Decentralized is the theme for 2022 with the expansion of Web 3.0, particularly with the metaverse and NFTs. DAOs are at the heart of what it means to be decentralized. Generally speaking, decentralization removes the responsibility of decision making – whether for financial transactions or company decisions, for example – from one entity and distributes it across a network or organization. DAOs stand for a decentralized autonomous organization. Below, we’ll look at what they are, how they work, and whether the hype is necessary.
What Are DAOs?
The concept of DAOs originated in 2015 by a team called Slock.it. The team wanted to raise funds for different Web 3.0 projects and startups, deciding that the best way to do so was to create an Ethereum classic crowdfunding smart contract, which quickly became the largest crowdfunding campaign in history. Slock.it went one step further by programming voting rights and ownerships into the smart contract.
Slock.it was one of the first teams to toy with the programmability of Ethereum. Before their smart contract, there was no way to decentralize an organization in a way that made it globally accessible. DAOs have continued to evolve with multiple organizations, such as DASH, MarkerDAO, and Augur, entering the market to prove that decentralized organizations work.
The easiest way to imagine how a DAO works is to think of it as an eCommerce business owned and managed by the members within its community. Any business decisions made are governed by voting to ensure anyone with ownership within the organization has a chance to share their opinion.
How Do They Work?
DAOs might work, but how exactly do they work? As mentioned above, decisions made within a DAO come from the bottom-up, meaning that everyone has a say in the overall running and decisions made within a DAO. To participate, investors buy into the Ethereum-based smart contract in return for a token. In the case of Slock.it, investors gained a $TheDAO token for their investment. At the time, 1 ETH = 100 $TheDAO.
Nowadays, smart contracts are nothing new. NFTs, for example, run using smart contracts. Smart contracts are essentially blocks of code that automatically execute whenever a transaction meets the criteria. In the case of Slock.it, the criteria was to deposit ETH in return for $TheDAO. It’s the smart contracts that determine the rules for the DAO.
Anyone with token ownership of a DAO has voting rights and can influence organizational decisions and changes. The organizational structure prevents DAOs from being overwhelmed with proposals as the majority of stakeholders first have to approve them. How a DAO determines the majority stakeholders differs from organization to organization – more details about stakeholder distribution are within the smart contract itself.
The great thing about DAOs is that they’re fully autonomous and transparent. Open-source coding means anyone can view it and can audit their built-in treasuries.
Do They Promise More Than They Can Deliver?
There are two arguments to this question. At its core, DAOs promise to deliver an organization governed by the masses rather than one entity – in that respect, it very much delivers what it intends to. But to some, DAOs are no more than a glorified Discord group.
The promise is that if you buy into a DAO and collect governance tokens, you get to vote on how the DAO operates and invests money. But that promise can create friction. Mismatched expectations can create endless conflict in the DAO decision-making process. And the success of a DAO depends on the DAO itself, much like with any other crypto-based investment.
Take NFTs as the perfect example. All NFTs are on a smart contract, with many of the most popular ones creating tokens attached to the NFT that reward investors with voting rights for future NFT projects. However, buy into the wrong NFT project, and your piece of the DAO pie is useless.
The same applies to all DAOs. It’s essential to conduct research into the DAO, its mission, and the terms stated in the smart contract before diving into an investment.
Disadvantages of DAOs
Despite DAOs gaining traction and popularity, there are still fundamental disadvantages that investors should be aware of:
- DAOs have governance problems
- There’s no legal framework for investment protection
- They’re a relatively new concept that’s attracting criticism
- The risks associated with giving masses of people the authority to make financial decisions
Still, DAOs are an exciting concept and one worth exploring as the concept of Web 3.0 evolves.
DAOs are very much in their infancy. There’s just as much risk attached to a DAO investment as a reward. It’s essential to understand DAOs, how many voting rights investors actually hold, and how those voting rights will influence the future success of a DAO.