What Is a DAO?
A Step-by-Step Guide to the Cooperative Entities at the Heart of DeFi
By: Rahul Nambiampurath • Loading...DeFi Explainers
Since the dawn of commerce, business leaders have been coping with the problem of governance.
Who has the right to run a company, and under what conditions? How much influence should shareholders have over a company’s strategic direction? Or for that matter, customers? And what role should boards of directors have in making sure companies operate in ethical and productive ways?
Thanks to smart contracts that can automate governing logic, decentralized autonomous organizations (DAOs) can reorganize decision-making in enterprises. With in-built rules and distributed voting governance, DAOs enable communities to pave the road to trustless governance.
Yet this new structure is a challenge: DAOs are largely based on cooperatives, steeped in egalitarian and democratic values and methods. Yet this ethos can often clash with the needs of business operations, and this tension is a major force in DOA governance.
DAO’s Intriguing Origin That Created Ethereum Classic
The origins of DAOs are tainted with malfeasance. The first such organization, named “The DAO,” launched in 2016. The team behind it was Slock.it, created by brothers Christoph Jentzsch (former Ethereum core developer) and Simon Jentzsch. The startup tried to develop a blockchain-based sharing economy.
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However, in making the “true” DAO independent of its Slock.it origin, some mistakes occurred. On June 5 2016, Christian Reitwiessner revealed a smart contract exploit that could be used to pilfer funds from DAO’s treasury. In fact, other DAO projects, such as Maker DAO, who took advantage of the open-source DAO code, “hacked” themselves soon after to safely store funds in a multi-sig wallet.
As a result of this mishap, Ethereum Classic (ETC) came to be, as a leftover of the new hard fork — Ethereum (ETH) as we know it today.
How Do DAOs Work?
The first two DAO prerequisites are the following: 1) governance is done online and 2) parties must agree to abide by DAOs rules. Depending on the DAO’s purpose, these rules vary. But they are all reliant on blockchain’s smart contracts, which self-execute when conditions are met.
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For example, one could deposit collateral to receive a loan. A smart contract’s code determines how much collateral is needed, based on the loan amount and based on the type of cryptocurrency used for the collateral. The smart contract sets the time needed to pay the loan, and the interest rate. It would also run a clock and sync up with oracle networks to determine if the collateral’s price changed.
Such smart contract flexibility that eliminates third parties is at DAO’s core. But DAOs extend the flexibility further because they can change smart contracts themselves. In turn, this changes the rules of the organization.
By holding tokens deposited into DAO’s smart contracts, token holders gain voting rights. Because of this direct monetary stake, similar to shareholders of a company, they tend to vote in their best interest. Specifically, to pass new governance proposals or create new ones. If they pass the majority token holder vote, it is then up to developers to implement proposals.
For this reason, by necessity, all DAOs are digital asset repositories, otherwise known as treasuries. As for the voting weight, it is proportional to the amount of tokens each token holder holds.
Examples of DAO Treasuries
All DAOs follow basic rules to get going. The first step is to decide the type of activity they will govern and how. The next step is for developers to encode that logic into smart contracts. The third step is to raise funds, by which token holders automatically become DAO members.
Typically, insiders/developers raise funds first, after which they deploy it on a public blockchain like Ethereum. At this point, developers relinquish their control of the DAO treasury. Here are some prominent examples of DAO treasuries:
- ConstitutionDAO tried to buy a rare copy of the U.S. Constitution in November 2021. The group successfully raised $47M across 17,437 DAO token holders (ETH). Although they were outbid by billionaire Kenneth Griffin of Citadel, ConstitutionDAO was a major proof of concept.
- BlockbusterDAO launched to revitalize the iconic video-rental chain and use its name for a decentralized movie funding platform. The first step was to raise funds necessary to buy the Blockbuster IP from the Dish satellite company. Unfortunately, Dish opted to decline. The team behind BlockbusterDAO rebranded itself into R3WIND, still pursuing its Web3 streaming dream.
- Yuga Labs of Bored Apes fame launched ApeCoin DAO. The governance treasury serves as the center point of Yuga Labs’ upcoming metaverse platform Otherside. This June, APE token holders voted to stay on Ethereum, as opposed to Yuga Labs’ own blockchain. Effectively, APEs voted 53.6% in favor of staying, 3.8M APE vs. 3.3M APE, showcasing that the community can go against the founders’ wishes.
- BendDAO launched as an NFT lending treasury, in which users can collateralize their NFTs to borrow ETH. Although the harsh bear market in the second half of 2022 plummeted NFT prices, the treasury showcases the expansion of digital assets beyond cryptocurrencies.
- Axie Infinity set the trend for blockchain gaming as passive income. But what if gamers don’t want to spend money on playable NFTs before getting started? This is where DAOs like Yield Guild Games (YGG) come in. They lend gaming NFTs, paid back when blockchain gamers start earning money.
As you can see, there is no limit to DAO deployment. If something can be codified, it can be recreated with smart contract logic, bolstered by the stake of digital assets. This makes DAOs complementary to any online venture.
How Much Wealth Do DAOs Hold?
DAOs hold almost $10B worth of digital assets, out of which $6.5B is liquid. If we go by unique wallet addresses, this wealth can be distributed across 3.9M governance token holders. According to DeepDAO aggregator, there are 2,276 DAO organizations in total, out of which 2.7% are above the $10M treasury threshold.
Given Ethereum’s continued market share dominance, all top five DAOs use ETH as the main treasury currency.
Top DAOs. Source: DeepDAO
Due to their flexibility, convenience, and transparency, we are likely to see DAO in every sector of society. While there are some areas of life that still can’t be mapped by rules of logic, digitization is constantly shrinking and offering new tokenization venues.
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.
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