pooled capital can also be directed toward philanthropic purposes. Holding governance tokens, sometime NFTs, represent a vote on how funds should be allocated or deployed. Maybe a portion of treasury funds can go to the DAO's protocol developers and another portion to charitable institutions. Policies in the DAO can also be changed based on the consensus of members.
Examples: Big Green DAO, Ukraine DAO, PleasrDAO
What are the Benefits of DAOs?
Trust-Less
Members don’t have to trust a leader or a central entity. The whole organization will continue no matter what happens to a developer or member.
It can't be Shut Down
A traditional business can be easily shut down by the government. However, in a DAO, the only way it can be shut down is when the members vote on it.
Open-Source
The code of a smart contract is open for anyone to review. It can be debugged and further improved through the suggestion of other developers.
What are the Current Problems of DAOs?
DAO is the ultimate frontier to the full adoption of cryptocurrency. If it can replace the traditional governments and institutions we have today depends on whether it can solve its current drawbacks.
Legality Issues
Organizations and businesses should abide by certain rules in a certain jurisdiction. However, DAOs are not bound to a certain place, exempting them from regulatory frameworks. Therefore, traditional laws, like taxes and corporate fraud, can't be applied to treasury activities inside the organization.
If the governance tokens have certain characteristics that the Securities and Exchange Commission (SEC) deems investment securities, it could also mean legal trouble for the DAO.
Exposure to Attacks
The open-source feature of DAOs is a double-edged sword. While it exhibits transparency, it can also be a way for hackers to find loopholes or weak points in the system. This is in full display in the famous hacking of The DAO, leading to the hard fork of the original Ethereum blockchain.
Centralization Tendencies
Unfortunately, there remains a degree of centralization in DAOs. In an on-chain governance structure, where a member’s crypto holdings represent its voting power, a democratic system cannot be achieved. The rich will always have the upper hand. They can accumulate more voting power and even influence others to vote in their favor.
DAO = A Paradigm Shift in Governance
While many obstacles are present, the concept of DAO can still improve over time. Many clever features will soon be discovered and implemented. Along with DeFi, Web3, and dApps, DAOs will surely offer a paradigm shift in how we govern institutions and businesses.
Disclaimer: The information and publications in this article are not intended to be and do not constitute financial advice, investment advice, trading advice, or any other advice or recommendation offered or endorsed by Coins.
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