What Is a Decentralized Autonomous Organization (DAO)?

• Decentralized autonomous organizations (DAOs) are non-hierarchical, community-led organizations that can gather for a number of reasons.
• Most DAOs are joined by buying the DAO’s governance token, which allows them to vote on actions the DAO will take.
• Believers in DAOs say that it will be essential to web3 while skeptics point out its potential to exacerbate inequality.

The underlying philosophy driving decentralized autonomous organizations (DAOs) is that our current democracy isn’t working. So DAOs give their members a way to directly participate in the development of the DAO. As a key building block in the web3 ecosystem, DAOs come with many promises and just as many criticisms. 

What is a DAO?

We can break the term DAO (decentralized autonomous organization) into its individual letters. As a decentralized organization, a DAO is community-led. In theory, there would be no central, hierarchical structure within a DAO. 

As an autonomous organization, DAOs operate on an open-source blockchain protocol. They’re powered by cryptocurrencies called governance tokens, which act like membership cards. These tokens also play a role in the upkeep and maintenance of these organizations, which we’ll focus on in a moment.

You can think of a DAO — as it exists currently — as a medium for people with similar interests to congregate without central leadership. The function of a DAO depends on the community. The purpose of most current DAOs revolves around investments or socialization. 

However, like many aspects of decentralized finance, much of the emphasis on DAOs is placed on what it could be in the future. So for many advocates, that “could be” is a rethinking of democracy as we know it. 

“This form of representative democracy that we’re in is not functioning adequately for the types of challenges that humanity is facing today,” says Rebecca Rachmany, the founder of DAO Leadership. “I want to say the inspiration behind DAOs is perhaps how we could invent new forms of governance, and new forms of democracy that would be appropriate for governing the things that belong to all of us, like the oceans, the planet, and the health of the planet.”

DAOs vs. traditional governance

The main difference between DAOs and traditional governance is where the decision-making occurs and who gets to make those decisions. 

How does a DAO work?

The specifics of how a DAO operates vary with each organization, but generally, in order to participate in a DAO, you need to own the DAO’s governance token. These tokens allow you to participate in the governance of the DAO, which comes in the form of member-submitted proposals.

Proposals can concern any number of things. Some proposals pertain to actions that the DAO will take like deciding which NFT a DAO should buy or selecting a venue to host a party. Others can address the function of the DAO itself, such as changes in the DAO’s code and protocol. 

With smaller DAOs, the process for creating a proposal can be relatively simple. But as a DAO grows and more members join, the number of proposals that the community is faced with can get overwhelming. “Voter fatigue is a huge problem,” Rachmany says. She says that some DAOs are lucky to get 10% of their members to vote. 

To avoid too many proposals, larger DAOs will require members to stake governance tokens to submit a proposal or charge an entry fee. If a proposal requires members to stake tokens, the proposal’s creator will put effort into ensuring that the proposal passes. 

Once someone has put forth a proposal, the community will vote on it. The number of votes a member has will be proportional to how many governance tokens they own. If a proposal is passed, it will be executed automatically through a smart contract. 

Types of DAOs

DAOs are formed for a multitude of reasons, often — but not necessarily — for monetary gain. Here are some ways that DAOs are currently used.

Protocol DAOs: One of the primary uses for DAOs right now, protocol DAOs govern decentralized protocols. For example, MakerDAO maintains the stablecoin Dai’s peg to the dollar. 

Collector DAOs: The purpose of a collector DAO is to acquire NFTs. Members of a DAO will pool their money and buy the NFTs chosen by the members of the DAO. PleasrDAO might be the most high-profile collector DAO, purchasing Wu-Tang Clan’s album “Once Upon a Time in Shaolin” in 2021 at a government auction.

Another Collector DAO named ConstitutionDAO attempted to buy a copy of the US Constitution at an auction, raising $47 million in Ether to do so. 

Social DAOs: Most DAOs have some kind of social aspect to them, but social DAOs are purely created with the explicit purpose of gathering people with similar interests. 

Since most DAOs require ownership of governance tokens, the social DAOs can start looking like a country club. For example, Friends with Benefits requires full members to buy 75 FWB tokens. Famously, the Bored Ape NFT collection grants owners access to the Bored Ape Yacht Club discord channel and members-only events. 

Investment DAOs: Also called venture DAOs, members of investment DAOs pool their money and vote on how and where to invest it using governance tokens. Profits and losses are shared by all members proportional to their stake. 

Philanthropy DAOs: These DAOs gather funds and collectively decide which organizations to donate them to, acting as a community-led charity. These operate similarly to grant DAOs, which choose DeFi projects to support.

Criticisms of DAOs

Like DeFi and blockchain technology, DAOs come with their criticisms. One of the most prominent criticisms is that if votes can be bought, then all the power within a DAO goes to the wealthiest members in the community and this supposedly non-hierarchical structure falls apart.

Even without exacerbating inequality, DAO proposals don’t always pass with the DAO’s best interest in mind. Rachmany says that proposals often become popularity contests, with voting results based on the person behind the proposal as opposed to the proposal itself. A DAO called Cordana got around this issue by appointing a Council of Experts that evaluates proposals on a five-star system. Yet appointing a board that evaluates each proposal then defeats the purpose of a decentralized organization.

As mentioned earlier, a DAO’s code is open-source which means that anyone can view it. This opens them up to bad actors who might exploit weaknesses in a DAO’s code. This is exactly what happened in 2016 when a DAO named The DAO was hacked. The hackers stole $11 billion in ether, forcing the cryptocurrency to fork. The old hacked ethereum is now sold as ethereum classic (ETC) while ethereum (ETH) is the newly forked, unhacked ethereum.

The future of DAOs

Supposedly, DAOs are supposed to take a major role in the web3 ecosystem. To understand this relationship between DAOs and web3, we can look back at the history of the web. In web 1.0, web pages were static and users couldn’t interact with the content. It’s also known as the read-only web. In web 2.0, users can read and write, interacting with content instead of just consuming it. This is the version of the web we know today. The newest iteration of the web, web3, includes reading, writing, and ownership. “This is really where DAOs come in, by having an organizational construct to align people around a common purpose,” says Rene Reinsberg, the co-founder of Celo, a financial tools development company. The governance token model theoretically allows for users to own a piece of the company they’re interacting with.