What is a DAO? How Decentralized Autonomous Organization works

Since the advent of smart contracts, DAO has been around, playing an indispensable role to make the blockchain world more decentralized. It is now spreading out to every corner of the blockchain ecosystem.

In this article, we will walk you through what DAO is and everything around this unique organization model in crypto.

What is a DAO?

Decentralized Autonomous Organization (DAO) is a new form of governance that is not controlled by a single entity such as a company, government, or bigger, a country. Decentralization is a notable feature of blockchain technology, and it can lead to a decentralized world.

In traditional finance, an enterprise operates with a board of directors who make every critical decision. This type of management has a limit that is for only a group of top stakeholders.

In crypto parlance, the community of token holders drives the fate of the crypto project via voting on an on-chain governance mechanism. The notion is derived from the decentralization of a blockchain network with a system full of nodes/validators. If it can decentralize a network, why not an entity.

DAO can leverage the power of community since the contributions can be derived from anyone in the crypto space. The DAO contributors gain value for the projects and long-term reputation.

How does a DAO work?

With blockchain technology, we can realize the notion of DAO.

How DAO works

In simple terms, DAO is built up by a series of smart contracts on top of the blockchain. Inside DAO smart contracts, every specific rule is written, and the organization will act accordingly to them. Therefore, it is impossible to manipulate things that are not included in smart contracts.

In addition, the smart contracts maneuver the DAO activity. Anyone with membership can make proposals and vote on them. This enables organizations like DAOs to work without any centralized authority.

DAO vs. Traditional Organization

Since DAO is a game-changing governance model, it has numerous noteworthy factors compared to traditional organizations.

• A DAO is a peer-to-peer community where everyone has the right to vote and put forward proposals. On the flip side, a traditional company has a hierarchical structure that divides the role of a CEO and an employee.
• The approval of DAO decisions is voted by everyone holding stakes (tokens, cryptos, etc.). However, a company often has a group consisting of a limited number of stakeholders.
• DAO data on top of blockchain is transparent, and everybody can look upon blockchain explorers.

The current context of DAO

Why do we need DAO?

Not only in the crypto space, but monopoly also lies in every corner of the world, and it’s still an itching problem. When things are under control by one central authority, the benefits mostly lean in one way.

In a hierarchy structure, everyone does not have the same voice. The top members can bury the good ideas of subsidiary members.

One of the core blockchain features is decentralization. Crypto natives are looking for a decentralized world to flourish their ideas. A decentralized world is composed of decentralized entities.

It eliminates the power of centralized authorities in crypto. DAO members understanding their roles can vote on protocol updates that can forever change the project's fate.

Limitations of DAO

Everything has its limitations and DAO is not an exception. Despite its watershed utility, DAO is still in the early stages of mass adoption. From technical and practical perspectives, DAO contains risks and drawbacks that might defy DAO's future to mass adoption.

Thanks to the advent of smart contracts, the DAO models can work. However, since smart contracts are written in pure lines of code, they can be exploited and even manipulated. This might cause fund loss or a fraudulent voting process, leading to the wrong outcome.

The DAO hack in 2016 is one of the most notorious crypto events. After finding a loophole in the code, the hackers stole 3.6M ETH (approx. 30% of the DAO’s fund). If the ETH price was $3,000, the hack could have had a total damage of over $10B. As a result, DAO is still vulnerable even if it gets audited.

2 popular types of DAO

In crypto, we can occasionally see two types of DAO, as follows:

Token-based DAO

Token-based DAO is widely used among blockchains and protocols. Decentralization is one of the ultimate states of any protocol. As a result, DAO integration is a must since it can grant control to the collective community.

Blockchains or protocols using the token-based DAO mechanism are able to change parameters or even conduct hard forks, decided by token holders. These community-centric decisions will sail the development.

As mentioned above, blockchains and protocols can apply DAO to their firmness.

• Blockchains like Bitcoin, and Ethereum… will reward miners with crypto when they participate in block verification. The more crypto they hold, the more voting power they get. This creates a risk when any centralized entity controls over 51% of the current circulation, which can cause negativity for the blockchain.
• Protocols like Aave, Uniswap, Anchor Protocol, etc couldn’t ignore the DAO trend. DAO of protocols works with the same principle as that of blockchains. Token holders can propose and vote on protocol changes and updates.

DAO is an inevitable feature since it empowers token holders the control over the protocol. From the perspective of crypto builders, their works will eventually contribute to the community and for the community.

Share-based DAO (Organization)

Share-based DAO uses shares as representatives for voting powers to anyone holding. Contributors need to meet some initial requirements to get a number of shares. This means not everyone is able to get shares even if they hold the project token.

Thus, a share-based DAO limits the number of members who can vote. This facilitates every governance process, but it is hard to scale up and be more decentralized.

It is not compulsory for every project to be fixed to either token-based or share-based DAO.

Decentralized Autonomous Organization examples

Ethereum

Ethereum is the largest smart contract platform in the crypto space. It is where most DeFi primitives get started. Using either PoW or PoS consensus, it still grants ETH holders the voting power on EIPs (Ethereum Improvement Proposals). EIP plays an important role in improving the Ethereum Network.

As time goes on, many EIPs have been voted through by the community, such as EIP-20, EIP-1559, and EIP-3672. For example, EIP-20 is when the ERC-20 token standard was first introduced.

There are countless EIPs waiting to be voted on by ETH holders. Therefore, they can stir the future of Ethereum via the token-based DAO feature to adopt any new situation.

Anchor Protocol

Anchor Protocol is a lending/borrowing platform built on Terra. According to DeFiLlama, it has a TVL of over $20B (Dominance: 8.71%) as of May 4th, 2022.

The platform is reputable for offering a lucrative income from staking UST with a semi-dynamic earn rate. The rate used to be 20%, but it is now dynamically changed, based on the yield reserve after the executed token-based DAO proposal named Dynamic Earn Rate.

Setting aside the juicy passive income, Anchor Protocol lets ANC holders vote on the protocol changes. This makes the platform more decentralized and sustainable in the long term.

The LAO

As mentioned, a share-based DAO is an option for projects to build a DAO since it allows a limited number of shareholders to vote on protocol changes. The total number of LAO members who can vote is limited to 99 members. This means the protocol is more concealed to a specific group, not a community.

Every LAO member is eligible to nominate and vote on any proposals for funding. After the proposal approvals, the LAO will invest in nominated projects.

To get LAO membership, participants must contribute ETH, purchase LAO units, comply with the terms, etc. The requirements are challenging for some individuals, but the LAO looks for top-notch members. In short, the LAO is governed by a group of big whales.

Potentials of DAO

DAO is the next development phase of any blockchain and protocol. The community can be involved in contributing to the growth of the protocol via on-chain governance. DAO enhances the decentralization feature of blockchain across every ecosystem.

As crypto projects are exceeding in number, DAO is integrated into those projects along with the development roadmap. You can arbitrarily pick a crypto project and look at the roadmap to see the DAO feature.

Despite the niche and blockchain platform difference, all top DeFi protocols by TVL on DeFiLlama have one thing in common: the DAO feature. On a small scale, the project builders can lead the development. However, when the project gets big, they will give the community control over the protocol.

Blockchain technology can make the notion of “decentralizing everything” real. DAO is often the next phase of the development of the crypto project. This phase will decentralize the protocol.

The community-owned governance will determine the best decisions in the long term. Things are transparent, and benefits will be distributed to every individual who makes contributions.

Predictions of the future of DAO

Community-governed protocols are the trending narratives in crypto at the moment. It is almost impossible for blockchain-based applications not to have the on-chain voting feature. Even new projects will eventually roll out their DAO.

Both token-based DAO and share-based DAO have their limitations. Token-based DAO is fast to scale, but the quality of votes is often mediocre. On the other hand, share-based DAO can not scale fast, but the control belongs to a limited group of people who meet the requirements.

As a result, the DAO model needs to evolve to eliminate the aforementioned drawbacks. The current state of DAO is DAO 1.0, then the next state will be DAO 2.0 like the DeFi 2.0 narrative.

As described in the summary above, DAO 1.0 has fundamental drawbacks that might be obstacles to DAO growing further. In DAO 2.0, there are some fundamental changes and how the organization is modified to make progress.

For example, in DAO 1.0, every member has a weighted vote. On the other hand, in DAO 2.0, there are groups consisting of protocol members who are willing to collaborate with each other. Furthermore, each group can act as an expert (specialized) in proposals. This will eliminate the bias of voting progress to get results with high accuracy.

Investment Opportunities with DAO

Join DAOs

Investment DAOs are the go-to place for investors who are looking for investment opportunities empowered by blockchain technology. An example of this is BitDAO (BIT). It allocates funds for crypto projects to grow via on-chain proposals. BIT holders are able to make proposals and have voting power on BitDAO.

Token holders can benefit from the demand for BIT tokens or making proposals to request funds for their ideas. Proposals can be treasury allocations, token swaps, project grants, and protocol updates.

Before joining a DAO, investors should estimate community engagement of the DAO as well as future growth. Since it is fast to create a DAO from the ground up, selecting a long-term DAO with strong community engagement is even more important.

DAO platform

The importance of DAO is undeniable in crypto as every protocol is going to implement DAO to decentralize its products. To be fast, project developers often use frameworks or tools to build a DAO instead of building it from scratch.

For most crypto projects, DAO is a feature. There are tons of things to consider before investing in a project with a DAO feature. Thus, we can aim at DAO platforms as they provide the DAO service to other developers.

DAO service providers might focus on crypto projects as customers, not retail investors. As a result, looking for a way to invest for an individual without the community can be a struggle.

Conclusion

That is everything you should know about DAO and its future potential. DAO can be a useful tool for the community to contribute their ideas and democratize the products. However, if you’re about to invest in DAOs, do your own research and be responsible for your investments.