Getting started with DeFi #3: DAOs
While for many, 2021 might go into crypto history as the year of NFTs, we’ve also witnessed a growth in DAOs (decentralized autonomous organizations); they surged not only in numbers but also in funds raised. DAOs on Ethereum alone hold $6 billion worth of crypto assets.
One DAO story that hit mainstream media was when a group of individuals came together in ConstitutionDAO and tried to buy a copy of the constitution. They failed in buying the constitution but beautifully demonstrated the power of DAOs, and people coming together with a shared goal.
Once you’ve figured out the basics of DeFi, such as setting up your Wallet, you might want to step into the fascinating world of joining a DAO. Why? Because doing is the best way to learn.
But before you do, here are a few things to know about DAOs.
What are they?
DAO is short for decentralized autonomous organization and describes a group of people that are committed to working towards a mission. Typically, the rules of a DAO are governed through smart contracts in the spirit of “Code is law”.
DAOs are easier to understand when contrasting them with centralized organizations, such as commercial companies. In most companies, there is a leadership team that defines the strategy, and managers who ensure there is alignment down to the frontline employees.
In big corporates, particularly, employees at the lowest level of hierarchy often have little to no vote in the direction the company is headed toward. Even though one could argue that at times they might have better insight on what customers or users are looking for.
And in big corporates, individuals can’t just join as they please. They have to go through a rigorous hiring process, sometimes spanning weeks or months.
Not so with DAOs. In a DAO everyone can participate. Some DAOs will limit participation in discussions to those who have bought a certain NFT, or hold a certain threshold of tokens, but others are open to everyone. Yet, when it comes to voting, the only way to cast your vote is by holding the DAOs governance token.
Unlike companies, DAOs are more like a general partnership where everyone gets to contribute in working towards the common goal. Generally, they are seen as a collaborative collective that could even replace a few traditional companies.
They aren’t a new idea
In fact, the idea of decentralized autonomous organizations emerged in one form in the 1990s, nearly 20 years before the release of the Bitcoin whitepaper. Back then they were described as a multi-agent system in an IoT environment, where devices could interact with each other without centralized guidance.
Outside of the crypto world, there have been attempts by organizations to leverage decentralization for commercial operations.
Decentralization in Commercial Organizations
In commercial operations decentralized management means that decision-making power is delegated away from the center (the C-Suite & leadership) to middle and lower management, sometimes even directly to team members.
The idea behind this approach is to give authority and responsibility to those who know best. At times, there can be a vast disconnect between a company’s upper management and ground staff, who are in contact with customers on a daily basis. By giving them control and decision-making power, businesses hope to achieve better results.
Benefits of such decentralization in business include faster decision-making, more creativity, and empowerment of the individuals. Potential disadvantages include that communication barriers between independent teams might arise, and it can be difficult to collaborate when so many people are in charge.
So how does Decentralization and working together play out in DAOs?
Let’s start by examining the history of DAOs. As mentioned, the concept isn’t entirely new.
Lessons from the past
In 2013, Vitalik Buterin described the DAO as the “holy grail of organization types.” Yet, the first DAO wasn’t the big success one might have hoped for from a “holy grail organization type.”
The infamous DAO
Some crypto enthusiasts argue that Bitcoin was the first DAO. However, nowadays we don’t use DAO to refer to the blockchain networks themselves, but to speak of organizations using smart contracts. It’s not limited to an organization that employs its own blockchain network.
According to that definition the first DAO was created in April 2016 by Christoph Jentzsch and his German start-up slock.it. They named it simply “The DAO”. The DAO experimented with smart contracts and evolved into an entity taking care of operations controlled by votes. Similar to a company, but with thousands of founders. The idea was to invest collaboratively in other ethereum projects and distribute the returns.
Investors contributed $12 million worth of ETH to the cause and received a governance token in return.
Soon the team discovered a critical smart contract security bug. Yet, the DAO rules stated that updates would have to receive a majority vote, and voting had to stay open for two weeks. Unfortunately, during those two weeks, an attacker saw their chance and stole $3.5 million worth of Ether.
In the aftermath, the community decided to roll back the blockchain to where the hack hadn’t happened, which to this day remains a controversial decision, as it undermines one of the basic principles of blockchains: its permanence.
For Gavin Woods, one of the leading developers behind Ethereum however it was a sign that humans still are the most important actors in this network.
“At the end of the day, it’s a community that stays in consensus, not a machine.” (Source)
The DAO ceased operations shortly after. While its demise slowed down the creation of new DAOs, it also offered valuable lessons for anyone looking to launch a DAO. Christoph Jentzsch, the founder of The DAO, shared them on his blog, highlighting:
- Smart Contract Security: smart contract security is constantly evolving but remains a nascent field. Even security audits are not a guarantee that there is no bug in the code.
- Unknown unknowns: we might think we have a good understanding of probabilities and risks, but DAO enthusiasts shouldn’t underestimate the unknown unknowns.🦢
- Governance: as the hack has shown, in some cases having a two week voting period can be detrimental to the protocol. Structures and methods have to be carefully considered to balance democracy with operations.
- Complexity: a recommendation to avoid them as much as possible.
DAOs have taken these lessons from history into account — some more than others — and with an increase in DAO tools, they have been one of the defining trends of the last year. We now have a vibrant ecosystem of DAOs dedicated to varying causes.
Different Types of DAOs
When looking to join a DAO, consider what you’re most interested in contributing to. There is a DAO for nearly every niche. To name just a few:
- Protocol DAOs such as MakerDAO; one of the most long-lasting DAOs in the space; or Compound which are all dedicated to governing their corresponding blockchain protocol ecosystems.
- Social DAOs include Friends with Benefits and Radicle, they are more similar to member clubs where like-minded people come together. Usually to gain membership prospective members have to purchase a certain amount of the DAOs’ token.
- Investment DAOs: as the name suggests these are DAOs where individuals contribute to investing in projects together. They are similar to investment funds with the difference that decisions are made based on tokenholders votes. Examples include DuckDAO and MetaCartel Ventures.
Regardless of your field of interest, chances are that you will find a DAO that’s dedicated to your cause. You might even consider creating your own DAO. DAO tools have improved tremendously over the last few years offering potential DAO creators anything they need from multi-sig wallet and treasury management software such as juicebox, to snapshot tools and real-time payment tools.
Before joining or creating a DAO, a few words on the challenges you should be aware of. DAOs remain a nascent field after all.
Challenges of DAOs
One of the biggest, and probably most difficult to solve challenges is that one person does not constitute one vote. Despite democratic ideals, most DAOs make decisions using governance tokens. The more tokens one holds, the bigger one’s weight in the DAO, which can lead to situations where the creators of a DAO effectively make most decisions.
DAOs might also run into situations where speculators outweigh genuine contributors in term of token allocation. Speculators might vote for decisions that will benefit the token price in the short-term, but could hurt the DAO in the long run.
Currently, Wyoming in the United States is the only place where a DAO can have a legal entity. They are recognized as a type of company there. Depending on one’s interpretation of the word decentralized, it might seem counterintuitive to have a centralized entity represent a DAO. But even outside of the legal status of a DAO itself, another question that might arise are best practices for coordinating relationships with sometimes anonymous individuals, and with the organizations (at times centralized) they engage with. DAOs employ and pay people, how that is to be treated legally is another area full of uncertainty.
As the above example of “The DAO” has illustrated, at times you might want to make decisions quickly to maintain operational efficiency. This becomes increasingly challenging the more people are involved. So the question is how do DAOs scale? Most start with a small team that’s managing treasury and slowly hand over control. An example of this is the Maker Foundation, which helped bootstrap the MakerDAO ecosystem until it considered its job done and dissolved; handing all control to the community.
Despite the challenges they face, DAOs are a great way to get involved in the space and can be an excellent learning experience.
Joining a DAO
You might now wonder, how does one join a DAO in practice? it’s a straightforward process once you’ve figured out which one you want to join. Also there is no requirement to get involved full-time, so you could join a DAO and just spend a few hours, or even just minutes in them.
- Find DAO you want to join & understand the requirements to join
- Purchase token/nft or simply join if there are no restrictions
- Get involved in communications, ask questions, vote, contribute.
Currently, most DAOs will host their community on Discord, so if you’ve never used that platform before, you might want to spend time getting accustomed to it. Don’t forget to read the DAO rules, and check out the FAQ section. And lastly, just because a DAO is decentralized, it doesn’t mean that it’s a chaotic organization.
Decentralisation doesn’t mean leaderless. Rather, more people are empowered to take initiatives towards shared goals: the DAO’s North Star. (Source)
At the moment, most DAOs run on the Ethereum ecosystem, a blockchain that is controlled by 2–3 mining pools. When the network moves to Proof-of-Stake, it will shift to being controlled by those with the highest stake.
We believe that for DAOs to be truly decentralized, they need to be built on a decentralized base layer. And give everyone equal voting weight. With Minima, every user runs a full constructing and validating node. What would you prefer? Being part of an organization where the impact you have solely depended on your financial means, or being part of an equal network where maybe, every node had the same one vote.