As the world of crypto and blockchains continues to mature, many compelling use cases are naturally being put to the test.
One such opportunity which has recently gained traction is the idea of decentralized autonomous organizations, or DAOs. While DAOs show a lot of promise, the approach has both pros and cons like other hierarchies of communication and management.
If you've been wondering what a DAO does, or if building a DAO is the right choice for your specific business goals, we're here to help!
Let's dig in.
What is a DAO?
Despite only recently making a push to become a household name in crypto lexicon, the first DAO was actually created way back in 2016.
Here's how Investopedia explains the origins of the first DAO:
"The [original] DAO was an organization that was designed to be automated and decentralized. It acted as a form of venture capital fund, based on open-source code and without a typical management structure or board of directors.
To be fully decentralized, the DAO was unaffiliated with any particular nation-state, though it made use of the Ethereum network. Why make an organization like the DAO? The developers of the DAO believed they could eliminate human error or manipulation of investor funds by placing decision-making power into the hands of an automated system and a crowdsourced process."
Using the blockchain, DAOs are structured to where anyone who has voting power can vote and help shape the direction of the project or company.
Decentralization and being autonomous are widely believed to be critical components of the Web3 ethos, and as such, DAO's make a compelling case for those looking to build in today's consumer-focused environment.
In theory, DAO's allow for a business or entity to be run by a group of supporters in the truest sense, without any one individual having the final say. Backed into the foundation of DAO's is the introduction of tokens that can be used to vote on various improvements or protocols.
With hundreds of DAOs being created since 2016 and a massive increase in developer education, more and more developers and business builders are considering DAOs for their structure in which to operate.
Benefits of a DAO
There are many benefits that DAO's provide, and one can reasonably expect those benefits to increase over time for specific use cases. As blockchain technology becomes more user friendly, more users will be able to actively participate in DAO's without the current technical knowledge limitations.
Let's take a look at a few of these benefits.
By design, DAOs aim to be as decentralized as possible. While it's difficult to reach 100% decentralization in any endeavor, decentralized autonomous organizations emphasize being driven by the collective rather than any one individual.
Generally, in a publicly-traded company, the CEO and perhaps board ultimately call the shots and users or customers might not have much say.
Take for example, the growing idea that many employees for retail jobs are not making a livable wage. CEOs may say one thing, and the employees may say another. If a retail store was operated in the confines of a DAO, users could vote for what they believe should be fair pay across the board.
With DAOs, participants have a much stronger say in the organization's direction. Although vote power can be weighted in DAOs, power is significantly reduced compared to more traditional businesses in which leadership determines the company's direction.
DAOs Provide "Skin in the game" for Participants
Part of the underlying mechanisms that allow DAOs to thrive is the idea that each participant has some "skin in the game."
For one, DAOs using governance tokens require users to burn or spend their tokens to cast votes, which encourages each vote to be considered thoughtfully. Governance tokens in essence give users the ability to affect the future of the DAO.
Secondly, each vote on the blockchain is public, meaning every time a user votes their reputation is on the line and in full public display. Keeping with the example of employee pay from above, after the vote, it would be clear who wished to keep employee salaries the same, or who was in favor of increasing salaries across the company.
Although not foolproof, this literal and figurative cost encourages thoughtful votes and reduces the spamming of 'bad ideas.'
DAOs also have the added benefit of making it easy for communities worldwide to connect and build a prospering vision together. With an internet connection and governance tokens, virtually anyone can participate in building the future of Web3. Whether that's shaping the future of domains like with ENS or even creating a popular play to earn cryptocurrency, DAOs are accessible to individuals who may have had the opportunity to participate in the past.
Furthermore, like with owning stock in a company, participating in a DAO gives you a sense of ownership, further driving innovation and even financial rewards.
Disadvantages of a DAO
While there are many benefits of a DAO, there are downsides that are important to consider.
Reduced Speed of Decision Making
Particularly, as a DAO scales, getting everyone to vote on proposals in a timely manner can be a challenge. With different time zones and investor priorities, keeping DAO participants up to date and engaged can be challenging.
While there are ways around this, if every decision needs to be voted on by the majority of stakeholders, the extra coordination can be a challenge. Those who choose a DAO as their organization's business vehicle must be well versed in making decisions based on their specific structure. Especially in a fast-paced Web3 environment, speed is critical in long-term success. Sometimes, having leadership make a decision quickly is the best path forward.
The Bikeshed Effect
The community-driven effect of DAOs can be both a blessing and a curse. While DAOs allow for more users to participate in decisions equally, it comes at the cost of what's known as the bikeshed effect.
As the DecisionLab explains, "Bikeshedding, also known as Parkinson’s law of triviality, describes our tendency to devote a disproportionate amount of our time to menial and trivial matters while leaving important matters unattended."
Farnam Street shared an excellent example of it in effect:
The Law of Triviality states that the amount of time spent discussing an issue in an organization is inversely correlated to its actual importance in the scheme of things. Major, complex issues get the least discussion while simple, minor ones get the most discussion.
Parkinson’s Law of Triviality is also known as “bike-shedding,” after the story Parkinson uses to illustrate it. He asks readers to imagine a financial committee meeting to discuss a three-point agenda. The points are as follows:
- A proposal for a £10 million nuclear power plant
- A proposal for a £350 bike shed
- A proposal for a £21 annual coffee budget
What happens? The committee ends up running through the nuclear power plant proposal in little time. It’s too advanced for anyone to really dig into the details, and most of the members don’t know much about the topic in the first place. One member who does is unsure how to explain it to the others. Another member proposes a redesigned proposal, but it seems like such a huge task that the rest of the committee declines to consider it.
Should the DAO discuss implementing a more technical protocol that may generate more revenue at the cost of alienating current users? Or should the color of a logo be updated?
"Bikeshedding can have negative consequences on personal productivity because it causes us to manage time inefficiently," writes DecisionLab.
While no structure is immune to the Bikeshed effect, DAOs are ultimately more susceptible to the downsides of human bias.
Although a DAO can be theoretically launched with a few lines of code, security remains a vulnerability as it requires significant technical expertise to implement. Given the immense tech stack a well-run DAO requires to operate effectively, it can be cumbersome and expensive to keep best security practices implemented. In addition, many participants of DAOs choose to remain anonymous, which creates additional security risks.
While the tools needed to run DAOs continue to improve, without a heavy security foundation, DAOs are at the risk of being exploited or worse. Although multi-signature signing can considerably reduce the risk of misused funds, there's no sure thing, especially in the wild west of crypto.
For example, a user interface exploit helped allow hackers to exploit BadgerDAO for the tune of $120m.
As core contributor Tritium told Decrypt, “It looks like a bunch of users had approvals set for the exploit address allowing [the address] to operate on their vault funds and that was exploited.."
From phishing attempts in Discord to user interface exploits, online threats remain real with so much money on the line. Fortunately, security remains a strong focus for some of the brightest minds building the future of DAOs and will likely improve significantly over a long enough time scale.
The Bright Future of DAOs
Despite the inevitable setbacks that DAOs will face over the upcoming years, dozens of incredible projects and businesses have launched using this promising structure.
From Constitution DAO's attempt to raise funds to buy a copy of the U.S. Constitution to the future of domains being built on the back of Ethereum Name Service, or ENS, there is ample opportunity for entrepreneurs to involve builders from all around the world.
We'll continue to see novel and unique use cases for DAOs spanning music, art, purchasing high-value assets, and more.
Though we have a ways to go before DAOs can work out their kinks, we aren't far off from sports fans banding together to buy a sports team or investors buying empty land and letting participants have a say in what should be built.
You can’t launch a DAO without building and deploying the smart contracts that form the backbone of the organization. At Alchemy, one of our primary goals is to help educate blockchain developers on the tooling available in the space, and to provide resources to help you become a better developer.
If you’re looking to learn how to connect to the blockchain and deploy your DAO smart contract, check out this article here: Why Use Alchemy?
And finally, we're always available to help 24/7 on our Alchemy Discord. Stop by and say hi - we'd love to help you on your journey to becoming a full-fledged blockchain developer!