Decentralized Autonomous Organizations - Past, Present, and Future
Decentralized Autonomous Organizations (DAOs). These blockchain-powered organizations are already revolutionizing the way we do business and operate as a society. What’s next?
This article will cover some of the challenges that DAOs face, their advantages and disadvantages, outlook for the future and a few notable projects.
What Is a DAO?
A DAO is an organization where decision-making occurs from the bottom up, like a grass-roots movement. Though participation in a DAO can take various forms, it usually manifests itself through token ownership and voting on (or abstaining from) organizational proposals.
Smart contracts define the rules of the DAO–they’re essentially chunks of coded rules that execute when certain conditions are met (e.g. “if x, then y”). By voting on or creating new governance proposals, members of a DAO have the power to influence how the organization works.
Though there are dozens of blockchains that compete on the basis of their programmability, Ethereum was the first to implement Smart Contracts (and perhaps unsurprisingly, became home to the first DAO).
Stakeholders vote on proposals for the organization. Whatever this particular organization looks like–e.g. a DeFi protocol vs. a group of individuals pooling resources to purchase a company–smart contracts are coded to implement said proposals (or for instance, even how governance decisions are tailored to a particular DAO).
And because it lives on-chain, the DAO is fully autonomous and transparent; due to its open-source nature, anyone can see its code. Furthermore, because its transactions are time-stamped and recorded on a public blockchain, anyone can audit their treasuries.
Why Should We Care?
Web3's obvious economic entity is the DAO. To some extent, it’s the logical political outgrowth of a, by definition, decentralized and permissionless world/structure. There is almost always a decentralized autonomous organization (DAO) governing decentralized finance protocols (DeFi), and there are hundreds of builders looking to create DAOs on Poko, for example. Thousands of fund managers, inventors, entrepreneurs and VCs are falling over each other building companies that seek to tap into this Web3 ecosystem (appropriately also referred to as ‘the ownership economy’).
With DAOs, entrepreneurs can raise funds globally and have ownership/governance transferred near-instantly to their communities. Thanks to its die-hard communities around the world, Axie Infinity, a blockchain-based game (often referred to as ‘Play2Earn’ or GameFi), reached a multi-million $ market cap. Axie wasn’t alone: If actions speak louder than words, we should probably be paying attention.
DAOs: Pros and Cons
As a shiny new alternative to traditional business models like a Limited Liability Corporation (LLC) for example, in which control of a business is held by a single or small group of individuals and a vast majority of the stakeholders never get a say, DAOs have the advantage of a more proportional representation and transparency (or even governance that is ownership-weighted) )In a DAO everyone decides how they want to participate if they want to participate, and if so, to which extent. They’re open, permissionless and trustless.
Simply, DAOs give a voice to a larger number of stakeholders. Full automation of blockchain systems have made it possible to execute decisions passed by DAO members/governance, with a time-stamped ‘paper trail’ to boot.
DAOs are also considered decentralized governance structures because they are. System automation facilitates leanness in management and operations. Project organizers save on salaries, as well as waste derived from human inefficiencies, error, menial labour,... DAOs eliminate the need to wait for a gatekeeper to process the application, or to get back to you with relevant information–if any.
While DAOs have many advantages, they also have some drawbacks. It is impossible for example, for developers to guarantee the security of a DAO (see the DAO Hack below). Developing code for decentralized autonomous organizations can lead to big losses if mistakes are made (or exploited). Furthermore, a fraudulent project may be disguised as a well-meaning decentralized autonomous organization, when in fact it’s just another rug-pull waiting to happen. Obviously if you plan to participate in a DAO, you should–as in with any crypto investment of time, money, or resources–DYOR(that’s Do Your Own Research and in crypto, DYOR is law).
Members of the organization must obey majority decisions (whatever those look like in one DAO or another). While decentralized project organization reduces the likelihood of collusion, it does not completely eliminate it.
Additionlly, deciding on project development can take a long time. Votes may not be collected as quickly as the system would like. Humans still remain potential bottlenecks. Moreover, many users blame the drawbacks of decentralized autonomous organizations for their "dehumanization"; because automated systems lack critical thinking capabilities, they can’t always handle ad-hoc crises or abnormal situations.
History: The DAO Hack
On May 1, 2016 a few members of the Ethereum community announced the creation of the DAO, also known as Genesis DAO, based on smart contracts, built on Ethereum.
Everyone with DAO tokens would be able to vote on plans (these are known as ‘Governance Tokens’), and if the projects turned a profit, those with tokens would receive rewards (like Dividends in legacy finance). After (over)securing financing, things looked promising… Unfortunately, hackers gained access to The DAO on June 17, 2016, exploiting a flaw in the coding, and made off with 3.6 million ETH (equivalent to $70 million at the time). As soon as the hacker had inflicted the damage they withdrew.
Using this exploit, the attacker could repeatedly request Ether from the smart contract (DAO) before it could update its balance. The bug wasn't caused by Ethereum itself, but by an application (poorly coded smart contract) that was built on it. (Remember: Programmable money). One of the flaws in The DAO code was the recursive call exploit.
Although they could have continued draining The DAO, the hacker stopped for unknown reasons. As soon as the Ethereum community realized an error had been discovered and exploited, they started working on multiple proposals to address it.
Despite this, the hacker couldn't complete their getaway as the funds had been placed in a holding account for 28 days. (This could not have happened on bitcoin because no one person has enough power to control any bitcoin address except the person holding its keys). So enacting Ethereum's first hard fork, the lost money was refunded to the owners. (They voted to go back in time to when the exploit had not yet been exploited—they ‘turned back the clock’ on the theft). Token holders received the same exchange rate as in the initial offering of 1 ETH to 100 DAO tokens. This hard fork resulted in a separate blockchain called Ethereum Classic for those who voted not to ‘turn back the clock’ on the exploit/hack, and Ethereum (the same blockchain as ETH today) was born. Ethereum Classic is therefore the longer blockchain, where no one meddled with the time stamps.
The DAO hack led the Securities and Exchange Commission to take action. The SEC ruled in 2017 that the tokens made available by the Decentralized Autonomous Organization (DAO) in 2016 are in fact securities, and they need to be registered as such.
As a result, Initial Coin Offering (ICO) participants are subject to SEC regulations and rules. An individual who participates in a token sale is required, in order for that token to be sold, to–so to speak–get their legal ducks in a row. A person who: advises on ICOs, or writes the code for token sale, or receives/manages the proceeds of a sale, or assists in finding investors, or, finally, manages purchases, may fall under the legal umbrella of SEC regulations and should carefully evaluate their role in such sales before engaging in them. To evaluate their positions with the SEC, ICO participants should seek out and obtain legal counsel.
Other DAO Projects
MakerDAO is another Ethereum-based peer-to-peer decentralized autonomous organization that allows people to lend and borrow crypto. A smart contract controls the borrowing and lending process on this platform (just like any other DeFi protocol).
MakerDAO determines repayment amounts and lending rates using a stablecoin known as Dai, which is ostensibly pegged to the dollar, but relatively volatile.
As a crypto lending facility, MakerDAO disburses loans at predetermined interest rates. Users of MakerDAO will need to deposit Ethereum into a Maker smart contract before a certain amount of DAI is minted. As a result of this smart contract, a collateralized debt position (CDP) is created.
During an auction, ConstitutionDAO banded to raise money to try to buy an original copy of the United States Constitution (hence the name, bravo!). Over the Ethereum blockchain, people around the world were able to donate to/invest in the DAO.
Having access to the Constitution would give them a voice in what the organization should/would do with it in the future. ConstitutionDAO raised $47 million (which was an enormous success–and first)... But as a result of not achieving ConstitutionDAO's stated goal–buying the copy of the constitution, and having been outbid by Citadel Securities’ infamous CEO Ken Griffen–the organization announced that it was shutting down. This was in 2021, details to follow.
With a decentralized management system and member voting, Decentraland is a hybrid homeowners association/city government.
The amount of 'land' they own determines how many votes they can cast. Among the many features Decentraland offers is the ability to vote on whether wearable items are permissible.
Uniswap governance token is one of the most frequently used and accessible decentralized exchange tokens available today. Decentralized exchanges like Unswap are the most popular in terms of volume and users.
Many people moved their assets to Uniswap as a result of users voting to reduce trading fees for certain transactions. The goal of the project is to improve DeFi governance, and so far, judging by TVL (a DeFi metric representing Total Value Locked) it has been successful.
There's no point in reading a guide on "What is a DAO token" without talking about Aragon–the DAO DIY. In addition to allowing users to introduce their own DAO projects, it is itself a DAO, enabling its clients to connect with anyone from anywhere.
With the Aragon DAO token (ANT) holders can express their agreement or disagreement on decisions affecting operations: DAO token holders can create or join Aragon-based DAOs with ANT, a very popular token indeed.
DAO Adoption Challenges
In contrast to traditional IPOs (initial public offerings), DAOs typically issue tokens. A token's governance rights or economic returns are common expectations for token holders and token issuers. However, token holders and DAOs often do not have a legal relationship. As a result, token holders are at risk.
Furthermore, several people are concerned about the legal make-up of DAOs. In DAOs, there are rarely formal corporate structures with explicit liability protection or clear differentiation between participants' roles. Instead, holders of governance tokens can suggest and vote on actions that the DAO should take, but the nature of member-liability will remain unclear until the legal form of DAOs is clarified, which creates significant risks for members.
The actions voted on by DAOs must still be carried out by intermediaries. By coding actions into automated smart contracts, a DAO may be able to completely bypass the need for executive representatives if its treasury consists of on-chain assets stored in a digital wallet (such as crypto). The DeFi DAO treasury, for example, is often controlled by individuals who must take action to implement votes.
There’s also uncertainty regarding the individual liability of DAO members, especially if they ignore passed proposals' instructions. In this way, DAOs are limited to operating in on-chain environments only (for now). It remains unclear what bridges need to be built to access off-chain assets.
The majority of countries do not allow DAOs to file taxes or receive tax refunds as traditional business entities do. DAOs are currently not clear whether they will be taxed separately or as pass-through entities. Individuals who invest in DAOs may be liable for direct taxes in many jurisdictions due to DAO membership.
Regulation is indeed achallenge of DAOs: The Commodity Futures Trading Commission (CFTC) recently filed a complaint against Ooki DAO in this respect. (In addition to filing suit against the DAO, the CFTC settled charges against its predecessor, bZeroX, and its founders.)
A CFTC settlement order and complaint against Ooki DAO and bZeroX identified registration failures for offering leveraged or margined cryptocurrency contracts to retail participants. Ooki DAO's complaint, however, relies on the novel and untested theory that all token holders have an obligation to be held accountable for violations of federal statutes as a result of voting for or operating the protocol.
CFTC commissioners (and crypto lawyers) are concerned that the CFTC's enforcement action against Ooki DAO could set a precedent for DAO regulation that could have a significant impact on the wider crypto market. (This is referred to in the industry as ‘Regulation by Enforcement’. In the abstract, this one action doesn’t mean the end of DAOs. Ooki DAO's action does not mean people will be discouraged from joining DAOs or participating in them. Crypto legal experts say this shouldn't be a problem as long as a DAO doesn't violate any laws that could expose members to liability.)
The Future of DAOs
Successful DAOs have emerged in recent years, such as TheDAO, ConstitutionDAO, and MakerDAO. In the coming years, we may see even more innovative and impactful DAOs emerge as the technology matures. DAOs have the potential to redefine how we live and work by creating vast networks of interconnected people and organizations. Same tech–new applications!
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