Blockchains are already radically transforming our financial system. However, properties such as trustlessness and immutability aren’t only useful in monetary applications. Another potential candidate ripe for disruption by this technology is governance.
Blockchains could enable entirely new types of organizations that can run autonomously without the need for coordination by a central entity. This article will give an introduction to what is a DAO in crypto, how does a DAO work, and a few popular examples of DAOs.
What is a DAO in Crypto
The acronym DAO stands for Decentralized Autonomous Organization. In simple terms, a DAO is an organization that is governed by computer code and programs. As such, it has the ability to function autonomously, without the need for a central authority.
Through the use of smart contracts, a DAO can work with external information and execute commands based on them – all this without any human intervention. A DAO is usually operated by a community of stakeholders incentivized through some kind of token mechanism.
How Does a DAO Work?
The rules and transaction records of a DAO are stored transparently on the blockchain. Rules are generally decided on by stakeholders’ votes. Typically, the way decisions are made within a DAO is through proposals. If a proposal is voted on by a majority of stakeholders (or fulfills some other rule set in the network consensus rules), it is then implemented.
In some ways, a DAO works similarly to a corporation or a nation-state, but it’s one that operates in a more decentralized fashion. While traditional organizations work with a hierarchical structure and many layers of bureaucracy, DAOs have no hierarchy. Instead, DAOs use economic mechanisms to align the interests of the organization with the interests of its members, usually through the use of game theory.
Members of a DAO are not tied by any formal contract. They are rather bound togETHer by a common goal and network incentives tied to the consensus rules. These rules are completely transparent and written in the open-source software that governs the organization. Since DAOs operate without borders, they might be subject to different legal jurisdictions.
Once a DAO is deployed, it cannot be controlled by a single party but is instead governed by a community of participants. If the governance rules defined in the protocol are designed well, they should steer actors towards the most beneficial outcome for the network.
Why is There a Need for DAOs?
DAOs tackle a problem in economics called the principal-agent dilemma. It happens when a person or entity (the “agent”) has the ability to make decisions and take actions on behalf of another person or entity (the “principal”). If the agent is motivated to act in its own self-interest, it may disregard the interests of the principal.
This situation allows the agent to take risk on behalf of the principal. What deepens the problem is that there might also be information asymmetry between the principal and the agent. The principal might never know that it is being taken advantage of and has no way to make sure that the agent is acting in their best interest.
Common examples of this problem occur with elected officials representing citizens, brokers representing investors, or managers representing shareholders.
By allowing a higher degree of transparency enabled by blockchains, well-designed incentive models behind DAOs can eliminate parts of this problem. Incentives within the organization are aligned, and there is very little (or no) information asymmetry. Since all transactions are recorded on a blockchain, the operation of DAOs is completely transparent, and, in theory, makes them incorruptible.
Examples of DAOs
MakerDAO
MakerDAO is an ETHereum-based protocol that issues the DAI stablecoin and facilitates collateral-backed loans without an intermediary. Its widespread use and DeFi integration make MakerDAO one of the most operational protocols in the crypto ecosystem.
BitDAO
BitDAO is one of the largest decentralized autonomous organizations determined to develop an ecosystem with a decentralized tokenized economy. The organization invests funds for the growth and support of other projects and partners in the DeFi space. The organization also facilitated several initiatives with the potential to benefit the industry.
Curve DAO
Another name on the list, Curve DAO, is among the most valuable decentralized autonomous organizations worldwide. It is an exchange liquidity pool working on the ETHereum blockchain. Curve DAO offers to move liquidity-based funds and resources securely and quickly around the world.
Closing Thoughts
In summary, DAOs allow organizations to break free from reliance on traditional institutions. And how does a DAO work? Instead of a central entity coordinating participants, governance rules are automated and steer actors towards the most beneficial outcome for the network.
The key to designing good DAOs is putting down an efficient set of consensus rules that resolve complex participant coordination problems. Hence, the real challenge facing the implementation of DAOs might not be purely technological, but rather social.
