A Full Guide to DAOs

Key Points

  • Recently, cryptocurrency and blockchain technology have become some of the most popular concepts in the technology industry. The innovative aspects of the blockchain are now being applied to various sectors of the economy and have set the unprecedented stage for decentralized finance (DeFi), non-fungible tokens (NFTs) and the metaverse.
  • Decentralized Autonomous Organization (DAOs) have emerged as another dominant aspect that stems from the blockchain. DAOs refer to a collection of individuals or organizations who pool resources together into developing a smart contract that powers DeFi and other blockchain-related endeavours.

Background of DAOs

Slock, a German blockchain protocol, became the first idea of a blockchain-based organization in 2015. The idea behind Slock was to create a venture capital system where investors could make key decisions using smart contracts. This would have eliminated any organic structure, with the only form of human participation coming from developers who will be writing the smart contracts codes. After coding, every other thing would be run via the rules of the blockchain.

The next major event related to a DAO occurred two months later following an infamous hack that leveraged on a leak, carting away roughly $50 million. This prompted the developers to create a fork. With a more foolproof protocol, a new network was formed and the smart contract was coded to reimburse investors.

Another significant mark in the evolution of DAO was the creation of the ConstitutionDAO, a movement that comprised 31 members, including John Elrich. The DAO allowed its members to make donations on the Ethereum network to buy a copy of the U.S. constitution. It was formed to compete at a Sotheby’s auction of the U.S Constitution, and got the spotlight it deserved despite losing the auction.

What Exactly are DAOs?

A DAO, or a Decentralized Autonomous Organization, simply refers to a group of people focused on a specific mission and working in coordination based on pre-existing rules encoded on the blockchain. The most notable benefit associated with DAOs is transparency. DAOs are more transparent than traditional institutions because anyone can have the opportunity to see all actions and funding associated with them. This helps in limiting the risks of corruption and censorship that can occur within traditional companies. For instance, members can have access to financial statements which are often audited by external parties. These reports do not completely expose the health of the company’s finances. Though traditional companies are beginning to embrace blockchain technology, they often make use of private book-keeping, giving access to only a selected few.

DAOs, on the other hand, make use of public blockchains and all information associated with the organization such as balance sheets, governance and more are clearly recorded on the blockchain. This way, shareholders can easily access the organisation’s financial statements whenever they choose. The DAOs public blockchain takes every single entry into consideration.

For example, during conflicts, the only way these kinds of disagreements can be resolved is when legal agreements are set up to ensure rules are binding. This will definitely give a clear representation of DAOs, where the smart contacts serve as legal agreements and the people serve as shareholders. Rules cannot be made without consulting with the stakeholders. This is what also makes DAOs different from traditional companies where rules are made only by executives.

Governance in DAOs

Decentralized organizations practically take advantage of the functionalities of blockchain to offer self-enforcing rules. Smart contracts store the rules, while the protocol’s native tokens help in securing the network and voting rights.

Below is an outline of how governance in DAOs work.

  1. Understanding the governance problem is the first step in creating a DAO. Developers analyze the governance problem before developing the smart contract codes to serve as the foundation of the DAO.
  1. The tokenomics in the governance model must be presented. This gives the foundation for the monetization of the DAO.
  1. The final stage is the launching of the DAO with the same token stakes for the shareholders and developers. This ensures there is a balance of power.

The overall precedents in developing DAOs create a pathway for transparency and autonomy. As such, the number of tokens a user holds is equivalent to their voting power, giving those with more tokens more privileges to introduce new governance proposals.

With the equal distribution of power in DAOs, there is a reduced number of new proposals, ensuring stability in passing new proposals with the affirmation of the majority of shareholders.

How DAOs Work

To understand how DAOs work, it is important to understand that DAO governance rules are created by its community using smart contracts which form the basic framework for DAOs. The smart contracts codes are visible, verifiable, and can be publicly audited, ensuring members are fully aware of what is happening in the protocol.

Once a DAO’s rule has been coded, the project is funded and fiscal inflow and governance rights will be determined. To raise funds, tokens are issued to users who then get voting rights that are proportional to the value of their assets. After this, the DAO will be deployed successfully.

When investors decide to start their DAO journey, they must understand that several DAOs exist and each of them serves specific purposes. For example, Uniswap allows its users to vote on fee distribution, while Compound lets users vote on the distribution of protocol fees for bug fixes and protocol upgrades. As such, investors can join the network to earn rewards.

There are other protocols that focus on policy treasury just like Shark DAO. This protocol allows token holders to pool funds to buy other blockchain-based assets such as NFTs. This is unique because shareholders would be able to access assets that may otherwise be expensive for other investors.

Many of the DAOs out there are autonomous, enhancing transparency because proposal details are easily accessible. And when voting takes place, the records are made public to all shareholders. Investors do not have to worry about communication with DAOs as most of them use Discord servers.

It is important for investors to understand that DAOs have some unique challenges. They include:

  • Onboarding issues: Investors who are not tech-savvy often find it difficult to join DAO communities. Hence, it is important that DAOs make their systems accessible and user-friendly.
  • Partial efficiency in voting governance: Some voting governance proposals are partially efficient, without any form of improvement in compensation contribution.
  • Regulatory issues: Many new blockchain protocols do not give an opportunity for legal and regulatory control.

Categories of DAOs

There are different types of DAOs, with all of them serving a particular purpose to ensure that critical matters are addressed, proposed and implemented following the protocol’s rules.

Below are several categories of DAOs, as well as examples of organizations that fall under them:

Investment DAOs

Investment DAOs are decentralized organizations that share similar features with traditional investment funds that operate with pooled funds. The only difference is that a single centralized authority does not decide the rules. Rather, investment DAO token holders can vote on what the pool of funds should be invested in.

Some notable examples of Investment DAOs are:

  • The LAO – is structured as a member-directed venture capital fund in the U.S and registered as a Delaware limited liability company(LLC).
  • MetaCartel ventures – is a sub-DAO under MetaCartel DAO which invests in nascent decentralized applications.

Grants DAOs

Grant DAOs are designed to fund new projects mainly within the decentralized finance ecosystem. These DAOs often stem from the philanthropic arm of larger projects in the DeFi space. However, some exist independently.

Common examples include:

  • Uniswap Grants – A DAO that manages the disbursement from Uniswap’s community treasury. It supports the growth of new projects around Uniswap and the DeFi space by funding hackathons and protocol development.
  • Gitcoin – an independent platform that funds developers and builders that create open-source applications.
  • Moloch – served as a framework for several new DAO.

Protocol DAOs

Protocol DAOs are the most common types of DAOs and are found behind major decentralized finance protocols. They are often used as an ownership and governance mechanism of lending protocols, yield optimization and several others.

Common examples include:

  • Uniswap – the top decentralized exchange on Ethereum. Uniswap’s governance system was launched in September 2020, giving UNI token holders the power to vote or delegate votes that controls the platform’s fees, treasury, etc.
  • Aave: a decentralized lending platform that enables users to lend and borrow major crypto assets.

Collector DAOs

Popular examples of collector DAOs include:

  • PleasrDAO – a collector DAO that pools funds together to acquire collectible items such as NFTs, music, real-life artwork, and more. While this DAO can be considered an investor DAO, the major difference is that it focuses only on art and collectibles.
  • Flamingo – a sub-DAO that stemmed from LAO. This DAO focuses on NFT investment opportunities to support the growing NFT and metaverse sector.

Social DAOs

Social DAOs are similar to country clubs where members gain entry into a social circle by paying membership fees in the form of purchasing a certain number of DAO tokens. Members of this circle share similar interests and the purpose depends on the DAOs.

Some notable examples include:

  • Bored Ape Yacht Club
  • Friends with Benefits

Frequently Asked Questions

Are DAOs truly decentralized?

Decentralization is a major characteristic of DAOs and in most cases, all details of DAO can be viewed by all community members.

What are the different membership models in DAOs?

The two types of membership models in DAOs are token-based and share-based models.

How are DAOs governed?

Governance of DAO completely relies on self-enforcing protocols called smart contracts, and governance can be on-chain or off-chain.