The term ‘Decentralized Autonomous Organization’ has been a buzzword for a while now. With many people interested in the DeFi space we thought it was time to explain the basics of a DAO. Because why would anybody ever need a fully decentralized organization? Well, we will tell you in the article below.

What is a DAO?

DAO is the acronym for Decentralized Autonomous Organization. They are Internet-based organizations that are jointly owned and managed by its members. The internal treasury can only be accessed through approval by their members. When decisions need to be made, the group votes on various proposals over a period of time.

A DAO operates without a hierarchical management structure. They are fully decentralized and are not affiliated with any specific party. Today's DAO’s owe their existence to The DAO, the first DAO created. After this project failed, other organizations adopted the philosophy and improved upon it. Still don't know what we're talking about? Watch the video below to find out how a DAO works.

How does a DAO work?

As mentioned above; DAO’s are organizations where decisions are made as a collective because they are owned jointly by all members. There are several ways to participate in a DAO. The most common way is by owning tokens (cryptocurrency) of the DAO.

DAO’s operate in an automated fashion because they work with smart contracts. Smart contracts are pieces of code that ensure that actions are executed automatically when certain criteria are met.

Thus, the rules of a DAO are determined by smart contracts. Decisions on new governance proposals are made by everyone with a stake in the DAO. Voting rights allow stakeholders to influence these proposals or create any new ones.

The way DAO works is entirely according to the philosophy of crypto. It works in a decentralized, autonomous and transparent way. Anyone can view the codes that are used because DAOs are built on open-source blockchains. In addition, it is possible for anyone to check money-related matters since the blockchain records all financial transactions.

How is a DAO created?

The creation of a DAO consists of three steps:

1. Developing the smart contract

The first step is to develop a smart contract for the DAO. Here it is important that the rules are set up properly and clearly, since once a DAO is launched you cannot change the rules indiscriminately. Only rules set through the governance system can be modified.

2. Raise funding

After the development of smart contract, it must be determined how DAO will fund its project and how the governance will be implemented. The easiest way is to sell tokens of the DAO to raise funds. These funds are then given voting rights because they own tokens.

3. Implementation

Once the DAO is fully set up, it must be implemented on the blockchain. After implementation, developers lose their exclusive rights and all stakeholders have equal rights. Thus, everyone has equal voting rights on decisions made by the organization.

Why DAOs?

DAOs have several advantages over traditional companies. For example, they are much more trustworthy. That's because thanks to smart contract, there can be no doubt that an agreement has been or will be kept. Instead of having to trust people with traditional companies, with DAO’s you only have to trust in the code. So human error is taken out of the product.

Trusting the code is easy because it is public to the public. Every action a DAO takes after launch must be approved by the community and is completely transparent and verifiable. In addition to being a public, trustworthy code, the lack of a hierarchical structure in the organization also brings benefits. Namely, the organization is not rudderless without a board. The lack of a hierarchy allows (individual) stakeholders to put forward an innovative idea. Internal disputes are usually easily resolved thanks to a voting system, in line with the pre-written rules in the smart contract.

Also, investors can pool funds. As a result, DAOs also give them the opportunity to make investments in startups and decentralized projects (usually at an early stage). The investors share the risks and any returns.

1/ What is a DAO? A thread 👇🌐

— The Metaverse (@themetav3rse) November 4, 2021

Disadvantages of DAOs

New technologies are never perfect right away, and that is certainly true of DAOs. They have received sustained criticism for legality, security, and structure issues since their existence in 2016.

Since a DAO can be distributed across multiple jurisdictions, there is no legal framework. Any legal issues that may arise are likely to be a thorn in the side for those involved, as numerous regional laws have to be dealt with which will potentially turn into a complicated legal battle.

Also, a DAO is never completely decentralized or autonomous. No (crypto) organization can guarantee that for that matter. Depending on the board, there are only different levels of decentralization.

Although the DAO network may have independent but equal network actors, the smart contract rules are always a loss of direct autonomy; thus, a loss of decentralization. Architecturally and geographically, a DAO is certainly decentralized, but it is and will remain (for now) logically centralized on the protocol. In addition, updating the code is done by experts, so thanks to them you also have a point of centralization.

The DAO

In addition, there are still uncertainties about DAOs in terms of security. This is partly due to the crash of "The DAO" in 2016. The DAO was one of the first DAOs and launched in 2016 on Ethereum's network after they raised $150 million in ETH, at the time the largest crypto crowdfunding ever.

A few days after the launch, developers expressed concern about a bug that would allow malicious parties to extract funds. While an attempt was made to fix the bug, an attacker took $60 million in ETH with him. At that point, 14% of all circulating ETH was invested in "The DAO. If you recalculate that to today's ETH price, it comes to over $60 billion.

Chaos ensued and a hardfork was implemented on ETH. Those who disagreed started supporting an earlier version of the ETH network, which became known as Ethereum Classic (ETC). This event showed that if there are holes in a smart contract that are not closed before launch, it can lead to potential theft and money loss.

The future of DAOs

DAOs have enormous potential to grow into a true revolution in the crypto industry. Unfortunately, they still face (sometimes) security and legality issues. The SEC, the US regulator of the various stock exchanges, suspects that some DAO companies have made illegal offers on unregistered securities. There is also a lack of understanding of cryptocurrencies among new investors and it remains difficult for many users to find their way around the crypto infrastructure.