Decentralized Autonomous Organization (DAO): Definition, Functionality and Examples

A DAO or Decentralized Autonomous Organization is a digital organization that operates based on code rather than traditional management structures. It is a new way of managing and governing decentralized communities and projects, and is seen as an emerging legal structure with no central governing body whose members share a common goal.

The importance of DAOs lies in the fact that it is:

DAOs can be used for various business functions and objectives, from crowdfunding projects to creating new decentralized applications (dApps). They can also be utilized for social and gaming communities as a way to coordinate groups of individuals without a central governing authority.

They have grown from being used to govern blockchain protocols and dApps to financially-incentivized communities for all interests, including crypto-related and non-crypto-related interests.

In this section, we will see the differences between traditional organizations and DAOs in decision-making, transparency, governance, and funding.

Decision-making

Traditional Organizations have centralized decision-making with a small group of individuals, such as a board of directors or CEO, making decisions for the entire organization. In contrast, in DAOs, decision-making is decentralized, with token holders having a direct say in all matters through voting.

Transparency

Traditional Organizations vary in transparency, with some being more transparent than others and internal workings not always publicly available. In DAOs, transparency is a core principle, and all transactions and decisions are recorded on a public blockchain.

Governance

Traditional Organizations have hierarchical governance with a clear chain of command and defined roles and responsibilities. However, in DAOs, governance is decentralized, with token holders having a direct say in how the organization operates.

Funding

Traditional Organizations receive funding from various sources, such as investments, loans, and grants, while DAOs generate funding through token insurance and token sales, where individuals can purchase tokens to become a part of the organization.

Voting

Traditional Organizations limit voting to a small group of individuals, such as shareholders or members of a board of directors, while in DAOs, voting is open to all token holders, providing a more democratic approach to decision-making.

DAOs, or Decentralized Autonomous Organizations, aim to replicate a company structure through open-source code and smart contracts. The core of a DAO is its smart contract, a self-executing computer program with the terms of the agreement directly written into lines of code. The smart contract outlines the rules and framework of the organization, as well as holds the treasury.

The rules are established by a core team of community members using smart contracts, which are openly visible, verifiable, and auditable for anyone to understand.

Once the rules have been established and programmed into smart contracts, DAOs enter a funding phase. The funding phase of DAOs is typically achieved through token issuance, where tokens are sold to raise funds, and fill the DAO treasury. Token holders receive voting rights proportional to their holdings in exchange for their investment.

After the funding phase, the DAO is ready for deployment. Once live on Ethereum (or any other blockchain), the rules can only be changed through voting. Decision-making processes and the treasury are also managed through the smart contract, eliminating the need for a central authority.

To keep voting and governance decentralized, users can vote on proposals through a number of DAO voting mechanisms, like:

1. Locking their cryptocurrencies into a voting contract. The weight of their vote is proportional to the amount of cryptocurrency locked.
2. Calculating how many voters have voted ‘for’ and ‘against’ a proposal.
3. Voting on in-progress proposals, and the vote’s power grows the longer they remain unchanged. It slows down as it reaches a maximum. Voters can change their vote at any time, causing their previous vote’s utility to diminish.

If the proposal is approved through network consensus rules, voters are rewarded with additional cryptocurrency.

A key feature of DAOs is the internal capital used to incentivize members and ensure the smooth operation of the organization. It aligns the organization’s interests with its members and encourages a distributed network to work towards a common goal.

People form DAOs to have a decentralized and democratic way of managing an organization, where decisions are made by a collective of individuals instead of a single authority.

This results in increased transparency, accountability, and autonomy. DAOs also offer a way to pool resources and work towards common goals without being limited by traditional organizational structures.

Launching a DAO involves three crucial steps:

Participating in a DAO (Decentralized Autonomous Organization) offers a unique way of becoming a part of a collective that operates based on the joint decision of its members. In this section, we’ll learn more about different types of DAO memberships, and how to get involved in a DAO:

Types of DAO memberships

DAO membership determines the voting process and other significant aspects of the organization. There are three different types of DAO memberships:

Token-based:

Token-based DAOs aim to decentralize control and empower the collective community. Access to voting in these DAOs is granted by holding the governance token, which can be traded on decentralized exchanges or earned through participating in liquidity or other proof-of-work activities.

MakerDAO is a famous example where the MKR token is widely available, and voting power is granted to the token holders in the Maker protocol’s future.

In the blockchain and protocol world, DAOs are being integrated to allow token holders to propose and vote on changes and updates. It gives the community control over the development of the protocol.

Integrating DAOs in the blockchain and protocol world is seen as inevitable as it empowers the community, and allows the work of crypto builders to contribute to and for the community.

Several protocols, including Aave, Uniswap, and Anchor Protocol, have also adopted the DAO trend and give token holders the ability to propose and vote on changes.

Share-based:

Share-based DAOs provide a combination of a permission and open structure. To join a share-based DAO, members must submit a proposal, and offer a contribution in the form of tokens or work.

The shares symbolize direct voting power and ownership; members can exit anytime with their corresponding treasury share. This type of DAO is ideal for more close-knit organizations like charities, worker collectives, and investment clubs but can also govern protocols and tokens.

A well-known share-based DAO is MolochDAO, which funds Ethereum projects and requires a proposal for membership. This assessment ensures that the potential member has the expertise and capital to make informed decisions about potential grantees.

In a share-based DAO, voting power is represented by shares, which must be acquired by meeting initial requirements. This results in a limited number of members who can vote. While it makes the governance processes more streamlined, it also makes them difficult to scale and decentralize.

Reputation-based: 

In a reputation-based DAO, reputation is the key factor that grants voting power and acts as proof of participation. Unlike token or share-based membership, it cannot be bought, transferred, or delegated but must be earned through participation.

Prospective members can freely submit proposals to join the DAO, and request rewards in the form of reputation and tokens for their contributions. These organizations are suitable for various purposes, such as decentralized development and governance of protocols and dApps, charities, worker collectives, and investment clubs.

An example of a well-known reputation-based DAO is the DXdao, established in 2019. It uses reputation-based governance and holographic consensus to manage its funds without anyone being able to influence its future through buying power.

How to get involved in a DAO

Getting involved in a DAO is a straightforward process. Typically, participants need to purchase its tokens, and if they already own a token, which is usually an ERC-based token, they may already be a part of the DAO.

To get started:

The DAO was an early example of a decentralized autonomous organization launched in 2016. It served as a venture capital fund, allowing token holders to reap the rewards through dividends or token appreciation. The organization relied on the Ethereum network but operated as an open-source, decentralized entity, unaffiliated with any nation-state.

With no traditional management structure or board of directors, it was based on open-source code and allowed for a unique investment experience.

In April 2016, The DAO launched its crowd sale of tokens, which was a huge success, raising over $150 million in funds through Ether (ETH). The launch’s success made it one of the biggest crowdfunding efforts at the time.

Explanation of how this DAO operates

Investors acquired DAO tokens by transferring Ether to its smart contracts. At its peak, the DAO held up to 14% of all Ether tokens that had been issued, according to The Economist.

However, within days of the token sale, developers raised concerns about a vulnerability in The DAO’s smart contracts that could allow malicious actors to drain its funds. A paper was also published warning investors not to vote on future investments until the security issues had been addressed.

Unfortunately, in June 2016, the vulnerability was exploited, resulting in the theft of 3.6 million ETH, worth around $50 million, from The DAO’s wallet.

This sparked a heated debate among DAO investors, with some calling for a solution and others for the DAO to be disbanded. This incident also played a key role in the subsequent hard fork of Ethereum.

Criticisms of this DAO

The DAO faced criticism due to its vulnerability to programming errors and attack vectors, which were a result of charting new territory in terms of regulation and corporate law. Investors raised concerns regarding potential liabilities for actions taken by the organization.

In July 2017, the Securities and Exchange Commission (SEC) ruled that The DAO had violated US securities law by selling securities in the form of tokens on the Ethereum blockchain.

Additionally, the DAO operated in a gray area regarding the classification of its tokens as securities and faced challenges in terms of converting ETH into fiat currencies. These long-standing issues impacted the value of Ether, as they raised concerns among investors and contractors about the real-world functioning of the DAO.

By the fall of 2016, following the controversy over The DAO’s future and the high-profile hack, several digital currency exchanges, such as Kraken, delisted the DAO token, effectively ending its existence as initially envisioned.

Let’s take a look at some more DAO projects:

AAVE: A Decentralized Lending Protocol

Aave is a top DAO project to consider in 2023. It is a decentralized lending protocol that offers a platform for borrowers and lenders to interact without the need for any centralized intermediary. The protocol is hosted on the Ethereum blockchain and has expanded to integrate with multiple other networks.

Key Features:

• AAVE token holders have a say in the protocol’s governance, including the use of Treasury funds and potential upgrades.
• AAVE can be used as collateral within the ecosystem, reducing fees.
• The total value locked in Aave is $4.42 billion.

After the bear market, AAVE is slowly improving and already has a good position in the global list of top decentralized autonomous organizations. It offers tokens to its members and is built on blockchain technology to ensure the safety and protection of valuable data and user privacy.

The users have a right to vote and attain governance within the organization by staking their tokens since Aave has accepted the DAO Governance module.

MAKERDAO (MKR): DAO Project Built on Ethereum Blockchain

MakerDAO is a peer-to-peer decentralized autonomous organization built on the Ethereum blockchain network. It allows users to lend and borrow using cryptocurrencies, which disburses loans at predetermined interest rates, with the process controlled by smart contracts.

Features of MakerDAO

• The platform uses Dai, a stablecoin, to determine lending rates and repayable amounts.
• To borrow a certain amount of crypto, users need to deposit Ethereum into a Maker smart contract, which creates a Collateralized Debt Position (CDP).
• The Maker Protocol, also known as the Multi-Collateral Dai System, was created to unlock the possibilities of DeFi and provide users and developers with innovative financial tools.

MakerDAO has gained popularity due to its innovative financial tools, and strong position as one of the top DAO projects in 2023. However, it has faced challenges, losing market cap to more competitive DeFi protocols and experiencing a significant loss in market cap since the beginning of the year.

CURVE DAO (CRV): Decentralized Exchange for Stablecoin Swaps

Curve DAO is a DeFi protocol that operates on the Ethereum blockchain network. The protocol is run by the governance token CRV, which is designed to make it easy to swap between similar ERC-20 tokens, primarily stablecoins (like USDC and DAI) and Ethereum-based Bitcoin tokens (like WBTC and renBTC).

Key Features:

• Over 70 liquidity pools are available where users can deposit their idle holdings and generate a yield.
• Yields are based on supply and demand, and certain pools offer APYs (Annual Percentage Yield) of over 30%.
• Focuses solely on stablecoins.

Despite the recent dip in market performance, the CURVE DAO project remains highly regarded and is considered one of the top DAOs to watch in 2023.

UNISWAP (UNI): The most popular decentralized crypto exchange

Uniswap, the most popular decentralized crypto exchange globally, has a market capitalization of $4.94 billion and a governance token, UNI. As one of the topmost active decentralized autonomous organizations, it offers thousands of tradable crypto tokens. Instead of the traditional order book format, Uniswap facilitates trades through “liquidity pools” and incentivizes holders to create liquidity in the system.

Key Features:

• Uniswap’s use of liquidity pools replaces the order book format of traditional exchanges.
• Anyone can place their idle ERC-20 tokens into Uniswap’s liquidity pools and earn yield returns.
• The returns generated from liquidity pools are usually far higher than traditional saving accounts or fixed income streams.

Uniswap has exponential growth in volume and membership, allowing users to apply for governance rights and become integrated members. Uniswap is a decentralized exchange (DEX) that runs on the Ethereum blockchain network, enabling investors to swap ERC-20 tokens without intermediaries.

LIDO FINANCE (LDO): DAO Project for Liquid Staking of ETH and other Tokens

Lido Finance is a DeFi protocol that offers a liquid staking solution for ETH and other tokens. Staking on the LIDO protocol converts ETH into a tokenized version called sETH, which can be used to earn passive income on DeFi platforms. The Lido DAO governs the liquid staking protocols, allowing for a secure and decentralized solution for proof-of-stake blockchains.

Key Features:

• Lido Finance’s version 2 decentralizes the protocol and allows for the withdrawal of staked ETH.
• Lido aims to solve the problems associated with initial ETH 2.0 staking, such as immovability, and accessibility, making staked ETH liquid and allowing for participation with any amount of ETH.
• Lido lets users stake their ETH without locking assets or maintaining infrastructure while participating in on-chain activities such as lending.

Lido Finance (LDO) is a promising DeFi project that offers liquid staking for ETH and other tokens governed by its own DAO, with the potential for passive income and growth.

Comparison of these 5 DAOs:

The rise of Decentralized Autonomous Organizations (DAOs) has taken the crypto space by storm as they offer a promising solution for web3 organizations. With their transparent, decentralized, accessible nature, DAOs present numerous advantages.

This section will explore some of the benefits of using DAOs in the web3 ecosystem.

Although DAOs present exciting prospects, they also have limitations that should not be overlooked. In this section, we will dive into the critical disadvantages of DAOs to make informed decisions about their adoption.

In conclusion, DAOs, or Decentralized Autonomous Organizations, are innovative solutions that combine blockchain technology and decentralized governance systems.

The purpose of DAOs is to provide a more democratic, transparent, and efficient way of managing organizations, where token holders make decisions instead of a central authority. Launching a DAO involves several steps, including creating a smart contract, obtaining funding, and deploying.

Participants in DAOs can be token-based, share-based, or reputation-based, and to get involved, participants need to be familiar with blockchain technology and the DAO’s specific requirements.

DAOs provide numerous advantages, including decentralization, participation, publicity, and community building. However, DAOs face challenges such as slow decision-making, education, inefficiency, and security.

Overall, DAOs represent a promising alternative to traditional organizations, and it will be interesting to see how they continue to evolve.