What Is a DAO and How Does It Work?

An in-depth look at how decentralised autonomous organisations work and what they mean for the future of business

Key Takeaways

• A DAO is an entity designed to be fully autonomous and operable without a central point of control
• A DAO is commonly defined by these five characteristics: flat organisation, transparency, open access, democracy, and decentralisation 
• The rules of a DAO are established by a core team of committee members and executed through smart contracts
• To obtain voting power or membership in a DAO, users are typically required to own its governance token
• Well-known examples include The DAO, Uniswap, and ConstitutionDAO

What Is a DAO?

The concept of a decentralised autonomous organisation (DAO) was first proposed in 2015 by Dan Larimer, founder of BitShares, Steemit, and EOS (Block.one). However, this method of governance only received mainstream attention after Ethereum co-founder Vitalik Buterin refined its theory. 

By definition, a DAO is an entity designed to be fully autonomous and operable without a central point of control. Instead, it is composed of a committee that agrees to comply with certain rules for a common purpose. These committee members collectively own and manage the DAO through its native token and help the DAO work towards a unified goal. 

A DAO is commonly defined by these five characteristics: 

• Flat organisation — A DAO has no hierarchy, and decisions are made by its stakeholders or members instead of leaders or managers; although, certain spheres of decision-making may be delegated to a core or selected team

• Transparency — A DAO must be open-source, and anyone can inspect the code on the smart contract or view the DAO’s transaction history on the blockchain

• Open Access — Anyone can, in theory, be a member of the DAO, as long as they fulfil the predetermined requirements, such as holding its governance token

• Democracy — No single party can veto a request once it passes the voting process

• Decentralisation — DAOs rely on smart contracts for execution. Occasionally, members of the DAO may hire human resources to fix issues like bugs or updates

How do DAOs Work?

Governance Through Smart Contracts

The rules of a DAO are established by a core team of committee members and executed — at least in theory — through the use of smart contracts. 

Smart contracts lay the foundational blueprint that the DAO operates from. Once finalised, these contracts are published on the blockchain. They are highly visible, verifiable, and publicly auditable; any existing or potential member can peruse the code and ensure the smart contract is aligned with the goals of the DAO. 

In principle, a DAO cannot be changed or altered unless the majority of members reach a consensus on the matter. Similarly, because the treasury (the funds) within a DAO is safeguarded by the smart contract, no single party can access the assets without approval from the majority of the DAO’s members. 

The implementation of smart contracts in a DAO allows for the organisation to be less reliant on human input to operate. Instead, decisions are made collectively through a voting process and executed automatically by the smart contract. 

Voting Power

DAOs are considered participatory and democratic. In other words, if the majority of members support a decision, the decision is made. 

To obtain voting power or membership in a DAO, users are typically required to own its governance tokens. Further, the voting power is often distributed amongst its members based on the number of tokens each member holds. 

To illustrate, a member who owns 100 tokens in the DAO may have twice the voting power compared to a member who holds only 50 tokens. The belief behind this common distribution of voting rights is that users who have allocated more capital to a DAO hold more decision-making clout, as they are incentivised to act in good faith of the DAO. 

Examples of DAOs

The use cases for DAOs range from simple single-purpose to complex long-term projects. Depending on its purpose, a DAO’s use cases can resemble that of a traditional company across any industry. 

Types of DAOs

DAOs are formed for a multitude of reasons, often — but not always — for monetary gain. 

Here are some ways that DAOs are currently used:

Protocol DAOs: One of the current primary uses for DAOs, protocol DAOs govern decentralised protocols. For example, MakerDAO maintains the stablecoin DAI’s peg to the dollar. 

Collector DAOs: The purpose of a collector DAO is to acquire non-fungible tokens (NFTs). Members of a DAO will pool their money and buy the NFTs chosen by the members of the DAO. PleasrDAO, one of the most high-profile collector DAOs, purchased Wu-Tang Clan’s album “Once Upon a Time in Shaolin” in 2021 at a government auction. ConstitutionDAO attempted to buy a copy of the US Constitution at an auction, raising US$47 million in Ether to do so. 

Social DAOs: Most DAOs have some kind of social aspect to them, but social DAOs are purely created with the explicit purpose of gathering people with similar interests. 

Therefore, since most DAOs require ownership of governance tokens, they can start to look a bit like a country club. For example, Friends with Benefits requires full members to buy 75 FWB tokens. Famously, the Bored Ape NFT collection grants owners access to the Bored Ape Yacht Club discord channel and members-only events. 

Investment DAOs: Members of investment DAOs — also known as venture DAOs — pool their assets and vote on how and where to invest them using governance tokens. Profits and losses are shared by all members proportional to their stake. 

Philanthropy DAOs: These DAOs act as a community-led charity, gathering funds and collectively deciding on which organisations to donate to. These operate similarly to grant DAOs, which choose decentralised finance (DeFi) projects to support.

Examples of Well-Known DAOs Include: 

The DAO

The DAO, the first of its kind, was created as a form of an investor-directed venture capital fund. It was developed by Slock.it, a German-based company built on the Ethereum blockchain, with the goal of integrating real-world transactions into the blockchain. 

In early 2016, the company was looking for a method to raise funds for its project, whose founder, Christoph Jentzsch, referenced the concept of crowdfunding and applied it to the blockchain. Hence, the idea of a DAO was born. 

During its creation period, The DAO became an unexpected success, as it managed to raise around US$150 million at that time from more than 11,000 participants, making it the biggest crowdfund ever. 

Uniswap

Uniswap is a cryptocurrency exchange that runs on a decentralised network protocol. This organisation aims to facilitate automated transactions between cryptocurrency tokens on the Ethereum blockchain using smart contracts. 

Similar to a typical DAO, Uniswap relies on its governance token, UNI, as a means to return the control of the protocol to its members. The UNI token gives the Uniswap community the ability to vote on proposals that impact the Uniswap project’s day-to-day operation and development. 

The UNI token has a maximum supply of 1 billion that is shared amongst the core contributors of the platform, including the development team, Uniswap community members, external investors, and advisors. 

Uniswap can be accessed via the Crypto.com DeFi Wallet.

ConstitutionDAO

ConstitutionDAO was formed in November 2021 with the goal of purchasing the original copy of the United States Constitution. This single-purpose DAO banded over 17,000 people and raised a collective US$47 million. However, ConstitutionDAO ultimately lost the bid to Ken Griffin, the founder of Citadel, and all assets were refunded to the DAO’s participants. 

Despite this, the event represented a crucial step that showcased the power of a DAO.

Conclusion

DAOs are tightly connected to the evolution of Web3 and the crypto space. With only a few years of operational history, refinements to their structure can be expected, and they might soon be more common within and outside the blockchain realm.

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