Technological innovation leads to shifts in the way that humans coordinate. For example, subsistence farmers of the Middle Ages were oblivious to the opportunities of mercantile capitalism that shortly followed, spurred on by the invention of the printing press and double-entry bookkeeping.
The former allowed for more widespread dissemination of information. The latter is a system where every transaction is recorded in two accounts: a debit to one with a corresponding credit to another.
This second invention allowed for the formation of the corporation, entities so prevalent in our modern society and arguably more powerful than the nation-state. Investors were able to contribute capital towards ventures, record their ownership, marshal resources, and through the issuance of stock, their rewards could be distributed should the ventures be successful.
We have entered another age of transition, the end state of which is difficult for many to imagine. This time spurred on by the internet (disseminating information on a hyper-scale) and blockchain technology (akin to triple-entry bookkeeping — although not adhering to the true definition of the term). Now, through the openness and transparency of the blockchain, any third eye can “peruse the books” and conduct business with the venture, knowing exactly who owns what and who owes what to whom.
In addition, this will allow for sequential interdependent transactions and the seamless integration of independent entities, unrestricted by upper management decisions and negotiations found in today’s corporations before business deals are crystallised.
As with the formation of the joint-stock corporation during the Age of Exploration, a new type of entity is emerging based on the blockchain. DAO stands for decentralised, autonomous, organisation. Just like the corporate innovations of the past, DAOs will create a wave of new ventures and enterprises for social coordination and wealth creation.
So what exactly is a DAO? Let’s break it down:
Decentralised
There is no central leadership, community-owned, and bottom-up governance. Decentralisation leads to permissionlessness, censorship resistance and self-sovereignty.
Autonomous
Run a predefined ruleset with treasuries governed by smart contracts, all enforceable on public blockchains.
Organisation
Vehicles for agent coordination around a shared missioned aim or purpose.
Essentially they are a company on a blockchain where some (and hopefully over time more and more) normal processes of a traditional company are carried out using automatically enforceable smart contracts (onboarding members, raising capital, voting of decisions, deploying capital etc.).
In their most efficient form, they have no controlling actors, who could either be inefficient, value extractive or malfeasant. There is no one to be targeted by government agencies wanting to shut down and prevent innovative enterprises from which they cannot seek rent. Anyone, anywhere in the world, can mobilise around a common interest or a shared goal, in an unstoppable fashion, with true stakeholder ownership over the value they create.
These global, internet-native entities incentivise people to achieve a shared joint mission. Because trust is implicit within blockchains, this allows disparate groups of people to formulate around an idea. They are evolutionary for business/enterprise and revolutionary in the sense that:
- Individuals/entities can recognise an opportunity, pool capital and vote on decisions.
- No need to know, trust, or even to have met each other.
- All decision-making is transparent, auditable and highly efficient.
What are DAOs being used for now?
Myriad DAOs exist. The first break-out utilisation of DAOs at scale was governing decentralised protocol and networks. As the basic infrastructure evolved, we saw smaller, more focused investment and collector DAOs emerge, then cooperatives and gaming guilds. You may be surprised at the extensive DAO landscape that currently exists.
Credit @Coopahtroopa — ID Theory direct investments are highlighted in blue and indirect investments (through various investment DAOs), are highlighted in orange.
The surface has only just been scratched in terms of the use cases and scale of DAOs. We are now seeing research and experimentation into utilising these structures at a much larger scale; cloud cities and nation-states. Outlined below are some of the current use cases.
Protocol DAOs
Usually associated with DeFi Platforms (such as Maker, Uniswap, and AAVE), distribute governance tokens that enable holders to vote on network decisions. Such decisions are often complex and technical, so a few protocols have seen knowledgeable delegations emerge via governance leaders. Their tokens represent exposure to the future value and growth potential of the networks the protocols create.
Investment DAOs
These can be multipurpose (such as the LAO, Spaceship and Metacartel) or mission focussed (such as Neon — Metaverse and Beaker — De-Sci). Members pool capital for a proportional share of ownership and voting power to decide how that capital is allocated. They vary in mission aims, structure and size. Their eclectic constituency results in a highly efficient hive mind, quality deal flow, and sound investment decisions.
Collector DAOs
Collector DAOs (e.g. Flamingo, Noise and KRPDM) are similar to investor DAOs but usually focus more on specific verticals or NFTs. Members contribute expertise and capital and can share in the upside and appreciation of the collection. Their hive mind is forward-thinking, can predict trends and position itself sufficiently ahead of the market.
Community and Social DAOs
Community DAOs organise around a shared interest and can use tokens to gate a specific space, such as a discord server. Such DAOs can create events and foster culture (such as Friends with Benefits DAO, often called the digital Soho House). They incentivise members to create value for their communities and earn a reputation within.
Service DAOs
Service DAOs (e.g. 5a.m.) can address the (often crypto-specific) needs of other DAOs and blockchain-based businesses. They are ready to disrupt the $250B consulting market. DAOs get direct ownership of the organisation they service in return for “sweat equity” by taking payment in the form of underlying tokens from other DAOs. In this way, they become quasi-ETFs for the industry verticals to which they provide a service.
Guilds and Gaming DAOs
GamiFi DAOS (Such as Dark Horse) invest in yield-generating assets and act as the supply side to gaming networks. Guilds (such as Ready Player DAO) sit on the demand side and provide training, tools, and NFTs to players in return for shared income. They are highly effective at dominating gaming universes and extracting value from open economies.
The Benefits of DAOs:
The properties of blockchain grant many beneficial characteristics to these entities. Their structure fosters trust and reduces the likelihood of self-dealing and opportunistic behaviour from individuals.
Permissionless
Only the DAO controls who can and cannot participate in certain activities within the DAO. i.e. the DAO is not governed by any external entities. Anyone, anywhere in the world, may contribute to these entities and can come and go as they please, unbound by contracts. This means DAOs can attract talent from anywhere.
Censorship Resistant
No nation-state, institution, corporation or third party can control who submits transactions to a DAO, therefore, different classes of citizens cannot exist within a DAO. Laws that govern the DAO are set in advance and can’t be retroactively altered to fit a specific agenda. This enshrines the perceived fairness of the DAO, attracting actors that may not want to work in other entities.
Open Source
People are free to build upon the shoulders of giants, and should contentious issues arise within a DAO, it is easy for communities to split, the DAO to fork, and for two entities to emerge to settle the contention. This encourages innovation through collaboration.
Transparent
A complete view of how votes are drawn, how funds are allocated, and who has participated in what way. It allows people to earn a verifiable reputation within the DAO which can translate to granting permissions. Therefore, DAOs are seen as fair meritocracies whilst avoiding opportunities for contested decision-making, fraudulent behaviour or simple mistakes.
No Central Points of Failure
As with the above, intermediaries are not only inefficient and expensive but can be incompetent and malfeasant. Furthermore, removing central points of failure reduces the attack surface of a DAO and makes them robust. This makes DAOs very hard to stop. No single DAO member or other individual has the unilateral ability to transfer funds or defraud the organisation.
Participatory
They have flat hierarchical structures and are not run by managers but by individuals with no information asymmetry. DAO-based voting often occurs on an ongoing basis, so it incorporates information and feedback from a wider group of stakeholders in various situations and circumstances. Members have the autonomy to respond to opportunities and drive value back to the DAO.
Stakeholder Incentivised
This pulls together disparate groups of people towards a common purpose giving them ownership in return for services they can provide. As opposed to corporations, whereby ownership is only earned through the contribution of capital (i.e. shareholders), DAOs can encourage people to provide value in other ways. Ownership of the DAO can be earned through contributions, elbow grease and sweat equity (i.e. stakeholders).
Efficient
Internally, things can be parallelised and automatically executed, leading to significant time efficiencies. Externally, due to the “third eye” of triple entry bookkeeping, DAOs can interoperate with other DAOs and entities automatically. However, it is the removal of intermediaries, which often comes at huge costs and the removal of the need for trust that can expedite many processes. This allows DAOs to operate in marginal profit zones where corporations cannot and are more responsive than existing legal entities with their fluid democratic processes.
Problems with DAOs:
As with all transitions, there are teething problems that these nascent organisations face. DAOs can be an effective mechanism for organisation but are not immediate solutions to historical governance or organisational issues or those of bad actors — this will take time.
Various problem areas require careful consideration when investing in or joining a DAO. As investment structures, most DAOs are often slow to act, have little to no legal grounding, maintain unclear security measures and are without effective governance structures. Although generalised below, it is worth caveating that problems within each DAO are specific.
Legal Ambiguity
Unlike traditional corporations, non-profits, cooperatives, and partnerships, DAOs don’t exist within a jurisdiction and are not regulated by any particular rules. This can create potential liabilities for DAO members resulting from the actions of the DAO itself, such as an unforeseen tax bill or an inharmonious event within the DAO itself, disincentivising individuals from joining due to substantial risk to their assets outside the DAO. Operating outside of legal systems can restrict the full scope of business activities that they may perform and thus their full potential.
Smart Contract Risk
Smart contracts are software scripts executed on a blockchain network. Writing rules reflecting the complexity characterising human decision-making is not easy. Other times it may mean that DAOs risk cyber exploitation if they exhibit weak code.
Governance Risk
Smart contracts also underwrite DAO governance; DAOs can be co-opted. Adversarial governance attacks are a threat, especially in token-weighted DAOs, assisted by general governors’ apathy, low voting window frame, weak proposals discovery and inappropriate voting quorums and thresholds. This can lead to bribing networks and plutocracies.
Low Participation
Participation is also inversely correlated with DAO size — meaning that the bigger the DAO gets, the fewer people vote. Two sociological theories partly explain this; Dunbar’s number and the Ringlemann effect. Essentially this is because as the group gets larger, members become more detached from one another and subsequently lazier because their voting power and effective influence are diminished.
Coordination
Given their global nature, members are usually spread across various time zones. Flat hierarchies and undefined roles and responsibilities are not helped by a lack of web3 native workspaces. This means that the ability to form a consensus rapidly and execute anything agreed upon is hampered.
Efficiency
Efficiency sometimes has to be sacrificed for decentralisation and transparency (a trade-off which, in the long run, should prove valuable). One of the key criticisms levelled at DAOs is that they are slow to act. Not everyone has sufficient knowledge or skill sets to contribute meaningfully, and large DAOs can have high noise-to-signal ratios.
Closing Thoughts:
There are significant barriers to overcome when attempting to create Decentralised Autonomous Organisations.
When it comes to the assumption that DAOs are slow-moving, we may have conflated our understanding of what it is to be efficient directly with the speed at which we act and have forgotten the critical consideration of wastage. Efficiency is as much about cutting through the noise as it is about acting fast — DAOs assist with this by collaborative due diligence and leveraging their hive mind.
In the long run, it may be that resilient decisions, based on DAO consensus, are more ‘efficient’ than those arrived at hastily in hierarchical institutions. However, the efficiency and accuracy of DAO consensus often depend on the specific group of members in the DAO. This means that effective decision-making can rely on several factors (including, but not limited to, size and membership).
In addition, ‘total’ decentralisation is almost impossible to achieve. People will never be completely independent of one another; collusion and discussion between subgroups of any structure are inevitable.
However, once there is a broad understanding that the mission aim is to achieve the most feasible amount of decentralisation — without sacrificing core elements of a functioning organisation — we can work towards how that might look. It is recognised that ‘partial’ decentralisation is not ideal but is the most realistic approach, at least for the time being.
When designing structures to manage complex organisational systems, assumptions of how these systems will react are often wrong. We are currently in the trial and error stage of complex internet-native structures. An excerpt from Gall’s Law highlights the idea that the testing realm of trial and error truly is the best place for some DAOs to evolve.
“A complex system that works is invariably found to have evolved from a simple system that worked. The inverse proposition also appears to be true: A complex system designed from scratch never works and cannot be made to work. You have to start over, beginning with a working simple system.”
- John Gall
We must continue to be flexible and iterative in DAO structures to move towards the ideal form of organisation and recognise that whilst errors will occur frequently, they are needed to build more robust and efficient structures.
In summary, DAOs have the potential to be hugely impactful in how businesses, societies and communities organise. Numerous DAOs exist today, fulfilling a wide range of niches and conferring many benefits vs traditional structures.
However, DAOs are imperfect and have many structural and behavioural challenges to overcome before they can be utilised more effectively and broadly.
The following article will highlight how DAOs are evolving to solve these issues.
Special thanks to Aaron Wright, Priyanka Desai and Harry Ephremsen for reviewing and providing critical feedback.
ID Theory may hold positions in some of the assets discussed in this post. This post is strictly for informational and educational purposes only. It does not in any way constitute an offer or solicitation of an offer to buy or sell any investment or cryptoassets discussed herein. Always perform your own research and conduct independent due diligence prior to making any investment decisions.
Interested in partnering with ID Theory or building something special? Get in touch through our website or at info@idtheory.io.
