Introduction to DAO

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Each of us in our careers has faced such a problem when the boss does not hear you and it is almost impossible to get through to him in some matters. This is a fairly common problem in the workflow. Therefore, a new type of organization, decentralized autonomous organization - DAO, changes this relationship with a flatter governance structure and a set of rules automatically applied in the blockchain. Decentralized Autonomous Organizations (DAOs) allow everyone to participate in discussions, thereby increasing the efficiency of the team and the effectiveness of the project itself. So, let's understand what DAO is, why it is needed, what real examples of this type of organization exist, and much more. Let's get started.


What is a DAO?

DAO is a decentralized autonomous organization in the blockchain, which is controlled by program code and does not depend on the human factor in any way.

The main feature of the DAO is that it does not have a central node - the “boss”, which manages the entire system without coordination with other participants. In other words, there is no hierarchical structure in decentralized autonomous organizations, and all ecosystem participants have the same rights and can vote for changes in the protocol on an equal basis with other participants, control is distributed among team members, and not concentrated around one authoritative person. In addition, the DAO uses smart contracts and governance tokens to enable participants to make consensus decisions about the allocation of the organization's resources. In the absence of the need for human intervention or centralized coordination, DAOs are often referred to as trustless systems.

History of DAO

The starting point for the emergence of decentralized autonomous organizations can be considered the emergence of Ethereum, the first blockchain platform in which the logic of smart contracts was implemented. Smart contracts made it possible to create autonomous systems controlled by a program, and not by a person, which eliminates the possibility of data manipulation, thus there is no dependence on the human factor.

Thanks to smart contracts, it has become possible to create various decentralized systems that allow users to perform transactions without the participation of intermediaries. These include DeFi protocols, decentralized exchanges (DEXes), applications (DApps), and autonomous organizations (DAOs).

The DAO protocol, launched in 2016, became the first platform that embodied the principles of decentralized autonomous organization. However, in the same year, hackers found a vulnerability in the service’s smart contract and withdrew approximately 3.6 million Ethereum coins from it, which at that time was about $60 million.

This incident led to a hard fork (a hard fork is a fundamental change in the operation of algorithms and the code itself) in the Ethereum network and the emergence of a new branch in the form of Ethereum Classic. The hard fork was necessary to eliminate the vulnerability and restore the funds of Ethereum coin holders. The “new” blockchain that arose as a result of the hard fork retained the name Ethereum, while the “old” one was named Ethereum Classic. After the separation, the networks began to function as separate ecosystems with their own blockchains, and users became owners of coins in both networks.

Why DAO is needed?

Let's understand how DAOs work. Within the DAO, all decisions are made collectively. That is, any member of the system can propose improvements for the decentralized protocol, and if the rest of the community votes for them, they will be accepted. Developers cannot implement changes without community approval, but only add new code when members have accepted the improvements.

In a decentralized autonomous organization, the role of the manager is played by the program, but it does not make decisions on its own! - this is done by the community, and the program only executes instructions.

Information about all transactions is stored in the blockchain, and any user can always check what is happening on the network. Therefore, DAO is not only decentralized, but also transparent.

In terms of internal architecture and management structure, DAO also differs from traditional companies. Ordinary companies have a multi-level structure. At the top level is leadership, and then there are several sublevels and the lower the level, the less authority. In our case, DAO has a single-level architecture, thereby removing the hierarchical structure.

I want to emphasize that DAO solves the age-old problem that is present in almost every industry and organization - the principal-agent dilemma.

When the system is structured in such a way that one person (the “agent”) has the ability to make decisions on behalf of another person (the “principal”), there is a risk of divergent goals, priorities, or access to important information by the parties involved. This is the principal-agent dilemma, which means that the agent can act in accordance with his own interests, and as practice shows, this problem can lead to disastrous consequences.

Currently this dilemma is common among a wide range of public and private organizations. To solve this dilemma by reducing or bypassing hierarchy or centralized coordination, DAOs are referred to as trustless systems. By ensuring that incentive structures and information flows within an organization are properly coordinated in the code, DAOs play a central role in mitigating typical problems associated with the principal-agent dilemma.

Where do we need DAO?

DAOs come in all shapes and forms.

  1. Crypto projects - are considered DAO if they are managed by decentralized governance, in which token holders can vote on the direction of the project, for example: MakerDAO.
  2. Grant Funding - DAO can be used to automatically award development funds based on established criteria, example: MolochDAO.
  3. Investments - MolochDAO has forked many times to create commercial DAOs that can distribute and transfer shares and other assets between participants, for example: MetaCartel Ventures.
  4. Collectibles - The non-fungible token (NFT) boom has led to the rise of DAO collectors, for example: FlamingoDAO.

The main disadvantages of DAO

One of the main disadvantages of decentralized autonomous organizations is the legal uncertainty that prevents their use. The problem is aggravated by the fact that once the system is implemented in a private or public organization, it will not be possible to establish control over it.

Another disadvantage is the controversial efficiency of the ecosystem. On the one hand, if we are talking about global changes to the DAO, then they outplay a huge bureaucratic system that requires huge investments in both time and finances. But in the case of small changes, a decentralized approach can be not only useless, but also harm the system. According to experts, a hybrid approach to management will be the most effective.

Partial centralization also presents a certain problem. The initial rules are pre-set in the code of the protocol by its creators, and, as a rule, they cannot be changed. But this problem can be solved if initially the contract provides for the possibility of modifying the original rules.

In addition, vote weight is determined by the number of tokens, not users. This plays into the hands of the "whales", who have concentrated most of the funds, to manipulate the platform and take control of it into their own hands.

Despite the high potential of the blockchain in managing systems, it hides many risks associated with the security of the protocol. The infamous case with The DAO platform in 2016 is a clear example of this.

Examples of DAOs

Now, there are a huge number of examples of DAO, but I have identified a few of the most popular organizations.

Ethereum - Ethereum became one of the first fully autonomous platforms. Although ethereum lacks complex mechanisms for platform management and voting, it is its smart contracts that formed the basis of DAO platforms.

MakerDAO - One of the first platforms to launch DAI stablecoins, which are pegged to the price of the dollar, was MakerDAO. Maker is one of the largest DeFi lending protocols. The protocol was originally run by the Maker Foundation, but management later decided to step aside and put the protocol in the hands of the community.

Uniswap - The leading automated market maker (AMM) is the Uniswap platform, which combines the functions of a crypto exchange and a DeFi protocol, allowing users to become liquidity providers. The platform has strong support in the face of a huge community of users.

In addition, Uniswap is based on Ethereum. However, the platform is not actively moving towards decentralization, since to make proposals for improving the protocol, it is necessary to keep at least 1% (10 million UNI) of the total supply of tokens. And this is a huge amount, exceeding $ 290 million.

How to run DAO

There are general steps a DAO goes through:

  1. Setting up smart contracts. Basic rules are defined and written in a series of smart contracts. Considering that future changes to DAO workflows, governance, and incentive structures must be voted on to take effect, this phase is an important step towards building a sustainable standalone DAO, as any initial errors or omissions could potentially destabilize the project in the future.
  2. Financing. When smart contracts are ready, DAO needs to get funding to work. DAO smart contracts involve the creation and distribution of some form of internal property, such as a native token that can be spent by the DAO, used in voting mechanisms, or to incentivize certain activities. Further, any person can purchase a DAO token, which is usually equivalent to acquiring the right to vote.
  3. Deployment. Once the DAO receives sufficient funding, further decisions are made by voting. As a result, token holders become stakeholders who make proposals for the future of the DAO and how funds are spent.

Future of DAO

It is quite difficult to say specifically what the future of the DAO will be, but it is worth noting that the popularity and fashion of using such autonomous organizations is only growing and growing every day, thereby acquiring greater scale. Hundreds of developers are working on technical innovations, improvements in control mechanisms and voting decisions.

Quote: “In 2021, The Maker Foundation, an icon of the crypto industry as an original supporter of the DAO, announced that it is officially handing over operations to MakerDAO (the creator of the DAI stablecoin) and will disband by the end of the year.” [1]

In addition, I would like to emphasize that decentralized autonomous organizations have shown themselves actively not only in the above examples, but also in the creative industries. In many cases, these creative DAOs have an element of centralization; for example, while DAO Decentralized Pictures Filmmaking allows token holders to vote on a shortlist of film projects to receive funding, the final decision on which project wins the award rests with a panel of judges.

As for the use of DAO in the public sector, there are a huge number of pros and cons, since DAO has its own positive properties and “pitfalls”. Some will benefit from it, while others won't. The practice of introducing this type of organization into the public sector has not yet been, but soon, many users and analysts consider it real. It is worth noting that the beginning of the process of successfully integrating and using DAO in the state system will most likely take a very long time due to the disagreements of the society.

REFERENCES:

  1. CoinTelegraph - https://cointelegraph.com/ethereum-for-beginners/what-is-a-decentralized-autonomous-organization-and-how-does-a-dao-work
  2. Investopedia - https://www.investopedia.com/tech/what-dao/
  3. Technologyreview.com - https://www.technologyreview.com/2016/05/17/160160/the-autonomous-corporation-called-the-dao-is-not-a-good-way-to-spend- 130-million/
  4. Ethereum.org - https://ethereum.org/en/dao/
  5. Wikipedia.org - https://en.wikipedia.org/wiki/The_DAO_(organization)
  6. Aragon.org - https://aragon.org/dao
  7. Wiki.metagame.wtf - https://wiki.metagame.wtf/docs/great-houses/house-of-daos
  8. Daohaus.substack.com (1) - https://daohaus.substack.com/p/-what-is-a-dao-and-what-is-it-for
  9. Daohaus.substack.com (2) - https://daohaus.substack.com/p/four-and-a-half-steps-to-start-a
  10. Coinmarketcap.com - https://coinmarketcap.com/alexandria/article/what-is-a-dao
  11. Quotes: [1] - Investopedia.com - https://www.investopedia.com/tech/what-dao/

Author: Konstantin

For the original version of this article, please, refer to: SVET Platform

Image: SVET is Light, by Svet and Victor

Date:2 February, 2022

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