A Decentralized Autonomous Organization (DAO) is a community-driven management system. They can be independent of third parties and public companies, and their business and organizational models are also very different from traditional organizations.
Quick navigation What is a DAO?
Thus, we can distinguish the following characteristics of DAO:
Non-hierarchical system: as the name implies, DAOs are decentralized systems owned and operated by token holders rather than the president, manager or CEO in a hierarchical system. Self-sufficiency: DAO members inject liquidity into the system by placing their tokens in liquidity pools. They can also run crowdfunding campaigns to attract investors and venture capital firms. Wide range of uses: DAOs can be anything – their systems allow the creation of NFTs (non-interchangeable tokens), digital tokens (Dash is a popular example as it is autonomous by the community) or decentralized applications (dApps). Onchain governance: DAO members must put a certain number of tokens to make changes to the protocol or other types of proposals that other DAO members vote on. Open Source: The DAO’s rule is that the code written and stored in its smart contracts can be seen by everyone. Every DAO member can see historical data, such as transactions and protocol changes.
Cracking the DAO 2016: the first DAO
The DAO is the first decentralized autonomous organization. It is a venture capital fund founded in April 2016 by Christophe and Simon Jentsch.
Unfortunately, it expired in 2016 after several community members discovered a vulnerability in the smart contract code and absorbed a third of the DAO funds (approximately $168 million was raised in a crowdfunding campaign). This led to the hardforcing of the Ethereum blockchain.
Although DAO considers its tokens to be “unregistered securities” and therefore subject to regulatory laws, it is also not in compliance with SEC (Securities and Exchange Commission) regulations.
How do DAOs work?
Smart contracts – digital contracts designed to be executed when certain conditions are met – are the backbone of DAOs.
Developers write the necessary code for smart contracts to create an autonomous system capable of performing transactions automatically without third-party involvement. This code can then be modified based on proposals submitted by eligible participants, whose criteria may vary from one DAO to another if voted for.
Create a DAO
Now, if you’re still having trouble digesting that, let’s try to figure out the simple process of starting a DAO.
If you want to create a DAO, you first need a non-hierarchical structure in which each member has a clear and defined role. These roles are usually, but not limited to developers, token holders, curators, community managers, etc.
DAOs can be large and complex organizations, and certain roles can be added or removed as needed.
Developers are usually responsible for writing the smart contracts to be deployed in the chosen blockchain on which the DAO is based. They also maintain the code. Token owners support DAO by owning native tokens and receiving the same token rewards for their commitment to the community. Token owners are also the ones who vote (or delegate their right to vote) and submit proposals. Curator: A Curator role has been created to prevent 51% attacks. Although their usefulness has been widely discussed, the primary role of managers is to whitelist the addresses of smart contract business proposals. Community Managers: they manage DAO’s social media channels, answer questions from community members, train new members, and generally manage DAO’s digital environment. Financial managers: DAOs can manage significant capital, and they often need someone with a strong financial background to manage fund allocation, financial reporting, diversification, etc.
Other roles may include vault strategists. Every DAO has a repository, a tool that generates new tokens for locked provisioning. As a result, many roles can be created, from the most technical level, such as developer, coordinator, and financial manager, to more community-oriented roles, such as content creators (writers, graphic designers) and community managers.
Write smart contracts
Once the main roles are defined and everyone has a clear idea of the DAO, it will come to life with the creation of smart contracts.
Developers are responsible for writing the smart contracts to be deployed in the chosen blockchain (usually Ethereum). Nevertheless, Solana has been an attractive alternative for developers to create DAOs such as Honey DAO or Mango Markets.
Creating a smart contract can take hours, days or even weeks because it needs to be thoroughly tested on all possible scenarios.
DAO needs funding once the smart contract testing phase is complete. While its participants can inject liquidity, selling tokens is a common strategy to raise capital and attract members and participants.
Deploying a DAO on a blockchain
The last step is the deployment of the smart contract in the blockchain. After that, the organization becomes fully functional, and all the aforementioned dynamics come into play.
Now problems can arise because once the system is up and running, problems such as bugs, security holes, and other issues can arise that compromise the security of the DAO.
The only way to fix a security hole or bug is to change the source code of the smart contract, but this can only be done by voting on proposals. While the voting process is underway, attackers can exploit framework vulnerabilities and exploit vulnerabilities, as happened with the DAO hack in 2016.
Applicable law and legal structure of the DAO
Most DAOs are concentrated in Wyoming, one of the few crypto-friendly states in the United States.
In July 2021, Wyoming lawmakers passed a law called a DAO LLC (limited liability company). This allows individual developers and organizations to create fully legal DAOs in the state, since DAOs are treated as either member-driven or algorithm-driven organizations that can take full advantage of an LLC organization.
However, if it is identified as a limited liability company, it may also be affected by changes in the law:
“Decentralized autonomous organizations are perfectly legal, but like all new technologies, DAOs are subject to significant regulatory change. Under bill SF0038 (effective July 1, 2021) current Wyoming law, a DAO LLC has many of the same requirements. as a traditional LLC, but with some additional criteria for the more complex management structure and server part required to operate it.”
This is a law that has not changed anywhere else in the world. CryptoFed is a U.S.-based DAO and the first DAO recognized as a legal entity in the state of Wyoming. However, other such practices have been classified by the SEC (Securities and Exchange Commission) as “unlawful offerings of unregistered securities.
Popular DAO Uniswap (UNI)
Uniswap is one of the most popular decentralized exchanges with an autonomous automated trading system. Its control token, UNI, is ranked number one in Coinmarketcap and has the largest market capitalization of any DAO at the time of writing in February 2022.
Aave is a decentralized lending protocol in which lenders earn interest by contributing funds to pools of liquidity. Borrowers then use this liquidity to create collateral in cryptocurrency to obtain express loans.
Maker was one of the first Ethereum-based DAOs launched in 2017. It allows for the issuance and distribution of DAI, a community-driven stable coin pegged to the US dollar.
Bit track (BIT)
BitDAO is one of the largest DAOs in the world, supported by the BIT token holder community. The project aims to create a robust decentralized ecosystem by leveraging the next generation of web3 organizations and autonomous objects in the DeFi space.
Benefits and limitations of DAO
DAOs have a wide range of uses, including investments, fundraising, lending, decentralized exchanges, and even NFT. DAOs are very attractive to the cryptocurrency community because they have potential applications not only in the DeFi space, but also outside of it.
Despite significant progress, the current DAO model is limited in terms of infrastructure and legal framework. As we explained above, security breaches are still difficult to hide, and breaches can have disastrous consequences for shareholders. To name a few limitations:
Technical vulnerabilities such as security holes in smart contract code, voting procedures, manipulation, etc. Most votes can negatively impact the lowest level of touchpoints in the group. If a DAO were established as a for-profit organization, it would violate regulatory laws, thereby limiting its ability to effectively place capital and serve the development of the ecosystem.
The Future of DAO
With the advent of the decentralized space, many powerful projects have emerged, and DAO can disrupt traditional hierarchies in traditional finance through a democratic, community-driven system. Nevertheless, there is still much room for work to properly expand the potential of DAO.
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