Decentralized Autonomous Organizations (DAOs) have been a controversial issue in the world of blockchain and cryptocurrency for a while now.
From their early days as seen in the case of Slock.it, the German startup that created the DAO, to its current iterations, DAOs have the potential to make or break the crypto and decentralized finance (DeFi) industry, and education will be the deciding factor.
If anything recent developments should go through, a misunderstanding of the true nature of the technology behind most DeFi projects could be a contributing factor to the lack of regulatory clarity. Recent dialogue between MakerDAO representatives and Senator Elizabeth Warren proves that regulators do not have a solid understanding of the DeFi space or how DAOs work.
In the conversations, not only did the senator show his disinterest in the organization, but one delegate claimed that a lot of time was spent convincing the anti-crypto senator that MakerDAO and the defunct 2016 DAO were different entities.
US Senator Warren, an outspoken crypto skeptic, also voiced concerns about the fast-growing stablecoin market, suggesting a ban on US banks holding reserves that support stablecoins.
Could a lack of understanding of how DAOs, such as MakerDAO, operate, is a contributing factor to how regulators perceive the sector? In this article, we look at the different DAOs being developed in the DeFi space and how they serve their purpose, and provide a primer to help you gain a better understanding.
So, what is a DAO?
Simply put, a decentralized autonomous organization is a concept of a blockchain entity built and collectively owned by its members. For governance, these entities will rely on decision-making protocols embedded in smart contracts rather than traditional organizations using centralized command systems.
Since smart contracts are impersonal, an organization can be governed by a horizontal structure without a well-established hierarchy. DAO members can decide to own a consolidated treasury bond that comes with restricted access to approved members who fit pre-set conditions.
Without a central governing body, DAO members can submit proposals and collectively decide on proposals to be implemented through the voting system. Smart contracts can assist throughout the voting process and automatically implement changes based on votes.
What makes DAOs different?
In essence, the DAO was created to address the perennial principal agent dilemma.
This problem is a common challenge that occurs when an agent (central entity or individual) gets into a situation where they have to make decisions that meet the divergent goals, priorities, and needs of the (main) group without compromising their own interests.
While this dilemma is pervasive among public and private entities worldwide, DAOs aim to eliminate this challenge by replacing centralized decision-making hierarchies with an unreliable system built on independent smart contracts.
Smart contracts can be programmed so that the incentives of all group members are aligned in a codified format embedded in the blockchain.
With a properly implemented DAO, all stakeholders in the organization will be able to participate in the governance and decision-making of the group.
How does DAO work?
Although the underlying mechanisms of DAOs differ from platform to platform, the general formula is one in which a series of smart contracts are deployed. These smart contracts can be programmed to allow for future changes should an incentive program be needed to help the DAO grow and expand into new functions.
A DAO can be created for practically anything from a network of freelancers to a charitable organization to a political government. Smart contracts make or break a DAO, as they facilitate transparency and enable the organization to operate independently without intermediaries.
After the smart contracts are fully created, tested and deployed, the DAO needs funding to incentivize members to run and maintain the organization. Most DAOs will use a token that grants holders voting rights as well as rewards for participating in platform maintenance. Through audited smart contracts and a suite of funding procedures, the DAO can launch and control its own future by the organization’s members.
Real-world examples of DAOs
There are many examples of DAOs that exist today. Technically, Bitcoin can be considered an early version of the DAO, as its network grows via community agreements between miners and node operators – as well as the lack of a central administrative entity.
Bitcoin
The Bitcoin network can be considered the first example of a DAO. It is managed by a network of participants (miners and contract operators) who coordinate their activities for the benefit of the entire organization as well as their own interests. However, it lacks a complex governance mechanism, which has become a typical feature of all DAOs, and by today’s standards, it would not really be considered a DAO.
dash
The Dash crypto project can be considered the first real attempt at DAO. It is the first known DAO, at least by today’s standards, whose governance mechanism allows stakeholders to vote on how the treasury is used.
Dash was first launched in 2015 and operates on a network of 5,000 master nodes distributed all over the world. The Dash Blockchain started as a Bitcoin fork, but has since evolved into a privacy-focused cryptocurrency.
DAO
The DAO, a decentralized autonomous organization that is not currently on Ethereum, is designed to operate as a decentralized venture capital fund for decentralized applications (DApp). DAO is developed as an open source platform by Slock.it, a German-based startup. During its launch, DAO was able to fund 12.7 million Ethers (ETH), worth about $150 million at the time.
The idea was to have DApp developers put their ideas to the community and receive funding if approved. Although DAO was one of the most heavily funded crypto projects to date, hackers were able to exploit a bug in his smart contract less than three months after its launch. It is important to note that the error or error in the smart contract was not in the Ethereum blockchain but the application developed by Slock.it and published on the Ethereum network.
As a result of the incident, the Ethereum community chose hard forks to offset the attack, while dissenting voices maintained the old chain that is now Ethereum Classic.
MakerDAO
Similar to the DAO, MakerDAO is a decentralized organization built on the Ethereum blockchain.
The project, a DeFi lending protocol operated by the Maker Foundation, was first introduced in 2015. The project’s multi-secure Dai stablecoin was launched in November 2019.
According to the Maker Foundation, the constant value of Dai makes it a useful digital asset for issuing loans and hedging against cryptocurrency volatility. However, Dai differs from other stablecoins in that its value is quietly pegged to the US dollar. This means that no central entity with dollar reserves supports Dai tokens. Dai uses collateral in the form of Ethereum-based assets locked into smart contracts on the MakerDAO platform.
With each Dai token generated, the value of the Ethereum-based assets locked into smart contracts must exceed the value of Dai issued to borrowers. This makes it possible for anyone to lock in more volatile assets and receive Dai, which is a more stable asset.
Uniswap
Uniswap is one of the latest successful DAOs in the DeFi space. After the successful launch of the decentralized automated market making protocol in 2018, the team moved to launch a governance token that would transform Uniswap into a decentralized community governed by its users. Now, Uniswap users can not only provide liquidity to the decentralized exchange, but also submit governance proposals to the platform.
Dangers of DAOs
DAOs are a new organizational structure that challenges traditional organizations, thus attracting many regulatory, operational and legal challenges.
For example, because DAO members can be distributed across different jurisdictions, legal issues related to handling contractual agreements and cross-border relationships can be quite challenging. Moreover, since DAOs are governed by the help of smart contracts, achieving consensus from DAO stakeholders can be a waste of time.
Also, malicious actors can exploit potential vulnerabilities in smart contract code to threaten the security and functionality of the DAO as was the case with DAO in 2016.
next trip
While the principles behind DAOs are designed to enable optimal and fully decentralized organizational structures, the underlying technology on which DAOs are built is not perfect. Currently, existing DAOs still rely on a certain degree of centralization to make effective decisions especially in the early stages of DAO development.
But despite the nascent stage of DAO’s development, the concept represents a globally changing governance structure that can deliver fairness and transparency across many industries.
When properly implemented, DAOs can also introduce decentralized forms of regulation and legal compliance, thus promoting the spirit of decentralization across multiple areas of society.
