A Beginner's Guide on Decentralized Autonomous Organizations (DAO)

A Beginner’s Guide on Decentralized Autonomous Organizations (DAOs)

August 17, 2018.
Learn about what a DAO business structure is, how it works, and its advantages and disadvantages

Bitcoin and its underlying technology, blockchain, have opened up new vistas to our digital world that further innovate and enabled traditional systems to improve. One such idea that was borne out of the blockchain’s decentralized nature is a decentralized autonomous organization (DAO).

The idea of a leaderless organization that can still operate smoothly without a hierarchical management has been in existence not long after the inception of Bitcoin in 2009. If Bitcoin can forego the need for an intermediary—significantly cutting down transaction fees and speeding up processes—then blockchain technology can also establish a business structure that can do without CEOs and managers. The applications for a decentralized organizational model could greatly revolutionize and disrupt the future of traditional business structures.

However, DAO, being a relatively new technology, is often poorly understood and is known only to a limited number of people, which are mainly cryptocurrency enthusiasts. Here, we’ll talk about the basic concepts behind DAO, how it works, and its benefits and limitations.


What are decentralized autonomous organizations (DAOs)?

A decentralized autonomous organization, otherwise termed as a decentralized autonomous corporation (DAC), is a composite of rules and bylaws of a company or organization that are programmed, enforced, and embedded into the code of a smart contract.

Therefore, a DAO is considered as the most complex form of a smart contract, where token governance rules are applied. All the financial transactions and program rules in a DAO are maintained in a public ledger called a blockchain.

Essentially, any blockchain-based organization with a decentralized governance system can be considered a DAO. Some examples of successful real-world applications of a DAO are Digix Global, DASH, and BitShares.


How does a DAO work?

Imagine a highly autonomous vending machine that not only dispenses snacks when inputted with a certain amount of money, but can also automatically reorder goods, determine what types of goods to stock, maintain the cleaning of its machine, and perform a variety of programmed actions on its own.

Essentially, a DAO functions similarly to a vending machine—the classic analogy to explain how smart contracts work. However, the mechanism behind DAO has a more intricate application of smart contracts, and here’s how it works:

• Programming of a smart contract
To be fully operational, a DAO requires the establishment of a set of rules and bylaws to which the organization operates. These rules are encoded as a smart contract within a blockchain. All kinds of contractual clauses can be embedded within the contract, such as what conditions need to be met in order to release certain amounts of funds, delineation of property rights, amount of dividend payouts, so on and so forth.

• Funding phase
As with any kind of business organization, a DAO also needs to have an internal property in the form of cryptocurrency tokens with which they can use to spend or to reward certain activities with. These tokens are used in initial coin offerings (ICO), a type of crowdfunding campaign where the tokens are created, sold, and distributed to shareholders of the organization as a form of investment. The amount of tokens purchased will determine the amount of voting power each owner will get.

• Proposals
After the funding phase is completed and a DAO is operational, all decisions regarding the organization and the use of the funds are made through a consensus system. Unlike a traditional centralized organization, everyone who bought a stake (or token) in a DAO has a say on the future direction of the company. Stakeholders can submit proposals to the network. However, to avoid stakeholders overloading the system with proposals, a monetary deposit is required.

• Voting
The stakeholders then vote on active proposals based on the consensus system employed by the network. The majority of the network needs to agree on a certain action in order to approve or disapprove a proposal. Additionally, in a DAO model, voting power may be delegated to someone to whom a stakeholder trusts more. It should be noted, however, that as autonomous as it is, a DAO cannot build and develop a product or write code by itself; it still needs a contractor to accomplish certain actions. Contractors are appointed, also, through voting.


What are the advantages of a DAO?

A DAO shares many of the benefits that blockchain technology has to offer, the main one being decentralization. A growing number of blockchain-based startups have adopted DAO due to the ideal business structure it presents, where the rigidity of a strictly regulated contractual relationship between the founders and investors are circumvented. Here are some of the other prominent advantages of a DAO:

• Governance
The main benefit of a DAO is that it provides every investor an equal opportunity to shape the future success of their organization and have a say on the decision-making process. Since the organizational structure is not hampered by a traditional hierarchical management line, every innovative idea and proposal can be fully considered by the entire organization.

• Efficiency
Bureaucracy has always been a challenge within hierarchical organizations, significantly slowing down processes. In a perfectly decentralized organizational structure, transaction times are faster and are more efficient. Additionally, as both placing a proposal and participating in its voting require every stakeholder a certain amount of tokens, it encourages them not to waste time on ineffective solutions.

• Transparency
As a DAO is built on the blockchain, every financial transaction, rules, bylaws, and decisions are recorded on the public ledger for everyone to review. The adoption of a consensus system also means that every stakeholder takes part in helping to decide how to spend the organizational funds and track the amount spent.


What are the limitations of a DAO?

As ideal as a DAO business structure seems to be, it is still far from perfect. In fact, the very first DAO project called The DAO, which was launched in 2016, suffered an unfortunate hacking where the attacker was able to drain more than 3.6M Ether. Analysts have attributed the attack to vulnerabilities in their initial code. Here are two of the most apparent disadvantages of a DAO:

• Security issues
The immutability of a smart contract is both the boon and bane of a DAO. Once the rules of a contract have been coded, it will be difficult to alter it once the system is up and running. Furthermore, since the code is visible to all and is hard to fix, any known security issues are open to exploitation.

• Legal status
While there are a number of countries that have legalized cryptocurrencies and the use of blockchain technology, the precise legal status of using a DAO as a universal business structure is still unclear. Startup businesses who adopt the DAO business structure need a legal framework in order for them to legally conduct business in certain jurisdictions and to interact with the world of traditional financial systems and intellectual properties. Otherwise, participants in a DAO are potentially subjected to legal liability.


In conclusion

The decentralization brought about by blockchain and its related technologies, the DAO structure included, introduces infinite possibilities in the area of business, finance, governance, and many more. A DAO and the blockchain itself still has a number of challenges to overcome, but with the rate of how improvements to the technology is developed, there is a huge potential for DAOs to become the business model of the future.


– Article written by Tinny

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Categories: Blockchain