What Is a Decentralized Autonomous Organization (DAO)?

Summary

Blockchain technology provides innovative methods of exchanging currency and information while automating complicated operations openly and securely. A decentralized autonomous organization (DAO) is an organization that operates fully and independently on blockchain technology per rules recorded via smart contracts. DAOs are typically referred to as “trustless” systems since they do not require human interaction or centralized coordination.

DAOs allow previously impossible levels of transparency, cost savings, and decentralized decision-making by utilizing cryptographic instructions that automatically execute when pre-established criteria are met.

DAOs: A Principal-Agent Dilemma Solution

A decentralized autonomous organization (DAO) is a blockchain-specific organizational design that addresses the principal-agent issue, which occurs in almost every industry and organization. When a system is designed in such a way that an individual or entity (the “agent”) can make decisions or take actions on behalf of another individual or entity (the “principal”), there is an inherent risk due to the respective parties’ divergent goals, priorities, or access to critical information. This is known as the principal-agent dilemma, and it indicates that the agent may be driven to behave in its self-interest even though the agent was chosen to make decisions.

At the moment, this conundrum is a frequent issue that affects a wide range of public and private enterprises. DAOs are sometimes referred to as “trustless” systems because they aim to address this issue by decreasing or eliminating the requirement for hierarchical human involvement or centralized coordination. DAOs play a critical role in minimizing the traditional issues associated with the principal-agent dilemma by ensuring that incentive structures and information flow within an organization are appropriately aligned in a formalized fashion. The alignment of incentives is a key idea in blockchain protocols, and DAOs apply the same reasoning to companies and governance. A well-designed DAO aligns the interests of stakeholders controlling an organization or decentralized platform, ranging from founders to token holders, users, and the broader community. The potential implications of adopting DAOs on a large scale are tremendous, as are the real-world obstacles of properly using DAO-enabling technology.

How Do They Work?

While the precise underlying mechanisms that enable a DAO vary amongst blockchain projects, there are many broad steps that a DAO must go through to start in a sustainable manner:

  • Before implementing a DAO, the underlying rules must be created and encoded in a series of smart contracts. Given that future changes to the DAO’s operational workflows, governance system, and incentive structures will need to be voted on to take effect, this phase is arguably the most important step in establishing a sustainable and autonomous DAO, as any early mistakes or overlooked details could destabilize the project later.
  • Funds: Once a DAO’s governing smart contracts have been established, the DAO will require funds to operate. Internal property, such as a native currency that may be spent by the DAO, used in voting procedures, or used to reward particular activities, must be created and distributed as part of the DAO’s smart contracts. Individuals or businesses interested in participating in the DAO’s growth can then purchase or otherwise acquire the DAO’s native token, which generally results in the acquisition of voting rights.
  • All decisions are made by consensus vote once a DAO has acquired sufficient cash to be deployed. As a result, all token holders get the opportunity to make changes to the DAO’s future and how its funds are spent. If the DAO’s token distribution policy and the consensus procedures specified in its underlying smart contract architecture are well-designed, the DAO’s stakeholders will try to achieve the greatest possible outcome for the whole DAO network.

As a result, the DAO organization that emerges from this mechanism can operate independently of its founders or any other central authority. The rules, transactions, and activities of a DAO are all recorded on the blockchain and can be viewed by anybody, ensuring complete transparency and immutability. In summary, the stakeholders of a DAO are united by a shared purpose, which they will vote to further by following particular network incentives spelled out by the DAO’s underlying consensus policies. As a result, the DAO organization that emerges from this mechanism can operate independently of its creators or any other central authority.

The rules, transactions, and activities of a DAO are all recorded on the blockchain and can be viewed by anybody, ensuring complete transparency and immutability. In summary, the stakeholders of a DAO are united by a shared purpose, which they will vote to further by following particular network incentives spelled out by the DAO’s underlying consensus policies.

DAO vs. Real World

DAOs confront several legal and practical difficulties since their structure and operation differ significantly from those of regular organizations. Because DAOs can be spread across several nations and jurisdictions, any legal problems would almost definitely involve dealing with numerous regional laws as well as any applicable cross-border contractual ties.

Furthermore, because changing a DAO’s code or smart contract structure requires a consensus vote, malicious actors may take advantage of a bug or design flaw before the DAO’s stakeholders can work together to fix it. The DAO was hacked in 2016 owing to vulnerabilities in its codebase, culminating in a controversial hard fork of the Ethereum network to move money taken from The DAO to a new smart contract. The attack changed the game in blockchain, and developers have been worried about a repeat attack ever since.

DAOs, on the other hand, have remained popular in the market. In the decentralized finance (DeFi) ecosystem, there are currently numerous intriguing blockchain initiatives with fully integrated decentralized governance systems.

It’s important to note here that the more stakeholders a DAO has, the more decentralized it gets. This is one of the main reasons why many existing blockchain projects allow for centralized decision-making in the early phases of development before scaling up to become a full-fledged DAO. And, despite achieving DAO status, many of these projects have yet to effectively decentralize, given that most DeFi efforts are just a few years old.

DAOs provide a potentially game-changing new type of corporate governance, notwithstanding the challenges of creating and implementing highly sustainable, value-generating DAOs. As the legal uncertainties around DAOs are cleared, a growing number of businesses may explore using DAO platforms to automate certain aspects of their core operations. While the increasing complexity of current business models forces DAO stakeholders to modify their systems, the aim of creating transparent, self-governing organizations is becoming a reality.

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