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A decentralized autonomous organization, or DAO, is a new form of organization or entity that has no central governing body and is instead run by its members who share a common goal.

In terms of blockchain use cases, DAOs have become a way to do corporate governance on a blockchain. A crypto DAO issues assets that are akin to shares, and the holders of those assets are then able to use them to vote to support or reject a proposed change to the organization, in proportion to the amount of the asset they hold.

These changes could be anything from changing the way in which a decentralized application distributes rewards to figuring out how a decentralized treasury should be used. If you’ve ever wondered what a DAO is in crypto then you’re in the right place.

How Does a DAO Work?

The specific way in which a crypto DAO functions will vary depending on the project, but the general idea is that it is an organization where decisions are made by a collective group of members. 

DAOs require smart contracts in order to function, as they establish the rules of the organization. These rules may include things such as the rewards for users who stake a specific asset, the collateral ratio required for users to borrow against their holdings, or simply what assets the DAO will support in general.

All of these rules are outlined in the smart contracts and are fixed unless a proposal changes them. Members of a crypto DAO can propose a change to a protocol (rules), and the other members can support or reject the proposal. If a majority accepts it, then it becomes implemented. It’s collective decision-making rather than top-down decision-making which occurs in many current organizations.

Advantages of DAOs

The main advantage of a DAO is that it is a publicly accessible set of rules created through smart contracts, which can be verified by reviewing code. This means that a DAO can be trusted as long as you can trust the code with which the DAO was created. You can do this before the DAO ever launches, allowing you to make an informed decision.

Then, once you’re within a DAO, you know there can be no change made to how it works without approval from the majority of the community. However, even if you’re a small fish in the DAO you can make a proposal for the rest of the community to consider. If it’s a good idea then it will get approved and implemented.

The Limitations of DAOs

The main limitation of a DAO is the number of members and their positions in terms of crypto assets. There isn’t much point to a DAO if there are one or two members with enough voting to make any of their proposals be approved. As with real life organizations, centralization of power can be an issue, so it’s key for DAOs to try and keep assets well-distributed in order to avoid some sort of corruption/bad actor situation.

The other main issue with DAOs is that their members are likely to be located all over the world, with different legal jurisdictions and regulations. As such, should a legal issue arise within a DAO, it may be very difficult to solve as there are so many laws to take into account.

DAO Example: What was “The DAO”?

“The DAO” was one of the first attempts at a DAO as we now describe it. It launched in 2016 as a form of venture capital fund for its users who were using the Ethereum blockchain. It raised $150 million in Ether for development and launched in April 2016. Investors could buy DAO tokens by depositing Ether into the smart contracts.

However, as the code was open-source, users noticed a potential bug in the code that could allow funds to be drained from the smart contract. While a proposal to fix the bug was made, the funds were drained before it could be fixed, resulting in $60 million in Ethereum being stolen. 

There was much debate within the Ethereum community as to what to do, but what ended up happening was a hard fork where two Ethereum blockchain resulted. One, now called Ethereum Classic (ETC), allowed the hack to exist, while the other, now called Ethereum (ETH), rolled the blockchain back to before the hack occurred.

“The DAO” now serves as a good example for all current and upcoming DAOs as to the importance of verifying a project’s code before investing money into it. 

Decentralized Finance (DeFi) Stocks

These days, most DAOs are related to various DeFi projects on Ethereum and other platforms. For example MKR, is a governance token for the MakerDAO platform, which is used to create dollar-pegged ERC-20 tokens that are backed by collateral in the form of ETH and other tokens. Another example would be UNI, which is the governance token behind the Uniswap decentralized exchange.

While all of these DAO governance tokens behind DeFi projects are intended to grow in value as the DeFi apps increase in popularity, it’s important to look at the specific tokenomics behind each of these tokens to make sure that is actually the case. Bad tokenomics in some projects have led to situations where a decentralized app has become pretty heavily used without much additional value accruing down to the underlying token.

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About the Author

Evan Jones

Evan Jones was introduced to cryptocurrency by fellow CryptoVantage contributor Keegan Francis in 2017 and was immediately intrigued by the use cases of many Ethereum-based cryptos. He bought his first hardware wallet shortly thereafter. He has a keen and vested interest in cryptos involving decentralized backend exchanges, payment processing, and power-sharing.

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