What is a DAO and How Does it Work?

DAOs are changing the ways we do business. But what are they and how do they work? Let's talk about DAOs and the benefits they bring, as well as the role they may play in the future of businesses.

What is a DAO and How Does it Work?

What would a Truly Democratic Organisation Look Like?

Imagine an organisation where every single member has equal power. That’s right, you and your boss now have an equal say in everything, from how the company invests its money, to salary distribution, to where the team will be getting lunch this week. In fact, eliminate the term boss altogether, you are now colleagues. You can even ask them for a cup of coffee — or a raise if you’re feeling cheeky.

Next, consider the issue of transparency. What if you had full knowledge of a company's decision-making processes and transactions? How would it influence your perception if you had access to its entire history, from daily expenses to asset distribution? More importantly, how would it influence that company’s actions if they had nowhere to hide their misdeeds?

Now imagine what could be possible if like-minded individuals from across the globe were able to rally behind a shared cause, without fear of corruption or having their interests curtailed by higher-ups with executive privilege.

This may sound like science fiction, but it’s actually the description of an organisational structure that already exists. It’s called a Decentralised Autonomous Organisation, or DAO for short.

What is the Meaning of a DAO?

A DAO is a Decentralised Autonomous Organisation and is pronounced ‘dow’.

The first major thing to understand about how any DAO functions is that it’s decentralised. This means that no one person holds the decision making power. 

Instead, the leadership is spread out equally amongst its members —  effectively removing the need for a central governing authority. In a DAO, the hierarchy is essentially flattened, facilitating a novel, more robust, democratic structure.

A DAO’s democratic structure can be as sophisticated or as simple as is deemed necessary. An organisation could choose to give all its voting rights to a handful of key members and still be considered a DAO.

Its level of decentralisation may be less expansive but has the crucial benefit of allowing for quicker decision making. Similarly, investors who stand to gain financially from a DAO could choose to cede control to strategists and experts that are best equipped to steer the course of the company. 

This type of decentralisation is made possible thanks to blockchain technology and smart contracts.

What is a DAO and How do they work?
DAOs can have members from all over the globe!

No Signature Required: A Quick Introduction to Smart Contracts

Smart contracts play an essential role in making DAOs both decentralised and autonomous.

One way to understand smart contracts is to think of them as almost identical to traditional contracts, but instead of paper records, their terms and conditions are established as code on a blockchain. 

Basically, smart contracts are self-executing computer programs that can be programmed to automatically execute any number of actions based on whether the requirements have been met. For instance, you could program a smart contract to only allow for a distribution of funds once a certain percentage of investors have agreed to finance a project. 

Another thing to note is that smart contracts are public, transparent, and immutable. No single person can change them. The only way to amend a smart contract is by majority rule. You would need to submit a proposal to the DAO, after which a predetermined percentage of members would need to vote in your favour for the changes to be instituted.

Voting Within a DAO

One of the most exciting things about DAOs is their ability to ensure a more robust democratic structure. Stakeholders in the organisation have equal voting rights on any number of things, like whether a new rule should be added, or where to invest company funds.

So how does this voting thing work exactly? 

Well, the overwhelming majority of existing DAOs are blockchain-based. As a result, we’ve seen most DAOs institute a native crypto coin. Once you buy and hold any of these coins you gain the ability to cast your vote on any number of matters that relate directly to that particular DAO.

The Benefits of DAOs

DAOs and smart contracts have tremendous potential to impact the world in positive ways. It can connect people across continents and provide a secure space to pool resources and share ideas.

And because DAOs are automated, it removes the threat of intermediaries or bad actors who might syphon off cash and divert funds for more selfish interests.

Imagine what this could mean for countries where corruption is endemic, or where human rights are under threat?

What About That Time Ethereum Tried to Be a DAO and Lost 60 Million Dollars?

You can’t talk about DAOs without mentioning The DAO.

Back in 2016, when blockchain and Web3 technologies were measurably less mainstream than today, the first DAO was created. In an effort to raise funds for upcoming Web3 projects, the Slock.it team constructed a crowdfunding smart contract, notably including voting rights and ownership. It was then officially deployed by members of the Ethereum community who (somewhat unambiguously) named it The Decentralised Autonomous Organisation, also known as The DAO. 

The organisation was intended to function as a venture capital fund for Web3, crypto, and decentralised projects, and would be governed by the cryptocurrency Ethereum, also known as ETH or Ether.

If you’re interested in learning more about Ethereum, you can check out this article we wrote: All You Need To Know About Ethereum.

Initially, things were looking great for The DAO. They’d raised hundreds of millions of dollars in a matter of weeks, and, more importantly, they were successfully rolling out a new type of organisation that would have massive implications for the future of democratic structures.

That was when the hack — which technically, wasn’t a hack — happened. 

One of the members of The DAO had identified a loophole in the smart contract, which effectively allowed them to drain small amounts of ETH on repeat. This was due to a flaw in the smart contract’s coding that prevented it from registering that the currency had already been removed when the withdrawal was below a certain amount, allowing them to repeat the transaction indefinitely.

Once other members realised this was happening, they had to act fast, but because the smart contract required a large majority of stakeholders to vote, they weren’t able to act as quickly as was necessary. As a result, the single bad actor was able to drain The DAO of over 60 million US dollars worth of ETH.

So What Does This Mean for DAOs Today?

The exploitation of this loophole had a massive impact. Not just on The DAO, which folded shortly after, but also on Ethereum, and how subsequent DAOs have been shaped. 

Today, the incident continues to provide valuable lessons on how to avoid similar calamities and gives us insight into some of the biggest flaws of DAOs.

Accidental (or intentional) coding loopholes pose a significant security threat to any DAO. The voting structure, which requires consensus from a certain percentage of its users and is considered one of its biggest strengths, is also a crippling weakness in situations where quick decisions need to be made.

The Future of DAOs

It’s been some time since The DAO incident, and in that time blockchain technology has become increasingly sophisticated. 

We’ve seen other examples of DAOs that haven’t ended in catastrophe, and you can now find entire categories of DAOs that do all sorts of things. From Grant DAOs that help foster new ventures to Investment DAOs that allow token holders to vote on what their pool of funds will be invested in. 

There may be flaws and risks that are inherent to DAOs — and they should DEFINITELY be taken seriously — but the continued excitement that accompanies this technology is undeniable. 

We're beginning to see the introduction of DAOs in several blockchain industries such as gaming, NFT projects and decentralised finance, and this is now a key element to consider for investors.

Whether it’s a DAO that’s supporting a fun and friendly currency like Dogecoin or an earnest project that is trying to tackle deep-rooted issues, every novel instalment brings us closer to fulfilling the democratising potential of this new medium.

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