All about DAO (Part IV): Strengths & Weaknesses of DAO

Like most inventions, DAO innovatively solves some problems, but also creates some others.

This is part IV of our series to explore and understand the concept of Decentralized Autonomous Organizations (DAO). As we said previous in our piece about DAO as an Investment Vehicle, based on Headline Asia’s research, there are about 240 active DAOs worldwide, which is a 100 percent increase from 2020. Ideally, DAO could be a perfect substitution for all the existing organizational structures.

The Principal-Agent Problem

But before we get ahead of ourselves, there are a few matters to confront first, such as the principal-agent problem. In an organization, there are priority conflicts between an organization (the “Principal”) and the representative authorized to act on their behalf (the “Agent”). An agent may act in a way that is contrary to the best interests of the principal, and may instead maximize his/her own personal gain. For example, a company might be facing a cash flow problem, and it would be in its best interest to reduce cost, however, the board of directors might want to maximize their own gain, increasing their salary drastically.

DAO could be an effective solution to this hierarchy problem, as it exists in organizations all over the world. Contrary to traditional organizations, in DAO an “Agent” doesn’t exist as there isn’t a small group of people that can make decisions on behalf of the entire organization. Conceptually, even if someone wants to act in a way that is contrary to the best interests of the DAO, they can’t unless they are able to persuade other members of the DAO to vote for them.

Photo by Philipp Katzenberger on Unsplash

The Strength of DAO

1. Highly efficient: In conventional organizations, such processes are carried out by an authorized trusted group of people, such a board. DAO eliminates a lot the delay caused by bureaucratic red tape, as the voting and the execution of every decision made by a DAO is carried out by computer programs such as smart contracts on a blockchain. DAO which runs on computer programs, can make major decisions faster, with less human error, with a lower human cost, and with higher transparency.
2. Equal footing: Because DAO is a decentralized organization, neither a CEO nor a hierarchy exists. Every member, located all around the world, contributes to the organization and participates in the decision-making process, all from the same position. Rather than leaving the research and development or innovation to a subset within an organization, anyone in a DAO can propose a new idea.

Photo by Annie Spratt on Unsplash

DAO’s Weaknesses

1. Hacking risk: While it is possible for any organization to be hacked, the chances are less. An organization that is not run on computer programs usually requires a certain person’s manual action to approve any transfer of large amounts of money. This slows down the process but makes it much harder for hackers to interfere. On the other hand, DAO is all digital and codes, making them susceptible to the online attacks. Just earlier this month, BadgerDAO reported that a hacker stole USD $119 million through a straight-forward front end attack using a MetaMask wallet to make illicit requests from users. BadgerDAO isn’t the first to confront this issue and likely they won’t be the last. Hacking is a major concern for Web3.0 and the crypto industry.
2. Quorum voting: Ideally, every member of DAO will propose and vote proactively. Unlike a traditional board meeting where members physically gather for votes, it’s unrealistic to gather all members of a DAO for every meeting. It’s the reality of the internet—not everyone is online and active at all times. If quorum isn’t met, which varies from DAO to DAO, a proposal cannot be passed. Thus, keeping members involved with the DAO and having them vote is an important challenge that every DAO needs to face.
3. Lack of regulation: While DAOs are fully legal in the state of Wyoming (they passed new legislation that defines and legalizes DAO in April 2021, giving DAO members equal rights as members of an LLC), most jurisdictions around the world have yet to come around. What results is that most DAOs are self-governed but are stuck in ambiguous legal limbo. Unregulated and unprotected, DAO members have few options to turn to for settling legal disagreements. Nonetheless, it is expected in the near future, that more and more jurisdictions will make clear their stance on DAO.