Glossary
Decentralized Autonomous Organization (DAO) - Definition and Overview
A Decentralized Autonomous Organization (DAO) are institutions governed by blockchain code instead of a central authority. This setup takes advantage of blockchain’s key features: its immutable record-keeping, transparency, and enhanced security measures.
Unlike traditional organizations controlled by boards and executives, DAOs use smart contracts to establish and enforce their rules. These smart contracts define mechanisms (including voting systems), allowing stakeholders to make decisions collectively and transparently.
DAO — Key Concepts
Autonomous Structure: DAOs operate without a central authority, utilizing blockchain technology for immutability, transparency, and security.
Governance by Smart Contracts: Governance and operational decisions in DAOs are conducted through smart contracts, with stakeholder voting enforcing transparency and collective decision-making.
Challenges: DAOs face significant challenges, including low voter participation, governance complexity, and the need for sophisticated decision-making capabilities among stakeholders.
DAO Examples: Neo, GrantShares, Maker DAO, and Compound illustrate complex governance structures and financial operations.
Legal and Regulatory Issues: Due to their decentralized nature, DAOs confront legal challenges, and jurisdictions are beginning to provide legal frameworks addressing these issues. States and countries are adapting existing laws or creating new ones to regulate DAOs.
Bitcoin may be considered the first DAO. It is decentralized, autonomous, and ruled by code. However, it lacks the governance mechanisms that define modern DAOs.
DAO Governance Using Smart Contracts
Smart contracts have enabled more complex DAO structures using programmable capabilities. In DAOs, governance and operations are carried out through code, which stakeholders trust over any individual or group. This reduces reliance on trust between parties and enhances integrity and verification processes.
The code limits a DAO’s power over an application. Some parameters cannot be changed, and others may have limits. DAO governance is challenging in practice and must be carefully balanced to avoid hostile takeovers and malicious behaviors.
DAO Challenges
The decentralized aspect of DAOs demands more time from participants to make informed decisions. They must also be political and communicate correctly. This is particularly challenging for developers, who often lack political and communication skills.
DAO governance also involves selecting new admins or maintainers; poor choices can compromise the organization. Voter participation, decision-making, and software bugs pose additional challenges.
Balancing these factors is critical to avoid pitfalls like hostile takeovers or governance paralysis.
Voter Apathy
DAOs face challenges such as ensuring effective voting participation, since token holders may not engage thoroughly with the governance process.
In practice, people don’t want to vote. Most investors don’t have time to study the best alternatives and outcomes. These users shouldn’t vote for something they aren’t familiar with. In this case, it’s recommended to delegate their votes to a third party or skip voting.
Legal and Regulatory Challenges
The decentralized and autonomous nature of DAOs presents a complex array of legal and regulatory challenges. These organizations exist and operate on blockchain technology, transcending traditional geographic and jurisdictional boundaries. As such, they often fall outside the scope of existing legal frameworks, raising significant issues regarding regulation, enforcement, and liability.
One of the primary challenges facing DAOs is their legal status. In most jurisdictions, there is no clear legal recognition of DAOs as entities, which complicates contractual obligations, liability, and legal accountability issues.
Similarly, if a DAO causes financial loss to a third party, determining liability is problematic because traditional laws do not necessarily recognize a DAO as an entity that can be sued.
DAOs as Legal Entities
Different jurisdictions have started responding to the existence of DAOs. Some countries are creating new legal frameworks specifically designed for digital and decentralized entities, while others are attempting to adapt existing laws.
However, recognizing DAOs as legal entities also brings about regulatory challenges. Regulatory bodies are concerned with issues such as anti-money laundering (AML), know your customer (KYC), and the potential for fraud within DAO structures. These concerns exist to ensure that DAOs do not become vehicles for illegal activities.
Given their global nature, DAOs can operate across borders, which means inconsistent regulations between countries can lead to loopholes and inefficiencies. International regulatory frameworks, or at least cooperative agreements between countries, could help create a more stable and predictable environment where DAOs can operate.
Vulnerable DAO Governance
Not all vulnerabilities are a result of coding errors. Sometimes, vulnerabilities arise from flawed governance decisions, such as overly permissive voting rules. These governance weaknesses can critically compromise a DAO’s security.
The implementation of governance mechanisms is not mandatory as it increases risks for users and project maintainers.
DAO Examples
Many projects implement governance features in their protocols. The following examples illustrate how a few of them work.
There are two common ways that DAO utilizes to govern. One is proof of stake, where the more tokens a user has, the more voting power they have. The other is proof of authority, where only a few groups are allowed to vote.
Neo Blockchain
Neo uses both proof of stake and proof of authority to govern its network. Users can vote for validators to earn extra GAS. Validators vote on network parameters, such as the block size and fees.
Users are given incentives to participate in the network governance system. The network checks the vote states and distributes new GAS tokens every 21 blocks. Neo-holders can vote anytime, and the election is never closed.
Maker DAO
Maker DAO is the institution behind Dai, a USD token on Ethereum. This is the most complex example of a DAO, as it includes voting members and depends on external actors to balance the price of their token.
Unlike USDT and USDC, reserve-backed stable coins, DAI pegs its price to USD using cryptocurrency collaterals. The protocol has parameters that can be voted on. The Maker DAO governance system decides the amount of collateralization and the tokens allowed to be used.
Voting requires MKR tokens. The more MKR tokens a user has, the more voting power they have. Instead of voting directly on proposals, users can delegate their votes to a third party.
Compound DAO
Compound is a decentralized finance (DeFi) platform enabling users to borrow cryptocurrency through a secure, autonomous protocol.
Using the Compound protocol, users can earn interest on cryptocurrencies they deposit as lenders, while borrowers can access these funds by putting up their crypto assets as collateral.
The governance is driven by its token holders, who can propose, debate, and vote on changes to the protocol.
GrantShares DAO
GrantShares is a DAO on the Neo Blockchain. It allows anyone to request funding for a project, and if it gets voted on, the funds are released to the proposed. GrantShares doesn’t have a token. It’s ruled by authority and only a few specialists are allowed to vote.
The funds released are stored in the GrantShares smart contract. No one can steal them; the only way to release them is by approving a proposal.
GrantShares allows projects to be sponsored without requiring approval from a centralized party. It uses GitHub to promote discussions. Once a project is discussed and put to vote, it can be accepted or denied.
Adaptation and Evolution of DAOs
Decentralized Autonomous Organizations (DAOs) constantly evolve to meet the market’s demands. As blockchain technology advances, so do the possibilities for DAOs, exploring new functionalities and governance mechanisms.
The evolution of DAOs can be seen in their increasing ability to handle more complex organizational tasks. Early DAOs were often limited to simple vote-based decision-making systems, where decisions were made based on majority rule. However, newer models incorporate layered governance structures, including delegation, sub-committees, and more voting mechanisms that can handle conditional logic and automate outcomes based on specific triggers.
The future of DAOs lies in their ability to adapt and evolve continually. This will involve technological advancements and cultural shifts within organizations. As more entities recognize the benefits of decentralized governance, such as increased transparency, enhanced security, and participation in decision-making, the principles and practices of DAOs are likely to become more mainstream.
The evolution of legal and regulatory responses to DAOs will likely continue to be an active development and debate area. As DAOs become more prevalent and their impact on various sectors grows, it will be essential for lawmakers and regulators to stay informed and responsive to the challenges and opportunities presented by this innovative form of organization.
