Apologies if you’ve had it up to here with random crypto abbreviations, but after NFT blew up last year the time is now for DAO. To make things easier for all of you, OMR has put together a DAO primer to break down the triumvirate arcanum, with broad strokes and deeper nuances on what it can do, what the risks are and everything else about DAO.
Let’s start with a hypothetical. Imagine you ran a young, plucky up-and-coming IT enterprise with a team located around the world. Growth is steady and you’re bullish about the future. One day, hackers attack and make off with 16 million dollars—half of company assets. Undeterred, you and your crack team of IT specialists located the culprit—an 18-year-old Canuck in college. And he files a lawsuit against you. He wants to keep his stolen bounty—and claims that your company bylaws of all things entitle him to just that.
That exact scenario played last month for DeFi protocol Indexed Finance. Indexed Finance claims it was robbed, while the hacker argues he “executed a fully legal arbitrage trade” due to the “nature of Indexed’s DAO structure. DAO stands for “decentralized autonomous organization,” a new way of structuring a company using computer code based on blockchain technology. The unwritten rule or unofficial ethos at the heart of a DAO is “code is law.” The thinking here is that if there is an available exploit or mistake in the code, then hackers are within their rights to take full advantage. At least they are according to the 18-year-old Canadian, who intends to see if “code is law” holds up in court. The only reason any of this is possible is the fact that DAOs are not legal entities. Indexed Finance is, of course, of another opinion. As interesting and potentially groundbreaking as that all is, we’re focussing on DAOs, why a company would choose to set itself upon a code, and what the benefits and risks are for entrepreneurs.
The dawn of DAOs
DAOs can be traced back to two German entrepreneurs Christoph and Simon Jentzsch, who founded The DAO, an investment company, in 2016. The idea was to create a community, which collects cryptocurrency Ether and to decide jointly in which crypto projects The Dao invests. Itself conceived as a crypto project, The DAO had no physical location, no one in charge and no hierarchy. There was just a code saved to the Ethereum blockchain. The Dao was off to a flying start, until it fell victim to a hack—just like Indexed Finance last month. While DAOs’ reputation took a major hit, new DAO projects kept popping up, some of which achieved some degree of acclaim outside of the crypto scene.
The DAO of now
For the most part, DAOs today are a new kind of company structure for crypto projects that employ blockchain technologies. They are open-source blockchain protocols, which, at their most basic, are a community of people who all contribute to writing the public code, whose datasets, for example, financial transactions, are saved to blockchains, like Ethereum. Embedded in this code are sets of rules, so-called smart contracts. Once set, the DAO runs independently of individual members. Smart contracts replace framework agreements that define the scope of work in standard employment relationships, including contracts and salary processing. Just like standard companies, DAOs are split into sectors, e.g. credit platforms, software companies and, as is the case with Indexed Finance, portfolio management entities for investing in crypto projects.
How many DAOs are there?
According to industry publication beincrypto, there are some 700,000 DAO members and token holders in the crypto space. That may not sound like all that many, but they are gaining in significance, especially in the financial sector. According to German financial publication Handelsblatt, the ten most-valuable DAO projects, including crypto lending platform MakerDAO and crypto exchange Uniswap, total over USD 30b. Check out daodir here for a directory of DAO projects.
What’s so special about DAOs?
The core pillars of DAOs are decentralization, autonomy and transparency. Decentralized stands for a lack of a central authority, like a CEO or a government, tasked with creating and enforcing regulations. A DAO’s fundamental rules are drafted and set by founding members when the project launches and cannot be modified further without member consensus. In fact, business decisions in general are made by the DAO communities. For example, they can decide which computer programers may help write code or which companies the DAO partners with. Once the code is finished, the blockchain protocol runs independently of its members. It executes and steers all of the core company processes automatically without any individual members able to influence any of the processes. Since the blockchains are open-source, DAOs are held to be very transparent.
How can I join a DAOs ?
Most DAO projects distribute tokenized voting rights. That’s another way of saying you can purchase your way into a project with cryptocurrencies. To join the world’s largest DAO organization MakerDAO, you can buy DAI tokens. One DAI costs about USD 1. DAOs, like MakerDAO, use the so-called proof-of-stake model for decisions. Basically, the more of a project’s cryptocurrency you own, the more weight your voice has on decisions.
DAO pioneers, like Wouter Kampmann, who is invested in MakerDAO, are major proponents of the open and flat structure. “Anyone can join and participate. The protocol is open to all and everyone can make suggestions in the company forums,” Kampmann told German trade publication Handelsblatt. Others see smart contracts and decentralized authority as a chance to place limits on bureaucracy. The code, for example, automatically pays salaries, instead of the accounting department—in the corresponding cryptocurrency of course. Kampmann goes as far as seeing a chance to restructure governments and societies. Kampmann says that the technologies lying at the heart of DAOs can shift the democratic process back into the hands of the people.
How do DAO operators make money?
In a DAO organization like MakerDAO coders earn money, which comes from fees that are levied on investors. According to Handelsblatt, roughly 40 people live off of MakerDAO, some of whom earn up to USD 1.5m each year. This income stems from the first round of financing that begins as soon as the company code has been completed. It’s not until that round of financing is complete and a sufficient number of investors have joined that the DAO is considered to be an autonomous system. Investors can also earn money from DAOs, should they, for instance, invest early in a token that increases in value. MakerDAO, for example, has a current market capitalization of approximately USD 6b.
Are DAOs risky?
The biggest risk facing DAOs is depicted in the aforementioned projects The DAO and Indexed Finance. If there are vulnerabilities embedded in the code, they cannot be fixed until a vote has been conducted with all of the organization’s members. That slow process coupled with the open-source code means hackers can inflict significant damage should they find an exploit—which can cause millions in losses for investors. Furthermore, there is no unified legal framework for DAOs. A lack of a physical location means there is no legal place of jurisdiction. This is further exacerbated by the fact that the majority of lawmakers and tax officers do not know enough about DAO structures. The proof-of-stake model has also been criticized as by selling voting rights there is nothing protecting DAOs from deep-pocketed organizations buying influence.
Where will DAOs go from here?
While it’s highly unlikely that we will all be plying our trade in a DAO anytime soon, they don’t appear likely to go anywhere either. Just like NFTs, DAOs are another creation of crypto developers that is slowly creeping its way into the mainstream.