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12 Jan 2022

What is DAO? Explanation, Protocols, and Real-World Utility

Ananda Banerjee

Through the Thou (DAO), a Person becomes I.

Well, this Martin Buber quote makes a lot of sense in 2022, with organizations trying to establish a sense of reciprocity by keeping the decision-making process transparent, agile, and open to all. 

Key Takeaways

  • Digital Autonomous Organizations are just decentralized and self-operating versions of physical setups or organizations 
  • Blockchain tech, Smart Contracts, and Code are the backbones of a DAO
  • DAO frameworks are verifiable, visible, and auditable
  • DAOs solve several fundamental problems associated with legacy firms, including trust and power abuse
  • There can be several DAO categories depending on the utility they serve

DAO or Digital Autonomous Organization isn’t just a fancy crypto buzzword. It is a utility, a new vision, or rather a reality which companies in the modern world need to accept asap. 

A DAO is a lot like the company you are working it, just digital, better connected, and free of human limitations.

But a discussion concerning DAOs need not be all techy. Instead, the parallels between real-world problem solving and DAOs are more evident than we know. And at CoinSwitch, we are going to address everything DAO with examples, stories, and, well, analogies.

Imagine that your Microwave has a built-in code that lets it calculate the electricity consumption, pay the bills online while being linked to your wallet, determine your food timings and habits, order raw materials online, instruct the mixer to prepare the batter, command the stroller to move the batter right into the microwave, and eventually move the end-product out.

Sounds unreal, right! While this seems theoretically possible, multiple elements still require human intervention. And humans intervening bring in the scope of factual errors, goof-ups, and bias. No offence to us, though!

 A human in charge of preparing the batter instead of an automatic mixer might want to add some extra sugar to amplify the taste, which brings in some sort of bias into the process.

And that is exactly what a DAO plans to address. Well, not exactly in regards to a microwave but in relation to entire organizations.

What is a DAO?

Modern-day organizations still conduct meetings behind closed doors. And only a select few are behind the decision-making process that might change the face of the firm in days to come. DAOs plan to eliminate the localized positions of power. 

In simple terms, a DAO is more like a virtual organization where the decision-making process and even the treasury management are managed over a Blockchain. From a more technical standpoint, every DAO is prefaced by relevant open-source code, making the firm’s management structure more transparent and open. 

Everything about DAO

What powers a DAO- Protocols, Code, and More?

D for Decentralized and A for Autonomous! These are the critical DAO elements that are currently driving massive global adoption. And yes, we will touch upon both. So let’s buckle up!

Imagine a setup where an organization conducts important meetings where every stakeholder (from Figurehead to Supervisor) can participate and offer inputs. If you do not think this is even possible, welcome to the ‘Decentralized’ world. 

DAOs, courtesy of the Decentralization, allow all voting, decision making, funding, and other relevant organizational processes to remain transparent. And every individual with voting rights can offer suggestions. Plus, the order of acceptance depends on an equally transparent consensus mechanism. 

Transparency and centralized power abuse are taken care of, but what’s next?

Well, just scroll up and revisit the ‘Microwave’ analogy. Autonomy or being autonomous is yet another concept powering DAOs, where specific Blockchain protocols are used, essentially as Smart Contracts, to manage every activity.

Starting from arranging on-chain meetings to managing funds to approving plans based on the chain-specific consensus mechanism, DAOs are powered by ‘Smart Contracts’ to do the heavy lifting for them. 

Therefore, Blockchain and relevant Smart Contracts are the technologies powering something as democratized as the DAO.

Problems it Solves

To reiterate, a DAO is a community-led organization or an entity that strikes off ‘Central Authority’ from its list of terminologies. And Smart Contracts are the DAO backbones, which determine the rules, proposals, voting mechanisms, and the very code that drives the system. 

But the million-dollar question is here, what problem exactly does a DAO solve? 

The Problem

Most modern-day organizations are still centralized. This means there is always a governing body that functions top-down. Proposals facilitating organizational changes that affect all of its units/ employees aren’t transparent, the consensus isn’t respected, and even finances aren’t clearly defined or allocated with only a select few in charge of the influential processes. 

The Solution

As an internet and blockchain-native entity, DAO promises several advantages, especially over traditional firms. And while we could write an entire whitepaper to explain the benefits, here are the two points that can help you summarize the idea better.

DAOs are Trustless

Unlike a formal organization where trust is the primary driver to connect individuals, DAOs have parties that only trust the code. And the code relevant to the Smart Contract manages every task essential to how the organization operates.

DAO solves the Principal-Agent Problem

The PA dilemma or the Principal-Agent conundrum is a common issue in a physical organization, where the agent’s interests aren’t aligned with the principal or the primary stakeholders. 

Imagine the agent as the CEO of a company and the principal as the Stakeholders. 

In a standard organization, agents might take work according to their free will, which might thwart the overall goal of the firm. However, DAO eliminates this altogether by bringing in community governance where stakeholders aren’t required to trust any agent, but the smart contract incentivizing their efforts. 

In simple terms, it’s like giving the power of the organization in the hands of the people running it and not the intermediaries managing it. 

Key Characteristics of a DAO

As mentioned, the set of rules governing a DAO is encoded into smart contracts by the ideators. And from there, changes can be proposed by any DAO member. However, the weight of the proposal, courtesy of the voting rights, is determined by the number of governance tokens that the member holds, which plays a significant role in giving a better seat at the tablet.

Here are some of the key DAO characteristics that separate it from any traditional organization:

  • Ideated by a core team
  • Completely visible framework
  • Verifiable across different points as no single person is in charge
  • Publically auditable as any DAO member can view any financial aspect of the firm without issues
  • Code changes or protocol changes need to be voted on, transparently
  • Can have DeFi, NFT, and utilitarian use cases built within

Note: If you are still unsure, think of DAO as a company where board meetings are conducted in a town hall with every stakeholder overseeing it. And while this breaks a chain of hierarchical influence, it even incorporates the ideas of every relevant individual. Exactly how any physical and offline organization should operate, shouldn’t it!

Types of DAO

Fact Check: Did you know that Bitcoin, due to its autonomous working module, was considered the first completely functional DAO even without the availability of full-fledged smart contracts?

But then, in 2022, the definition of a DAO and the resources powering it have evolved. And here are the generic categories that a DAO can fall into, depending on its structure, modus operandi, and technology:

  1. Operating Systems– Standalone platforms that allow organizations to create their own DAOs. Key projects include Orca and Colony.
  2. Protocol DAOs– Common DAOs which actually work as independent organizations with tokens used as the voting metric to implement the protocol and financial changes. Key projects include Uniswap, Maker, Yearn, Synthetic, Curve, and more.
  3. Investment DAOs– Supports capital pooling for various DeFi operations and investments. Key projects include The LAO, BitDAO, and more.
  4. Grants DAOs– More like decentralized Venture Capitalists with communities, where governance tokens are used to vote on capital allocation. Key projects include Audius Grants, MolochDAO, and more.
  5. Collector DAOs– Meant for NFTs and artists to support fractional or complete ownership of art and content. Key projects include Flamingo.
  6. Service DAOs– Talent hunting and acquisition model for agencies and individuals. Key projects include MetaverseDAO, DaoHaus, and more.
  7. Social DAOs– Decentralized platform for interactions. More like social networking. Key projects include Seed Club, FWB, and more.
  8. Media DAOs-More like a decentralized news aggregator that is transparent and works in the consumers’ common interest. Key projects include Mirror.

Use-Cases

DAOs are already significant, and as reported by DeepDAO, the market valuation for the same is close to $13Bn. And leading the charge is Uniswap (UNI), with over 2,75,000 members associated with the ecosystem. Also, if you are an optimistic investor, DAO ecosystem tokens like MKR, UNI, and CRV are worth paying attention to. 

Disclaimer: While financial advice is mighty swell, this isn’t one. Do your own research before taking any coin or token seriously. 

Coming to the use cases or real-world utilities of DAO, here are some examples that require mentioning:

  • Shapeshift Exchange in July 2021 announced that it would be going completely decentralized with power and control to be allocated among stakeholders, depending on Shapeshift (FOX) token holdings.
  • Wyoming recently became the first and the only US state to give DAOs the same authority and set of rights as LLPs (Limited Liability Companies)
  • Soon after, BLOCKS became the first Wyoming-based DAO LLC to offer services across the globe.

And if you are still not on board with the concept, do know that billionaire Mark Cuban believes that DAOs have it in them to be the future of legacy businesses. According to him and us, ‘Trustless can surely pay’ in the long run. 

Know your DAO Better: The Flipsides

While the concept of a Digital Autonomous Organization sounds liberating and progressive, there are a few roadblocks that you must consider before jumping right in:

  • DAOs are still coded, and codes can be vulnerable at times
  • Most DAO-based products aren’t yet in sync with their centralized and offline financial counterparts
  • It is still in the nascent stage and requires a more critical view 
  • Consensus and voting mechanisms can slow down a few key processes
  • Disputes might end up in a hard fork

Wrap-Up

And that’s all regarding DAOs for now. As a concept and even a technology, DAOs are brimming with the potential to change how organizations operate. Also, like most crypto use-cases, even Digital Autonomous Organizations are hopeful of a euphoric future, provided people start investing time in learning the nitty-gritty of the concept. 

But then, if you have skipped right to the end to get hold of a simpler perspective of a DAO, here it is. A DAO can be anything, starting from a channel to a social networking platform to trading platforms (Automated Market Makers) to anything else. It is just a representation of a fringe physical idea realized as a colossal decentralized business. 

And yes, it is as simple as that. 

Had fun reading about DAO? Read more pieces like this and stay updated with the key crypto concepts.

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

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Ananda Banerjee

Content Writer

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