Decentralized Autonomous Organization (DAO): Definition, Purpose, and Example

Posted by  Fintra , updated 2023-03-24

Wondering what is a Decentralized Autonomous Organization (DAO)? The decentralized autonomous organization (DAO) is a legal structure form that is emerging. It has no central body governing it, and its members share a common goal to act in the best interest of the entity. Popularized through blockchain technology and cryptocurrency enthusiasts, DAOs are used to make decisions in a bottom-up management approach. DAO's members own tokens of the DAO, and they can vote on initiatives for the entity. Even smart contracts are implemented for the DAO, and the code that governs the DAO's operations is publicly disclosed. It is believed the creation of DAO was first made public by some of the members of the Ethereum blockchain community in early May 2016. 

In this blog, Fintra attempts to enable you to understand the meaning of the term and the important facts related to it. The topics we highlight are: 

1. Understand What are Decentralized Autonomous Organizations (DAOs)
2. How Decentralized Autonomous Organizations (DAOs) Function
3. Benefits of Decentralized Autonomous Organizations (DAOs)
4. Advantages and Disadvantages of Decentralized Autonomous Organization (DAO) 
5. Three Steps For Launching a Decentralized Autonomous Organization (DAO)
6. How can you use a Decentralized Autonomous Organization (DAO)? 

Understand What are Decentralized Autonomous Organizations (DAOs)

One vital feature of digital currencies is that they are decentralized, which means they aren't controlled by a single institution such as a government or central bank. Divided among a variety of networks, computers, and nodes, in various cases, these virtual currencies use this type of decentralized status to attain levels of privacy and security, which are typically unavailable to standard currencies and their transactions. In other words, the Decentralized Autonomous Organization (DAO) is a blockchain-based technology enabling users to organize and oversee themselves. Users play along with the set of self-executed public blockchain rules, and they can even avail funds from the DAO by projecting their pitches to the community.  

Taking inspiration from the decentralization of cryptocurrencies, a group of developers brainstormed and came up with the idea of creating a decentralized autonomous organization (DAO). The concept of DAO is to facilitate oversight and management of an entity similar to a corporation. However, since DAO lacks a central authority, its collective group of leaders and participants act as the governing body. A DAO even strives to have strict governance, which is dictated by code on a blockchain.

How a DAO makes money? Initially, a DAO earns capital by trading fiat for its native token. The native token denotes voting power and ownership proportion across members. When a DAO gets successful, the value of the native token will increase. Then, the DAO is enabled to issue future tokens at a greater value for raising more capital. A DAO can even invest in assets if its members decide to approve such measures. For example, a DAO may acquire NFTs, companies, or other tokens. As those assets' value increases, the DAO's value also increases.

There's a reason why DAOs are needed. For example, when you desire to build up an organization with another party, there's a process involving money and funding, and along with this, it also demands lots of trust in the parties you are dealing with. At times it may not be a wise move to trust someone you have just interacted with on the internet for a business partnership. Hence, by using DAO, there's no need to stress out about finding trustable people because its system will provide a hundred per cent credibility and transparency on the DAO code. This advancement pulls in so numerous opportunities for worldwide collaboration. For this reason, DAO holds its importance in the world of trade.

How Decentralized Autonomous Organizations (DAOs) Function

Smart contracts are the foundation of DAOs. They have logically coded agreements, which dictate decision-making based on the underlying activity on a blockchain. For example, based on the outcome of a decision, a certain code might be implemented to increase the circulating supply, burn off a select amount of reserve tokens, or issue select rewards to existing token holders. Later on, the voting process for DAOs gets posted on a blockchain. The users have to select between mutually-exclusive options. Generally, the voting power is distributed across users based on the number of tokens they hold. As an example, if one user owns 100 tokens of the DAO, it will have twice the weight of voting power over the user that owns only 50 tokens. The theory behind this practice is that those who are more monetarily invested in the DAO will be more incentivized to act in good faith. For example, if a user owns 25% overall voting power, it can participate in bad acts, but by doing so, the user will jeopardize the value of their 25% holding.

DAOs usually have treasuries that hold tokens, which can be issued in exchange for fiat. The DAO's members can vote on how to use the funds. For example, those who have the intention of acquiring rare NFTs can use DAOs to vote on whether to relinquish treasury funds in exchange for assets.

Benefits of Decentralized Autonomous Organizations (DAOs) 

There are diverse reasons for an entity/collective group of individuals to have the intention of using a DAO structure. Below are some of the benefits of DAO:

• Decentralization: As opposed to a central authority which is often vastly outnumbered by its peers, when it comes to a DAO, decisions that impact an organization are made by a collection of individuals Instead of relying on the actions of one individual or a small collection of individuals a DAO decentralizes authority across a larger range of users.
• Participation: Within an entity, individuals could feel more empowered and connected to the entity when they are having a direct say and voting power on all matters. Individuals might not have strong voting power, but DAOs encourage the token holders to cast their votes, burn tokens, and/or use their tokens in ways they think is best for the entity.
• Publicity: Within a DAO, the votes get cast through blockchain and then they're displayed publicly. This requires users to act in ways they feel are best because their votes and decisions are eventually made publicly viewable. This practice motivates voters to take actions that benefit their reputations and discourage acts against the community.
• Community: DAO's concept encourages people around the globe to harmoniously come together for creating a single vision. With only an internet connection, the token holders interact with other owners anytime, anywhere.

Advantages and Disadvantages of Decentralized Autonomous Organization (DAO) 

Advantages of DAO

1. Decentralization: DAO emphasises being driven by a group of individuals rather than an individual. With DAO, individuals have a stronger say in the organization’s direction. 
2. Community Driven: DAOs enable various communities worldwide to easily connect with one another and build a prospering vision together. DAO is accessible to individuals who might have had the chance in the past to connect and work together.
3. Principle-agent dilemma: One vital advantage of DAO is that it furnishes a solution for the principle-agent dilemma. This dilemma is a clash in priorities between a person (principal) and the entities who make the decisions on their behalf (agent). One of the common examples of this is the problems between the CEOs and Stakeholders. DAO solves this issue via community governance. Here, the principles don’t have to trust the agents who are working on their behalf, instead, they work together as a part of a group whose incentives are aligned.

Disadvantages of DAO

1. Security: Since DAO is launched with a few lines of code, a well-run DAO requires to function effectively. Thus, security stays a vulnerability because it requires considerable technical expertise, and it is pricey to keep best security practices enforced.
2. Slow Decision-Making: Since DAO involves getting everyone to vote on proposals in a timely manner, where individuals could be in different time zones and investor priorities could differ from others, keeping DAO participants up to date could be challenging.
3. The Bikeshedding Effect: Some of us might be aware of Parkinson’s Law of Triviality which states that in an organization, the amount of time spent discussing an issue is inversely connected to its importance in the scheme of things. This is also known as bike-shedding. Thus, this may have a negative impact on personal productivity as it causes inefficient management of time.
4. There's no legitimate structure for circulating DAOs: There’s no legitimate structure for DAOs and they can be dispersed across different locales. Moreover, if any lawful issues emerge, it might need those required to manage various territorial laws in a convoluted fight in court. 

Three Steps For Launching a Decentralized Autonomous Organization (DAO)

Launching a DAO involves three major steps as stated below:

1. Smart Contract Creation: In this step, behind the DAO, a group of developers or a developer creates a smart contract. It is extremely vital for the developer to extensively test the smart contracts before launching to make sure they don't overlook vital details. After the launch, only the rules set can be altered via the governance system.
2. Funding: After the smart contracts have been created and launched, the DAO requires to determine a method to receive funding. Occasionally, to raise funds, the tokens are sold, and these tokens give holders voting rights.
3. Deployment: Once everything is set up and on track, the DAO has to get deployed on the blockchain. From here onwards, stakeholders decide the organization's future. Later on, the developers who had created the smart contracts, no longer influence the project. 

How can you use a Decentralized Autonomous Organization (DAO)? 

Following are a few examples of how one can use a DAO:

1. DASH: DASH, a well-known computerized money, is one of the illustrations of a decentralized independent association in light of how it is represented and how its planning framework is organized.
2. A Cause: You could acknowledge enrollment and gifts from anyone around the globe and the gathering may choose how they desire to spend gifts.
3. A consultant organization: An individual can create an organization of workers for hiring those who pool their assets for office spaces and programming memberships.
4. In charitable organizations: By using DAO, one can approve membership and contributions from people around the globe, and the respective organization can decide on how they wish to spend these donations.
5. In a freelancer business: One other example of how one can use DAO is by building a network of contractors who are keen to combine their funds for office areas and software subscriptions.
6. Pool investment: One can launch a venture fund to merge investment capital and count on enterprises for supporting it. Later on, the refunded funds can be distributed again amongst the DAO members.

Conclusion

Nowadays, the term "Decentralized Autonomous Organization” or DAO is getting well solidified in the blockchain platform. DAOs are gradually becoming critical because they're assisting in systematizing the principles of a business, furnishing robust decision-making equipment, and nullifying the need for papers and external authorization. In fact, enthusiasts believe DAOs will shortly become more sophisticated. Some trends include progressive decentralization, anonymity, and better incentives towards participation. Future DAOs will employ prediction markets, initiate voting and act as delegators in other DAOs.