If you have already a good knowledge of cryptocurrency, blockchain technology, and smart contracts, it is time to define DAO now, also known as Decentralized Autonomous Organizations.
DAO stands for Decentralized Autonomous Organization, which you can rate as one of the most complex forms of smart contracts.
But, this is not all of it. Let’s define DAO in detail in this article.
If you look into it, you can get an idea from the name what DAO actually is. As it stands for Decentralized Autonomous Organization, you can have a sense that we are talking about an autonomous organization, which is decentralized just like cryptocurrency and blockchain technology.
This is exactly how we define DAO, and it is kind of self-explanatory from its name. The idea was on the market ever since the first cryptocurrency was launched back in 2009. In an effort to help Bitcoin get rid of intermediaries in financial transactions, the DAO emerged as the best possible solution.
Decentralized Autonomous Organization (DAO) is actually an organization that can run on its own without having any hierarchical management. It operates based on the pre-defined code which is why we call it a type of smart contract.
The above is a simple definition of DAO, but let’s define DAO in more technical terms.
“DAO is a form of contract in which the processes and laws of a decentralized organization are inserted as a permanent code of the smart contract, and operates through a distributed consensus protocols.”
Real Life Example to Define DAO
Let’s understand DAO with an easy to understand example.
Have you ever used Uber? The chances are, most of you have.
Now consider that the Uber is DAO. In that case, the car will be driverless that searches for the passengers on its own. It picks up a passenger on its own and drops a passenger on it own. In addition, it gets payment on its own, gets fuel on its own and pays for the fuel on its own from the profits. Simply put, the car, if it is acting like a DAO, will not need any external help to perform its tasks.
Same is the case with Decentralized Autonomous Organizations. They don’t need any management to run them, they operate on pre-defined code and directions, and are decentralize with no central authority to control them.
Any organization that satisfies the above condition is a DAO.
Traditional Organization vs. Decentralized Autonomous Organization
To define DAO in a better way, it is mandatory to understand the difference between a Decentralized Autonomous Organizations and a traditional organization.
- A traditional organization follows a top-down hierarchy with centralized authority, but DAO does not as DAO is a distributed network of autonomous stakeholders.
- A traditional organization is one legal entity, but DAO has no centralized legal entity. You can learn about the legal status of DAO in the last part of the article.
- A traditional organization offers legal contracts to its employees, but DAO doesn’t as it uses smart contracts.
- A traditional organization is centralized but DAO is decentralized.
How DAOs Work
To further define DAO in detail, let’s look into how it works.
The first ever DAO is Bitcoin. It was also the first ever fully-functional Decentralized Autonomous Organization. The same concept was followed by other cryptocurrencies like Ethereum, as it was enabled on the Ethereum platform.
This was the first time the DOA was used by another organization other than Bitcoin. It also helped others also interested in the concept, and helped shaped its current look.
Now, how does a DAO work?
You need to start with the set of rules first. What are the rules you want to define under which you want a particular organization work? You need to brainstorm all the rules as you need to add all these rules to the smart contract.
All the rules are then coded into a smart contract, which is essentially a computer program. It autonomously exists on the internet and requires people to do tasks that it can’t do on its own.
When you are done with setting up the rules and creating a smart contract, next is the funding phase. It is one of the most important steps in the process for two reasons.
First, all DAOs need tokens, which are essentially an internal property of a particular DAO. These tokens are used by the organization to reward activities within it.
Second, when the user invests into the DAO through the funding process, they actually buy voting rights. So the more someone spends on the DAO, the more influence he can have on the way it operates.
After setting up rules, creating a smart contract, and the funding process, the next step is deployment. Immediately after the deployment of a DAO, it becomes independent of its creator and goes on fully autonomous mode.
All DAOs are open source, which means, after deployment anyone can see the code behind the DAO. All the financial transactions and rules are recorded using blockchain technology.
As an Ethereum blockchain records all the financial transactions, it makes a DAO fully transparent and incorruptible.
You also need to understand that DAO also has some limitations. For example, it can’t write a code on its own, develop hardware or build a product. This is where contractors come in, as to achieve these tasks, DAO hires contracts based on the voting process.
How Does a Decentralized Autonomous Organization (DAO) Spends it Funds?
Remember the funding process we discussed above? We have already mentioned that when someone invests in a DAO, he buys a right to vote about how a DAO must work.
Similarly, the same investors with voting rights made a decision about spending funds by reaching a consensus. This mean, whatever direction gets the most votes, the DAO takes that direction.
The investors also have a right to come up with a proposal, but that often results in proposal spamming in the past that overburdens the network. To prevent that, an investor also has to deposit some amount of funds before putting up a proposal for voting.
As soon as a proposal comes forward from any of the stakeholder or investor, other investors can vote on that proposal. To reach a consensus on performing any action, a majority must favor that action. Also, a DAO code can also already have an embedded majority percentage, so it varies for each DAO. It is not necessary that getting 51% vote is the majority unless the code says so.
What Does a DAO Do?
To define DAO in detail, you not only need to understand how does it work, but also, what does it do.
In simple words, it allows the investors or stakeholders to exchange their funds with anyone without any intermediary, which means, no involvement of financial institutions like banks. This mean people can make investments, borrow, or raise money for any task using a DAO.
Becoming Part of DAO: How to Become a Stakeholder in DAO?
If you have already invested in cryptocurrencies, and have a wallet already, investing in a DAO is easy. All you need to do is to buy tokens of a particular DAO that you have an interest in.
The process is simple and straightforward, which is equivalent to buying shares of a company. You can do this during the funding phase. The more tokens you buy, the more influence you can have during the voting process.
It is simple, the more you invest, the more influence you have on how DAO works, and more chances of you making profits.
However, here is a recommendation. Make sure to look into the open-source code to make sure the code of smart contract is bug-free.
The Case of the First DAO: The DAO
I recommend you to invest in DAOs after a thorough inspection of its code because the start of the DAOs was not that promising.
In the beginning, when the first Ethereum DAO for venture capital funding by the name of The DAO was launched back in 2016, with an initial investment of USD 150 million, it was immediately hacked due to bugs in the code.
Actually, it was the first Ethereum DAO. It was hacked using the recursive Ethereum send exploit. It immediately faced a multi-stage hack due to the loophole in smart-contract.
Even though it resulted in the highest ever crowdfunding campaign, but experts immediately identified the issues with the code.
The hackers drained USD 50 million immediately. However, the financial loss was reversed in the following few weeks. Still, it was a prime example of hackers taking advantage of code bugs.
This brings us to the next important question, is DAO really safe for investment?
Is DAO Secure?
The simple answer to the question is, Yes, it is. But only if the initial code is flawless and does not provide any loopholes for hackers to exploit.
As no one can change the code of a DAO after its deployment on the Ethereum blockchain, no one can change the rules. Someone can change the smart contract rule only when the majority votes to hire someone to alter code.
This makes it pretty secure as no one person has an authority to change the DAO process to their advantage. This is often the case with traditional companies you may have shares of. With decisions centered within top management, these organizations are usually more prone to corrupt practices due to lack of transparency. However, this is not the case with a DAO.
Although DAOs are comparatively secure and safer for investments, there is one issue with DAO security. As I have already mentioned, you can’t change code once you deploy a DAO. The limitation is counterproductive if there is a bug in the code. You can’t get it fixed in time, and hackers can take advantage of the issue.
This is why it is important to only invest after making sure the code is bug-free.
What is the Legal Status of DAO?
Unlike a traditional organization, there is no legal status so far for the Decentralized Autonomous Organizations. In simple words, there is no decision on the legal status on the DAOs by lawmakers for now.
The lawmakers use a term “general partnership” for DAOs and their investors. This puts every stakeholder or investor or someone who owns the tokens for that particular DAO liable for any debts or legal actions that the DAO faces.
Therefore, there are two drawbacks to DAO so far. You cannot define DAO without looking into the other side of the picture, do you? Here is a small list of problems that you can face with DAO or while investing in the DAOs.
- Ambiguity in the legal status
- Unable to change the code in time if there is a loophole
You can learn more about the updates on the legal status of DOA on Ethereum Forum.
Other than that, DAOs are the perfect new world solution and offer a futuristic concept of leaderless organizations that are more effective as they are autonomous and decentralized.
DAO or Decentralized Autonomous Organizations are future and ready to replace many traditional organizations. The current evolved structure of DAOs can easily replace the functions of many current companies. For example, Uber, Amazon, Dropbox, and many others.
The DAOs offer a perfect solution to get rid of human managers and other human resources that often drains unnecessary finances. According to Mike Hearn, a well-known Bitcoin contributor, DAOs will power all the organizations in the world within the next 30 years.
We recommend reading our previous blog post about smart contracts if you still don’t know what smart contracts are.
Similarly, Vitalik Buterin, the creator of Ethereum, also finds the concept very promising. According to him, DAOs offer a perfect opportunity for traditional organizations to get rid of intermediaries that cost them up to 30% of the operational costs.
All in all, some of you may have a different opinion, but for me, and many more experts around the world, DAO without a doubt is the business model of the future. It is just the beginning of the future that we will see soon.