What is a DAO

DAO is an acronym for decentralised autonomous organisation. The term originated among the nascent Ethereum community in 2015. A DAO is essentially software code running over a decentralised peer-to-peer network that incorporates governance and decision-making rules. It is a form of organisation that is managed through rules encoded in smart contracts. The purpose behind a DAO is to design an organisational structure that could function and perform actions independently of human hierarchical management. It can implement contractual obligations as well as business logic rules. Therefore it is a quasi-autonomous, transparent company. With a DAO, most management and administrative functions and internal processes could undergo automation. Smart contracts would distribute the "value" in a given context among virtual stakeholders.

It is therefore a new type of application that the  blockchain technology makes possible. In a very simplistic way we can equate them to cooperatives, but with obvious differences.

How it works

A DAO is bound by the governance and decision rules encoded in smart contracts by a software developer. In particular, the terms of collaboration between different participants and stakeholders are specified. Once operational, an algorithmic consensus mechanism validates decisions on a DAO. The interaction between the members of a given DAO, which are usually represented by pseudonyms, is normally done through the underlying blockchain through which all actions are executed.

A DAO is therefore nothing more than an organized system of people gathered under a single purpose/project, and thanks to the use of the blockchain and tokens, allow their participants to vote on issues. So as if they were shareholders but in this case the decisions lead to approve or not a certain solution or idea. 

These types of systems, very simple to use, allow users to use a specific token, often created by the DAO itself and that has the function simply of governance of the DAO, and therefore without a particular value if not to vote on internal decisions. But this does not exclude that the same token has a market value that goes beyond the DAO itself.

DAO examples

DAOs are appropriate for many purposes, such as investing, charitable giving, fundraising, lending, or buying NFTs, all without intermediaries. A simple example: a DAO could accept donations from anyone around the world. Then members could decide how to spend the donations.

The first popular implementation of DAO was named TheDAO, and was launched in April 2016 on the Ethereum blockchain. TheDAO was a kind of hedge fund, where contributors could directly vote on proposed projects. It became the most successful investment crowdfunding in history at the time. It raised $150 million, and concentrated 14% of all ETHER tokens issued at the time.

A recent example is Constitution DAO which raised nearly $47 million in ETHER through a campaign conducted on social media. The goal of this non-profit DAO was to purchase an antique copy of the U.S. Constitution at a Sotheby's auction.

At the auction, however, a private individual bid higher and won the item. The DAO then voted to return the funds raised to the investors rather than seek other types of capital use.

Those who want to create their own DAO can rely on existing platforms that allow to configure the DAO according to their needs. The main platforms that provide DAO deployment as-a-service on Ethereum allow users to create their own DAO are Aragon, DAOstack, DAOhaus and Colony. All are free/open-source projects in development, in various stages of maturity. Of these, the largest in terms of usage is Aragon.

Problems encountered

Participation

Participation by token holders of a DAO can be problematic. There is the high risk of lack of participation in voting. This is due to the fact that it takes time and energy to evaluate each individual proposal.

Legal Status

The precise legal status of this type of business organization is generally unclear, and can vary by jurisdiction. On July 1, 2021, Wyoming became the first state to recognize DAOs as legal entities. Some previous approaches to blockchain-based companies have been deemed illegal offerings of unregistered securities by the U.S. Securities and Exchange Commission. In other legislation, the simplest solution is to consider a DAO as a foreign corporation or as a set of contracts between individuals.

Security

The programming code of a DAO is difficult to change once the system is up and running, including bug fixes that would otherwise be trivial in centralised code. Fixes to a DAO require writing new code and agreeing to migrate all funds. Even if the code is visible to all, it is difficult to fix. Thus leaving known security holes open to exploitation, unless the community calls a moratorium in order to allow bug fixes.

Conclusions

DAOs are another example of use of the blockchain technology. In this case, it is not originating a new category of financial products, rather it is a tool to build and manage organisations. The focus is primarily in the area of people who are remote from each other or do not know each other. Such an organisation can function due to the fact that members have the right to vote when it comes to making decisions. Member are sure that the vote is correct being based on the blockchain.

Whether the organization has as its purpose to invest funds or provide a service of any other kind, it changes little.

It is a new organisational mode that will have to undergo large scale tests to understand its pros and cons. Moreover, it will be necessary to make sure that the law develops to cover this new domain in a clearer and less fragmented way.

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