Understanding DAOs: Decentralised Autonomous Organisations explained
Ethereum has grown at a staggering pace over the last six years. Since emerging onto the cryptocurrency scene as a groundbreaking smart contracts platform, the network has given rise to powerful new innovations like DeFi and NFTs. Ethereum is currently best known as the home of both niches today, but many of the network’s biggest enthusiasts believe that DAOs will be the next area of the space to explode. DAO stands for “Decentralised Autonomous Organisation”. In this guide, we’ll explain how DAOs are evolving on the blockchain, and what the development could mean for the future of organisations around the world.
A Decentralised Autonomous Organisation is an Internet-native community that governs itself through smart contracts. Unlike organisations in the traditional world, the rules and principles of a DAO are embedded on the blockchain, so they are not prone to manipulation or attack.
As DAOs use smart contracts, they are mostly found in Ethereum, the world’s leading smart contracts platform. Similar to Ethereum’s DeFi ecosystem, DAOs rely on code rather than the trust of a third party such as a CEO.
In the traditional world today, most organisations or companies follow a hierarchical structure, often with a small minority claiming ownership. DAOs differ in that they are owned by the entire community, with management left to members. The flat structure of a DAO can allow for human coordination in a way that’s never been possible before as there is no leader or central party, which is partly why many crypto believers are excited about their potential.
DAO members are often rewarded based on the contributions they make to the organisation. Rewards are determined by the smart contract code, which is open and transparent on the blockchain.
The rules for a DAO are always open for anyone to view. Any change to the rules requires a majority vote among the members of the DAO. Voting is recorded on-chain so it is also public.
In the 2014 article “DAOs, DACs, DAs, and More: An Incomplete Terminology Guide”, Vitalik Buterin described DAOs as follows:
“The idea of a decentralised autonomous organisation is easy to describe: it is an entity that lives on the Internet and exists autonomously, but also heavily relies on hiring individuals to perform certain tasks that the automation itself cannot do.”
Buterin’s description highlights two key points: DAOs are Internet-native, similar to the rest of the blockchain and cryptocurrency space. Moreover, they require contributions from members to fulfill their potential. Contributions to a DAO may include writing notes for the website, offering social media support, researching in relevant topic areas, or producing merchandise.
DAO members can make a proposal for their contribution, and they typically earn remuneration in the form of the DAO’s governance token. If members pass vote on the proposal, the contributor receives the remuneration from the DAO.
While smart contracts offer a way to automate and execute transactions, DAOs complete tasks that can not be executed by code alone. Key decisions in DAOs are made through a voting process; members can use their tokens for voting power. This means that any updates or developments within the DAO are only made after members of the organisation reach consensus. Where blockchains like Bitcoin and Ethereum aim to achieve consensus for every transaction through nodes, DAOs rely on their members to vote on updates.
DAOs are global and permissionless, which means that anyone can join from anywhere in the world. While companies are usually closed off to only a limited number of candidates living within a certain catchment area, DAOs do not present the same limitations. As they are decentralised and global, they can grow at a faster rate than traditional companies.
While DAOs are open and permissionless, they often have certain requirements for becoming a member. SquiggleDAO, for example, is a DAO for owners of the popular Chromie Squiggle NFT. Many other NFT projects have similar DAOs of their own.
DAOs and DeFi
Bitcoin is frequently described as the first DAO because it is based on an immutable set of rules. It rewards Bitcoin miners for securing the network via Proof-of-Work consensus, and those rewards change over time as issuance reduces by 50% every four years.
The advent of smart contracts has greatly expanded the possibilities for DAOs. Smart contracts paved the way for the growth of DeFi on Ethereum, which has been foundational to the evolution of DAOs. DeFi eliminates the need for trust in intermediaries, using cryptocurrencies to exchange value between users.
Cryptocurrencies are also key to DAOs: many of them reward users through their own governance tokens. Ownership of tokens can be used to vote in key decisions affecting the protocol, which is a model many DeFi projects have adopted.
DeFi projects often launch tokens as a way of attracting liquidity and bootstrapping the network, while also decentralising the governance so that it is managed by a community rather than a team. In many cases, tokens can also be earned for participation in the protocol.
The risks of DAOs
While DAOs have huge promise, they also present potential risks. DAOs decentralise governance so that no one party holds control, but it’s possible that some members can have more power over others. When voting power is determined by token ownership, for instance, wealthy groups such as venture capital firms owning a large supply of the tokens can end up having major influence over key decisions.
While one member alone may not have enough of a stake alone to sway decisions, they could potentially collude with other members for their own financial gain.
Moreover, as DAOs have economic growth baked in through their incentive mechanisms, they may end up placing too much focus on financial interests. A group dedicated to supporting emerging musicians using NFTs, for example, may select those with a bigger community following in the hope that they reap rewards for the group in the future.
DAOs ultimately depend on the community to drive the direction in a way that matches the group’s ethos. As much as rules can be embedded into code, ideological values are harder to record on the blockchain. DAOs need communities to evolve in fitting with the organisation’s mission without being influenced by the potential financial rewards.
The future of DAOs
Like DeFi, NFTs, and the Ethereum ecosystem itself, DAOs are still in their infancy. In fact, they arguably occupy the least explored niche in Ethereum today. However, it is already clear that DAOs could form a key part of the future of Web3.
DAOs highlight the power of community, something that’s integral to the blockchain movement. They create a way for online groups to gather and coordinate in a way that didn’t exist pre-Bitcoin.
Some notable DAOs have already emerged in the Ethereum ecosystem in recent months. PleasrDAO, a group formed to acquire an NFT by pplpleasr, has made waves in the NFT space and even acquired a one-of-a-kind album by Wu Tang Clan. ConstitutionDAO, meanwhile, recently raised over $45 million to buy a copy of the US Constitution, but narrowly lost out in the Sotheby’s auction for the item. Nonetheless, the DAO’s efforts highlighted the possibilities of human coordination at scale.
As the world moves towards an open, Internet-based financial system, DAOs will create a way for communities to cooperate via rules that live immutably on a public blockchain.
While Bitcoin can be described as the first DAO, smart contracts have created new possibilities for organisations to function in a decentralised manner. Today this is particularly true of DeFi protocols such as Maker, which have decentralised their governance in favour of the community of token holders. Moreover, the NFT space has spawned many groups such as PleasrDAO, which focuses on buying high quality tokenized art. In the future, it is likely that DeFi, NFTs and DAOs will further collide as Ethereum evolves.
However, DAOs in their current iteration are only at the beginning of a long journey. DAOs have shown their promise within the context of decentralised crypto-native protocols. Soon, it could be time for traditional groups and companies to see the power of decentralised governance. In the future world of Web3, it may not be standard practice for someone to take up a job in a company — they’ll be contributing to a DAO instead.