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 of 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 that Turing threshold, thus enabling such DAOs.

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

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 for influencing the organization's future. All stakeholders of a DAO are able to 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 having encouraged 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 have an influence on 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.

Issues

Social

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]

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 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]