What Are DAOs and How They Work?

Crypto fans have surely come across DAO and wondered what it is. We’re here to solve your doubts. DAO is short for Decentralized Autonomous Organization, so it’s not exactly a cryptocurrency.

DAO structures allow companies, organizations, and communities to manage treasuries in a completely decentralized way. The voting is done using tokens and smart contracts, both of which are run on the blockchain.

DAOs are not coins or cryptocurrencies. They’re rather investment groups, a governance of blockchain projects, or donation organizations.

What Precisely is DAO?

Many crypto enthusiasts think that DAO is a cryptocurrency like Bitcoin or Ethereum. That’s not the case. Its history starts in 2016 when the first DAO was formed.

It was named “The DAO” and operated as a blockchain venture capital fund on the Ethereum network. A token sale then followed, and it raised more money than expected.

The group expected around $5 million for the Ethereum project Slock.it. However, it raised a total of $150 million. It represented around 15% of the entire supply of ETH.

Just a few months later, hackers attached the smart contracts to drain the fund. The group noticed the attack, and with the help of white-hat hackers, it was able to move funds to safe wallets. Many investors were able to recover their funds through them.

For example, hackers managed to steal $3.6 million ETH. The ETH community proposed a fork on the chain to undo the damage. The fork split into two chains. The original chain exists under Ethereum Classic, while the new chain is simply called Ethereum.

After the Hack

The DAO did have a very rocky start, but the group didn’t give up that easily. DAOs are still active today with a much simpler goal – governing protocols.

• The top DAOs you’ll find are Arbitrum, Lido, Uniswap, and MakerDAO.
• The concept branched out further with social impact DAOs and investment DAOs. The former includes Big Green DAO, UkraineDAO—which acts as relief effort to the Ukrainian war—and VitaDAO. Investment DAOs include OrangeDAO, SeedClub, and SyndicateDAO.
• Single purpose DAOs have a goal to unite people with the same goal. For example, ConstitutionDAO was launched in 2021 to big on a copy of the US Constitution on offer at Sotheby’s. There are also NFT and Collector DAOs which allow investors to own digital assets such as NFTs.

Main DAO Features

Decentralized Autonomous Organizations are much different than traditional organizations. The use of smart contracts and DAO tokens are the two major differences.

DAOs are decentralized and trustless. This term means that users don’t need to trust any leader or authority.

DAOs use smart contracts for governance votes. A single token represents 1 vote, and allows decentralized decision-making.

It also gives DAO users control of the treasury, which isn’t the case with centralized organizations. Below we’ll take a look at the main features and how they work.

Smart Contracts

You might have heard this term in relation to the Ethereum blockchain. It’s not an exclusive ETH feature. Smart contracts are used by DAOs too. They’re rooted in a very simple action-reaction phase – when something happens, the contract does another thing. They’re like switches that follow a decision tree to complete transactions.

In DAOs, smart contracts allow votes to be accounted for. They may also automate the release of funds. Before a vote is reached, DAOs use several phases, including a temperature check to check interest, a consensus phase for discussion, and a governance proposal phase where on-chain votes are proposed via smart contracts.

Governance Tokens

In order to vote on matters, DAO users use governance tokens. This is usually the only official token for the protocol, such as Uniswap or Arbitrum. Some governance tokens play a dual role as gas tokens which pay for transactions on certain networks.

Creating a DAO

Thanks to their features, DAOs are pretty popular among crypto enthusiasts. They’re also easy to create, with the process going through 3 key steps. These include creating a smart contract, fundraising, and deploying the contract on the Mainnet.

Groups with a shared goal can create DAOs on any blockchain with smart contract functionality, including Ethereum, Solana, or Arbitrum.

DAOs can be wrapped or unwrapped. The latter is wrapped with a legal entity such as an LLC that holds the DAO. This is a crucial step to consider before creating a DAO, as it changes its nature completely.

Creating the Smart Contract

Creating a DAO starts with the creation of a smart contract. There are several things to consider before it, including the tokenomics and how many tokens you want your DAO to create. You should also decide if the tokens are governance tokens, or they represent ownership in an asset pool. This process can be automated with apps such as Aragon. It allows you to create smart contracts the way you want them. Audits are important too, so consider bringing a smart contract audit firm on board. Once deployed, these contracts can’t be modified.

Fundraising Phase

Next comes the fundraising phase. Token sales is the first step. Apps like Aragon can help minting them. Most DAOs use a delegate system where all users delegate the tokens to a smaller group.

Activating the Ecosystem

The final step is to activate the ecosystem. The smart contract must be deployed on a blockchain – preferable Ethereum. Once deployed, nothing can change unless the community votes for such an action.

DAOs vs. Traditional Organizations

Those who favor decentralization and privacy will always be in favor of DAOs. Forming one can be simple. However, forming several DAOs is not effective. That’s because the tiered decision-making process subjects some well-thought out ideas to a vote. Many of these ideas will simply be left on the back burner.

Traditional organizations use a stable system with clear goals and means to implement them. Depending on the project, it’s up to you to decide if you want to go with one model or the other.

What to Use DAOs for?

There are many ways to use DAOs for. They can serve all kinds of purposes, from non-profit organizations to governance or decentralized apps and platforms. In the purest form, a DAO allows the community to vote with tokens on what happens next. It can also be used for smart contracts, as the decentralized DAO owns the smart contracts on the platform.

As a Decentralized (DeFi) platform, many companies are already using DAOs to manage their platforms. It can also be used in venture capital firms, providing support to startups in many niche markets.

Other uses include supply-chain management and content creation.

Risks of Using DAOs

There are several risks of using DAOs instead of traditional organizations. Being a new technology, DAOs may face regulatory uncertainty and may be costlier than fiat money transactions.

There are also concerns about smart contract vulnerabilities, as hacks are not uncommon. While there are governing bodies that can solve disputes regarding traditional finance, the decentralize nature of DAOs means you’re in uncharted waters.

Of course, the pros much outweigh the cons, but you should be aware of potential issues when using DAOs that may face challenges ahead.

Conclusion

The decentralized nature of DAOs made them a perfect choice for anyone looking to get far away from traditional organizations. Its flexibility is controlled by nothing more than the imagination and the technical limits of users.

There are still many challenges ahead, including some regarding security and regulatory issues. However, the blockchain is resistant and has a history of finding solutions unlike traditional finance.

If you’re into smart contracts and prefer the blockchain to traditional organizations, then DAOs are an excellent choice. Their pros outweigh the cons, and if you want to step into a brave new era, you should consider them.