What Is a DAO: Promoting Governance With No Central Authority
A decentralized autonomous organization, or DAO, is a unique way to connect people using blockchain technology. Its structure is quickly becoming popular among users who have common goals and a desire to collaborate. DAOs are innovative because they give every member an equal voice.
New DAOs are emerging every day. Whether you want to grow your investments using NFTs or donate funds to a charity, a DAO could be the answer. This guide demystifies DAOs, how they use blockchain technology, and what their advantages are over traditionally structured organizations.
What Is a DAO?
A DAO is a blockchain-governed autonomous organization owned by its community members. It does not have a governing CEO or board of directors. The collective utilizes smart contracts to lay foundational rules, and is designed to give members equal votes on changes or modifications.
At any given time, members can create proposals to improve the DAO’s protocol, after which all community members have the opportunity to vote on them. Proposals with a predetermined percentage of votes in their favor will be accepted and implemented, based on the rules within the smart contract.
Community members are incentivized to approve proposals that benefit the protocol. As long as a protocol is healthy and sustainable, like-minded people will want to join the community. This, in turn, increases the demand for the DAO’s tokens, which elevates the value of the members’ tokens. As such, it’s in every member’s best interest to ensure that the protocol succeeds so they, too, can be successful.
Types of DAOs
The purpose of a DAO is to connect people with similar goals into a group that doesn’t want a leader. Operations are managed by the community and follow blockchain-based rules. Decisions made within the DAO are rendered through proposals and voting, making all activities transparent for the members to see.
Each DAO has its own decentralized governance and tokens. Growing blockchain technology has enabled users to create DAOs with a wide range of goals. Here are a few examples of DAOs and their uses.
A protocol DAO governs a decentralized protocol — such as exchanges, lending and other applications — using smart contracts. This type of DAO can also be referred to as an AMM DAO, or automated market maker DAO.
The first protocol DAO was MakerDAO, formed in 2015 and launched in 2017 onto the Ethereum network. Since then, protocol DAOs have become the most common type of DAO, with thousands of different applications.
Protocol DAOs are also used for decentralized cryptocurrency exchanges, or DEXs. Each DEX enables traders to exchange different tokens with user-funded liquidity pools. Typically, a DEX will offer users rewards for staking the DEX’s native token. Some examples include Uniswap and SushiSwap.
Philanthropy DAOs focus on promoting social responsibility initiatives and other charitable causes. They employ several different models to collect and distribute funds, using cryptocurrency.
Their goal is to create a meaningful impact through sustainable, globally accessible fundraising methods. One example is UkraineDAO, which raises donations for Ukrainian soldiers. Another is Popcorn, which benefits multiple social impact organizations elected by POP holders.
Investment DAOs concentrate on investing funds as a group. As with other types of DAOs, each decision is made by those who own the investment DAO’s governance token. The objective is to generate revenue for the group in the form of cryptocurrency, NFTs or other decentralized assets.
One of the biggest benefits of an investment DAO is the collective decision-making process. In most traditional investment organizations, a small group of professionals, or one individual, is making each key decision. However, in an investment DAO, anyone holding the governance token can make a proposal, and everyone benefits when the investment pays off.
NFTs and digital collectibles are growing in popularity. Collector DAOs gather funds to purchase and own these digital assets. For investors, a collector DAO is a good way to own a piece of an expensive NFT, or other collectible, at a reduced financial risk.
Not all collector DAOs are formed for investment purposes. Some help make key decisions about a collection of NFTs or digital assets. These DAOs may have only a few dozen participants who use the technology to grow the community or spread awareness. As in an investment DAO, once the assets of a collector DAO become profitable, funds or other rewards are distributed to its participating members.
A grant DAO is similar to an investment DAO, except any collected funding goes to supporting new projects. Typically, these DAOs are philanthropic in nature and part of a larger community-driven program. An example of a grant DAO is Aave Protocol, a community focused on building and funding DeFi projects.
How Does a DAO Work?
Each decentralized autonomous organization is a little different. In general, you need to own the DAO’s governance token to participate in the decision-making process or receive rewards. The exact rules of the DAO are defined using smart contracts on the Ethereum blockchain.
Some DAOs have prerequisites for joining, but most require only a secure crypto wallet, which lets you purchase the DAO’s governance token and receive rewards. Additional community requirements may include filling out an application, joining a Discord server or owning a specific NFT.
Remember that DAOs have no centralized leadership. All decisions are made by voting on member-submitted proposals. Even small decisions affecting the DAO are made this way, including how to promote the organization, distribute funds, operate new protocols and what to invest in.
The method for submitting a new proposal also varies from DAO to DAO. Large communities tend to require members to stake tokens, or pay a fee, to submit a proposal. This system encourages members to submit only serious proposals, and it increases voter participation.
After the proposal is voted on, a smart contract is automatically executed. Because of the DAO’s transparency and security, modifying a contract after it has been executed is very difficult.
What Is the Purpose of a DAO?
Users may want to create a new DAO for several reasons. Typically, each DAO token holder has a voting power equal to the number of tokens they hold, which means that a person holding 50 tokens would have 50 times the voting power of someone holding just one token in the voting process. It is believed that someone who is more monetarily invested in a DAO would have a stronger motivation to ensure that the DAO succeeds. As such, this practice acts as a safeguard to ensure that users who are not as monetarily invested are not able to act in bad faith and cause the DAO’s fall.
DAOs are needed because they enable participants to pool funds and support initiatives without having to rely on third parties. Instead, after a proposal is voted on, participants trust codes to automatically execute a smart contract. This makes each transaction verifiable on the blockchain by any member, whereas a traditional organization may not be as transparent.
Advantages of a DAO
While each DAO is built a little differently, they have the same core advantages. The decentralized and autonomous structure allows for smooth operations and easy collaboration. Here are some additional advantages DAOs have over traditionally structured organizations.
A DAO’s structure is mostly automated, giving it a huge advantage over traditional organizations. To smoothly run daily operations, a large staff isn’t necessary. Smart contracts handle every activity, so work doesn’t have to be prioritized, and tasks aren’t overlooked. The autonomous structure also allows each participant to remain independent; they can participate in the DAO as much as they like, with little to no impact on the DAO’s daily business.
Another benefit of using a DAO is the reduced need for human interaction thanks to the presence of smart contracts. While DAOs tend to have strong communities, they don’t have leaders. This gives rise to a neutral environment without any power plays from authority figures, which reduces conflict within the organization and ensures the organization functions as intended at all times.
Because of the DAO’s structure, each member is responsible for their own actions. DAO members also tend to have the community’s best interests in mind when creating proposals or voting on them. Every transaction on the blockchain is also clearly documented. In addition to having an invested interest in the organization’s future, most investors want the DAO to remain credible. This increases the likelihood of members conducting research before creating, or voting on, a proposal.
DAOs are very community driven. They can attract a large number of members, each with their own thoughts and opinions. While participation isn’t typically mandatory for token holders, it’s highly encouraged. The more investors contribute to a project, the easier it is for the project to grow. Every member has the opportunity to express their opinion and share ideas.
Disadvantages of a DAO
Before you create a new DAO, explore some of their potential disadvantages.
One of the biggest advantages of using blockchain technology is speed. Although DAOs use this technology, the community-driven aspects of the organization can impede progress. Because all changes to the DAO need to be voted on, impacts to the code can be time-consuming. This is incredibly problematic for emergency decision-making, such as responding to a security breach.
Lack of Security
In a world where blockchain technology is growing at an alarming rate, security has become more important than ever. While smart contracts are generally thought of as tamperproof, new technology or hacking methods could create vulnerabilities in a DAO.
Concentrated Voting Power
To vote on a proposal, you need to own the DAO’s tokens. Each token represents one vote; however, there are several DAOs that offer more voting power based on the number of tokens one has. This means the more invested you are in the DAO, the more voting power you have. Investors who have accumulated large amounts of DAO tokens may have enough to always have the majority vote. While some DAOs have rules against this, others may not see the issue until several impractical proposals have been passed.
All rules and regulations for a DAO are enforced by smart contracts without the need for a single leader. This can make it difficult to change existing rules, especially if these rules were not clearly defined early on. Rather than a single person being responsible for the outcome of a vote, the group is responsible for the decisions it makes. This can cause issues with the overall management of a DAO, and may be problematic if a DAO gets involved in a legal battle.
Best DAO Projects
Here are some of the most impactful examples of DAO projects.
Released in 2016, The DAO was the first of its kind. The independent enterprise ran on the Ethereum blockchain and enabled users to easily pitch ideas for projects. While the project raised millions of dollars, it had a bug that was exploited, and funds were stolen. Recovering the funds resulted in a hard fork in the blockchain. This led to the creation of Ethereum Classic.
Launched in 2017, MakerDAO controls DAI, a decentralized stablecoin pegged to the U.S. dollar. MakerDAO allows users to deposit DAI and earn interest. Users can also create collateral loans. While MakerDAO is known for DAI, its governance token is MKR. To participate in the governance of MakerDAO, you need to use the Oasis.app.
Bored Ape Yacht Club
The Board Ape Yacht Club (BAYC) is a popular NFT project. The collection consists of 10,000 NFT ape PFPs, some valued as high as $24.4 million. These prices have made BAYC among the most successful NFT projects. The project also has an active DAO, known as ApeCoin DAO, which is composed of members who hold Bored Ape or Mutant Ape NFTs. While ApeCoin DAO focuses on selling and monetizing the NFTs, holders can get additional rewards and drops. Because a limited number of Bored Ape and Mutant Ape NFTs are available, the ApeCoin DAO has a maximum of 30,000 members.
Uniswap is a DEX that allows users to trade and stake tokens. While users can interact with hundreds of DeFi apps on Uniswap, the protocol is owned and governed by UNI token holders using an on-chain voting system. Anyone holding at least 0.25% of the total supply of UNI can submit a new proposal. Users can also participate in an active community forum.
After its launch in 2020, Yearn.Finance quickly became a popular investment DAO. It’s known for offering rewards to its members, but Yearn Finance also has several different financial projects aimed at helping users grow their investments. For example, vaults are unique staking pools that operate automatically, and enable users to share gas costs. Yearn Finance’s governance tokens are known as YFI, and each token is worth one vote.
This successful collector DAO is focused on investing in NFT art and other blockchain-based assets. Since its public launch in 2020, Flamingo DAO has amassed several high-value NFTs from well-known digital artists. Flamingo DAO hopes to unite collectors within the NFT community and encourage new investment strategies.
Aave is an investment DAO that uses a decentralized lending protocol built on the Ethereum blockchain. It aims to match lenders to qualified borrowers, and allows lenders to earn rewards for using liquidity pools. The DAO’s governance token is AAVE, which is also used as collateral for borrowers.
MetaCartel Ventures is a for-profit investment DAO focused on funding projects that provide high financial returns to its members. Since its release, the DAO has gained a reputation for investing in new DApps early. Some of the projects it supports are focused on the advanced usability of web3. DAO membership must be requested and approved before new users can join.
Big Green DAO
Governed by its members, Big Green DAO is one of the first philanthropic DAOs to focus on the social responsibility of web3. Every aspect of Big Green is controlled by grantees and donors, helping nonprofit organizations become more involved in grant-making. Big Green has been active since 2011, and focuses on teaching people how to grow food.
Charity DAO uses blockchain and cryptocurrency technology to coordinate several different fundraising activities. Their goal is to promote charitable causes using decentralized technology, and help empower community members to solve problems. What sets this platform apart is its simplicity; it’s designed so users with limited technical knowledge can donate. One of their active fundraisers benefits orphans in Vietnam.
How to Create a DAO
DAOs are an excellent choice for many decentralized projects. Creating one is fairly simple and cost-effective. Most users can set up a new DAO and promote it immediately.
What to Consider Before Creating a DAO
First, you need to define your DAO’s goal, and consider all the available options. DAOs have a unique organizational structure on the Ethereum blockchain, and are completely decentralized. You may be working with anonymous individuals on your project. Therefore, it’s imperative you do extensive research in order to avoid liabilities.
One challenge you may face during setup is the legality of your DAO. When establishing a company, investment firm or charitable organization, you’re required to follow local and federal regulations. In setting up a decentralized organization, you don’t necessarily need to follow regulations, but that doesn’t mean you aren’t liable if your DAO does something illegal or becomes involved in a legal dispute.
Features Needed in a DAO
A DAO needs several key features to be successful. The most important is a strong purpose that people want to support. You must have a solid, clearly defined reason for your DAO to exist. Not only will this help you connect with like-minded people, it will also help your project continue to grow and reach more investors.
Every DAO has a voting mechanism of some kind. While there are several third-party companies that can develop a system for your DAO, some of the most successful DAO projects have built their own systems from scratch. You’ll also need to create a governance token or share system so individuals can vote on proposals.
Fund management is also a necessity. As an automated organization, you won’t have a treasurer responsible for collecting or distributing funds. Instead, all transactions will be completed using smart contracts. You’ll also need to securely store any funds. Most DAOs choose a multi-signature wallet with very limited access.
A Step-by-Step Guide
You can create a new DAO within a short period of time, as long as you have the right tools.
Step 1: Set up a secure crypto wallet and add funds to it.
Step 2: Allow a third-party development service to create the voting system and structure for your DAO. Some popular services include Aragon, Snapshot and DAOstack Alchemy.
Step 3: Configure your organization and establish the rules it must follow to function automatically. For example, what percentage of a vote is needed, or how many voters need to approve a proposal before it’s passed?
Step 4: Create the native token that will govern your DAO. If your DAO already has members, distribute the token accordingly.
Step 5: Test-drive your DAO by creating a simple proposal question.
Step 6: Choose a way to effectively communicate with DAO members, such as via a Discord server, social media account or website.
Unless you already have a large established following, you’ll need to find innovative ways to attract new people to your DAO. While a DAO can operate with a small membership, if you want to see long-term success, you’ll need to steadily grow your community.
The Bottom Line
Creating and participating in decentralized autonomous organizations has its advantages. As blockchain and smart contract technology continue to grow, DAOs will also evolve. Several highly successful DAO projects already exist, and more are being created every day.