Decentralized Autonomous Organization (DAO)

Decentralized Autonomous Organizations (DAO), sometimes labeled decentralized autonomous corporations (DAC), are organizations represented by rules encoded as a computer program that is transparent, controlled by token holders, and not influenced by a central government. A DAO's financial transaction record and program rules are maintained on a blockchain. The precise legal status of this type of business organization is unclear.^[1]

A well-known example, intended for venture capital funding, was The DAO, which launched with $150 million in crowdfunding in June 2016 and was immediately hacked and drained of US$50 million in cryptocurrency. This hack was reversed in the following weeks, and the money was restored, via a hard fork of the Ethereum blockchain. This bailout was made possible by the Ethereum miners and clients switching to the new fork.^[3]

In July 2017, the Securities and Exchange Commission (SEC) issued a report, which determined that The DAO sold securities in the form of tokens on the Ethereum blockchain, violating portions of US securities law.^[4]

Background

Decentralized autonomous organizations are typified by the use of blockchain technology to provide a secure digital ledger to track financial interactions across the internet, hardened against forgery by trusted timestamping and dissemination of a distributed database.

This approach eliminates the need to involve a mutually acceptable trusted third party in a financial transaction, thus simplifying the transaction. The costs of a blockchain-enabled transaction and the associated data reporting may be substantially offset by the elimination of both the trusted third party and the need for the repetitive recording of contract exchanges in different records.

For example, the blockchain data could, in principle and if regulatory structures permit it, replace public documents such as deeds and titles. In theory, a blockchain approach allows multiple cloud computing users to enter a loosely coupled peer-to-peer smart contract collaboration.^[1]

Daniel Larimer first proposed the concept of a "Decentralized Organized Company" in an article published on September 7, 2013, and implemented in Bitshares in 2014, and EcoinOS in 2018.^[5]

Vitalik Buterin proposed that after a DAO was launched, it might be organized to run without human managerial interactivity, provided the smart contracts were supported by a Turing complete platform. Ethereum, built on a blockchain and launched in 2015, has been described as meeting the Turing threshold, thus enabling such DAOs.

Decentralized autonomous organizations aim to be open platforms where individuals control their identities and their personal data.^[6]

Type of DAOs

Grant DAOs

A Grant DAO, or Grant-making DAO, is a type of DAO that is designed to distribute funds in the form of grants to support various projects, ideas, or individuals within a decentralized ecosystem. These organizations typically operate on blockchain platforms, leveraging smart contracts to automate the grant allocation process. Following are examples of Grant DAOs:

Gitcoin DAO: Gitcoin is a platform that facilitates funding for open-source projects. Its DAO allows contributors to vote on grant proposals, allocating funds to projects that advance the development of the Ethereum ecosystem.
The LAO (Limited Liability Autonomous Organization): While not specifically focused on grants, The LAO is a decentralized venture capital DAO. Members pool funds to invest in blockchain projects and decisions are made collectively through voting.
DAOstack: DAOstack is a platform that enables the creation and management of DAOs. It can be used to set up Grant DAOs with customizable governance structures.

Protocol DAOs

Protocol DAO is a type of DAO that governs the development and maintenance of a specific decentralized protocol. These protocols often underpin blockchain networks, defining the rules, consensus mechanisms, and functionalities of the network. The DAO's purpose is to enable decentralized decision-making and coordination among community members involved in the development and use of the protocol. Following are examples of Protocol DAOs.

Uniswap DAO: Uniswap is a decentralized exchange (DEX) protocol built on Ethereum. The Uniswap DAO oversees the governance of the protocol, allowing token holders to vote on proposals related to the development and upgrades of the Uniswap protocol.
MakerDAO: MakerDAO is a decentralized autonomous organization that governs the Maker Protocol, which issues the stablecoin DAI. MakerDAO token holders participate in governance to make decisions related to collateral types, stability fees, and other parameters.
Aave Governance: Aave is a decentralized lending platform, and its governance involves AAVE token holders who vote on proposals to modify the protocol's parameters, introduce new features, or upgrade the underlying smart contracts.

Social DAOs aim to address social issues, foster community engagement, and support charitable or humanitarian causes. These DAOs operate on blockchain platforms, utilizing smart contracts and governance tokens to enable community members to collectively make decisions about funding, projects, and initiatives with a social impact. Following are examples of Social DAOs.

Giveth: Giveth is a decentralized platform and Social DAO that facilitates transparent giving and supports charitable causes. It enables users to create and fund social projects through the use of smart contracts and governance mechanisms.
Commons Stack: Commons Stack is a project that focuses on building tools and infrastructure for the creation of Decentralized Autonomous Commons. These DAOs are designed to support and sustain open-source and community-driven initiatives.
DAO Incubator: While not exclusively focused on social causes, DAO Incubator supports the creation and development of DAOs, including those with a social impact. It provides mentorship, resources, and connections to help emerging DAOs thrive.

Benefits of a DAO

A DAO's main advantage is its decentralization, an essential characteristic. According to their basic design principles, DAOs aim to achieve the maximum level of decentralization. The concept of complete decentralization generally loses value in other endeavors. Decentralized organizations have the advantage of allowing members to decide the future of the organization. ^[8]

DAOs, or Decentralized Autonomous Organizations, offer communities around the world the opportunity to connect and work together on a promising future of the organization.

A sense of ownership is another characteristic of decentralized autonomous organizations. This can encourage members to innovate and establish new standards for receiving compensation in exchange for participation as a result.

Each member of a DAO has the power to influence the organization's future. All stakeholders of a DAO can provide proposals for protocol updates and improvements. DAOs don't limit decision-making to the C-level boardrooms which is a crucial benefit of a DAO. Thus, DAOs can provide innovative ideas to the organization by encouraging stakeholders and numerous participants from all over the world. ^[7]

How does a DAO work?

A DAO is an organization where decisions are made from the bottom up; a collective of members owns the organization. There are many ways to take part in a DAO, it is usually through the ownership of a token.^[4]

DAOs operate using smart contracts, which are bits of code that execute automatically whenever some criteria are met. Smart contracts are released on numerous blockchains nowadays, but Ethereum was the first to use them.^[4]

These smart contracts establish the DAO’s rules. Individuals with a stake in a DAO get voting rights and influence how the organization operates by deciding on or creating new governance proposals.^[3]

This method helps prevent DAOs from being spammed with proposals: A proposal will only pass if a majority of stakeholders approve it. How that majority is determined varies from DAO to DAO.^[2]

DAOs are fully autonomous and nonambiguous. As they are built on open-source blockchains, anyone can view their code.^[2]

Launching a DAO

Smart contract creation: Firstly, a developer or group of developers will have to create the smart contract behind the DAO. After launch, they can't change the rules set by these contracts, unless through the governance system.
Funding: After the creation of the smart contracts, the DAO needs to determine a way to receive funding and how to enact governance. Most of the time, tokens are sold to raise funds; these tokens give holders voting rights.
Deployment: Once everything has been set up, the DAO will then be deployed on the blockchain. From here on out, stakeholders decide on the future of the organization. The organization’s creators will no longer influence the project any more than other stakeholders.

Use Cases of DAO

Managing protocols and products: DAOs can be used to manage protocols and products. For example, a DAO could be used to manage a decentralized exchange (DEX). The DAO would be responsible for managing the protocol and product development. It would also be responsible for managing the treasury and allocating funds to developers.
Managing funds: DAOs can be used to manage funds. For example, a DAO could be used to manage a decentralized hedge fund. The DAO would be responsible for managing the fund's investments and allocating funds to investors.
Managing organizations: DAOs can be used to manage organizations. For example, a DAO could be used to manage a decentralized company. The DAO would be responsible for managing the company's operations and allocating funds to employees.
Managing communities: DAOs can be used to manage communities. For example, a DAO could be used to manage a decentralized social network. The DAO would be responsible for managing the network's operations and allocating funds to users.
Raising money for charitable causes: DAOs can be used to raise money for charitable causes. For example, a DAO could be used to raise money for a charity. The DAO would be responsible for managing the charity's operations and allocating funds to charitable causes.

Issues

Shareholder participation in DAOs can be problematic. For example, BitShares has seen a lack of voting participation, because it takes time and energy to consider proposals.

Legal liability

The precise legal status of this type of business organization is unclear; some similar approaches have been regarded by the U.S. Securities and Exchange Commission as illegal offers of unregistered securities. Although unclear, a DAO may functionally be a corporation without legal status as a corporation: a general partnership. This means potentially unlimited legal liability for participants, even if the smart contract code or the DAO's promoters say otherwise. Known participants, or those at the interface between a DAO and regulated financial systems, may be targets for regulatory enforcement or civil actions.^[5]

One approach is to seek legal recognition for DAOs as a new type of entity, specifically designed for decentralized structures. This would require legislative action and could involve creating a regulatory sandbox where DAOs can operate under provisional rules until a more permanent legal framework is established.^[10]

Security

The code of a given DAO will be difficult to alter once the system is up and running, including bug fixes that would be otherwise trivial in centralized code. Corrections for a DAO would require writing new code and an agreement to migrate all the funds. Although the code is visible to all, it is hard to repair, thus leaving known security holes open to exploitation unless a moratorium is called to enable bug fixing.^[6]

In 2016, a specific DAO, "The DAO", set a record for the largest crowdfunding campaign to date. Researchers pointed out multiple issues in the code of The DAO. The operational procedure for The DAO allowed investors to withdraw at will any money that had not yet been committed to a project; the funds could thus deplete quickly. Although safeguards aimed to prevent gaming the voting of shareholders to win investments, there were a "number of security vulnerabilities". These enabled an attempted large withdrawal of funds from The DAO to be initiated in mid-June 2016. On the 20th of July 2016, the Ethereum blockchain was forked to bail out the original contract.^[5]

Organizational Frameworks

There are several projects that are pioneering further tooling and frameworks in this space, to eliminate problems thus far encountered. Examples are DaoStack, Aragon, Colony and the Economic Space Agency.^[2]

Tax

There are commercially focused DAOs. Investment DAOs may see gains or losses in their portfolio. Collector DAOs may see the value of their art or NFT holdings appreciate. DAOs are likely to be treated as business entities for tax purposes, meaning that they may be subject to profits tax. DAO members may also have tax reporting or payment obligations. However, it may be difficult to determine their reportable income. DAO members may also be subject to tax if they engage in taxable transactions such as staking, lending or mining, and other types of disposition of tokens.^[9]

Major DAO projects

As of January 2023, the total number of DAOs in existence reached 10992, which was three times the number recorded in 2022. And well over 13,000 DAOs in existence in May 2024 with a total treasury of US$24.4 billion. This includes 10.4 million token holders and 3.2 million active voters and proposal makers. Following are some of the major DAO projects.^[11]

Uniswap: Uniswap is one of the most popular decentralized trading protocols that is best known for enabling the automation process of trading decentralized fiance (Defi) tokens. Soon after its creation, it became a DAO. Individuals who hold the native UNI token can vote on decisions regarding the treasury, governance, and road map. Any proposal put forward by a member of the community must gain at least 25,000 yes-votes to be considered. The individual must put forward their proposals and reach 50,000 in yes-votes for their proposal to be approved – this is the consensus check. Finally, the governance phase has to attract 40 million yes-votes to be adopted.^[12]

Compound: Compound is a DeFi protocol that allows the community to deposit their crypto assets into different pools supported by the platform to earn interest. Holding the compound governance token, COMP, allows holders to delegate voting rights to individuals of their choice. In theory, an individual does not need to hold this ERC-20 token to obtain voting rights in the DAO.^[13]

Decentraland: Decentraland is an immersive 3D virtual world browser-based game, where players can acquire digital assets such as land using the in-game currency, MANA. These virtual assets are bought as Non-Fungible Tokens (NFTs) using the Ethereum blockchain. The DAO governs key components of this virtual world including MANA, NAMES, LAND, and Estate smart contracts. The community holds the power to issue grants and make changes to the list of banned names, Proof of Importance (POIs), and catalyst nodes. ^[14]

ApeCoin: ApeCoin is an ERC-20 used for governance and utility purposes in the APE Ecosystem. It grants access to ApeCoin DAO, which makes decisions on fund allocations, governance rules, partnerships, and other ecosystem-related matters. All ERC-20 token holders can participate in the DAO, with voting power increasing based on the amount of ApeCoin held. ^[15]

Maker: The Maker Protocol is a decentralized project on the Ethereum blockchain and gives users the ability to generate DAI, a stablecoin issued by MakerDAO, by leveraging collateral assets approved by the DAO. Such assets include Ethereum (ETH), 0x (ZRX), and Chainlink (LINK). Users are required to hold the native token, MKR, to govern the MakerDAO which grants voting rights on issues such as managing and stabilizing the financial risks of DAI. The voting power is linearly proportional, dependent on the number of stakes in the voting contract, DSChief.^[16]

Illuvium: Illuvium is a decentralized open-world fantasy battle game that runs on the Ethereum blockchain. The Illuvium DOA consists of more than 150 contributors and thousands of token holders who are responsible for governing and maintaining the protocol. To participate in governance, users must hold ILV tokens which give them the power to vote on proposals, such as rules and game mechanics, and elect council members. The DAO has implemented a quadratic voting system, which reduces the voting power of large ILV holders and helps to prevent the dominance of wealthy players.
Lido Finance: Lido is a liquid staking protocol with an emphasis on safety and security, supporting both layer-one and layer-two cryptos that use the Proof of Stake (PoS) consensus mechanism. The organization provides a solution to the liquidity problem faced by other PoS'. The Lido DAO influences key components of the liquid staking protocols by holding votes. Like most DAOs, the voting power is linearly proportional meaning the more an individual holds in LDO — the native token — the greater the decision-making power the voter gets.^[17]

Curve: Curve is a decentralized exchange dedicated to stable coins and uses an Automatic Market Maker (AMM) to control liquidity. AMM uses algorithmic bots to facilitate the buying and selling of crypto assets. The Curve platform allows users to exchange tokens at low slippage rates. Holders of the CRV token govern the Curve DAO. This community of stakeholders manages the protocol by voting on decisions regarding changes to the algorithm, the addition of new stablecoins, changes to fee structure, and other matters of the protocol. One of the Curve DAO’s unique characteristics is that it features a gauge system to encourage liquidity providers to supply specific stablecoins to the protocol – this ensures enough liquidity is available for trading and reduces slippage.^[18]

Aave: Aave is a fully decentralized lending platform where individuals can lend, borrow and earn interest on their crypto assets while eliminating third parties. The DAO is governed by the token AAVE. Token holders are able to discuss, propose, and vote on upgrades to the protocol. Token holders can choose between voting themselves or delegating their vote to an address of their choice.^[19]

BrainDAO: BrainDAO is the governing DAO of the IQ ecosystem. BrainDAO's mission is to build a more intelligent future through the IQ token, which powers a knowledge ecosystem including applications such as IQ GPT, an AI agent for blockchain knowledge, IQ.wiki, the world's largest cryptocurrency and blockchain encyclopedia, IQ.social, an AI-powered social forum for crypto news and insights, and IQ Code, an upcoming AI product created to assist people in coding Solidity and Vyper sets. The DAO is collectively made up of all IQ token stakers and governs the token. ^[21]

The BrainDAO treasury portfolio of Ethereum, IQ tokens, stablecoins, blue chip NFTs, and other digital assets back the value of the IQ token. ^[20]