What is DAO and How Do They Work?

What Is DAO?

DAO, which is the popular and convenient acronym for Decentralized Autonomous Organization, is formed by a group of people who decide to abide by certain rules to meet common goals. However, what makes DAOs different from other systems is that these rules are written into codes of the organization. DAOs use smart contracts, which are algorithms that work on the basis of certain criteria that are met. The following segments explain how DAOs work, the process of setting up a DAO, and some common questions related to DAOs answered. 

How Does a DAO Work?

DAOs work on the basis of smart contracts, which form the foundational framework that dictates how the DAO will operate. These smart contracts are responsible for the functioning of a DAO without requiring any human intervention. The core team of community members comes together to create the smart contract. Smart contracts characterize verifiability and visibility, and they can be audited publicly, which allows every potential member to gain a complete understanding of the functioning of the protocol at every step.

In order for the DAO to function seamlessly, there is a need for funding. Funding is generally gathered using the token issuance method, wherein the protocol sells tokens in exchange for funds. People who receive tokens are given certain voting rights based on their holdings. The stakeholders of the DAO decide the rules, and these rules and transaction records are stored on a blockchain with complete transparency.

With the completion of funding, the DAO can be deployed. One of the most remarkable aspects of DAOs is that, once the codes are written and implemented, they cannot be changed and no member holds any special authority to make it happen. Any changes to be made have to first gather member voting, and upon reaching the consensus, the specific changes in concern are made. If there is a need for a change to be made, it is generally suggested through proposals. It is when the proposal gathers votes from a majority of stakeholders or when the proposal fulfills a certain set of rules in the network consensus rules that the changes are implemented.

What makes a DAO’s work distinct from most traditional organizations is that a DAO functions in a decentralized fashion. Additionally, DAOs, unlike traditional organizations, don’t have a hierarchy and they’re rather driven by economic mechanisms.

There is no formal contract that ties the members of a DAO to it. Instead, all the members share a common goal that keeps them tied to the consensus rules. Since the rules are written in an open-source software governing the organization, they are transparent.

Key Benefits of DAO

DAO is growing in popularity in different areas from sports, arts, and finance to crowdfunding. There are several benefits that it offers, which might be the reason why groups, entities, and individuals would want to pursue the DAO structure. With that said, here are the major benefits of DAO-

Decentralization

The basic design principles of DAOs are well aligned with the goal of achieving the highest level of decentralization. This essentially means collective participation while eliminating dependence on one or a few individuals. This helps give an equal amount of importance to every stakeholder and member to have their voice when it comes to the decisions made. However, DAOs are not completely decentralized as members who invest in more tokens have more voting privileges. Despite this, the voting power is still well-distributed which prevents power transfer to one or a few individuals.

Participation

DAOs, as a result of being as decentralized as possible, encourages more participation than most traditional organizations. When the members of an entity feel like they have fair voting rights, they feel more empowered to contribute. This is what drives the DAO stakeholders to use their tokens in ways that benefit the entity, cast their votes, and burn tokens.

Publicity

Since DAOs are built on open-source software, the votes that are cast via blockchain are visible publicly. Since the decision made by every voter and member is viewable, this brings a sense of accountability and responsibility to the members to act in the best ways. Therefore, the voters would want to act in ways that benefit their reputation while keeping away from acting against the community.

Community

Decentralized Autonomous Organizations have great community involvement, which enables people from all over the world to connect with each other to work on goals. All it takes is an internet connection and DAO governance tokens to be able to enter the world of web3. Since the decision-making process is not limited to a group of authorities or the boardroom for DAOs, every member can contribute in ways that add to the productivity of the goals. And with this, there is more scope for innovative developments from the organization and its members.

Pros and Cons of DAO

Decentralized Autonomous Organizations have both pros and cons, some of which have been highlighted-

How to Launch a DAO?

There are several factors worth considering when launching a DAO. To ensure you’re going about the process in a systematic manner, here’s a step-by-step process of launching a DAO, and for this instance, using the Ethereum network.

1. Deciding the DAO Structure

Before starting a DAO, it is crucial to understand your needs to start one and determine if DAO is the solution you’re looking for. While DAO has significant benefits, it may not be ideal for every type of project. Knowing your goals and short-term and long-term vision can help you understand how you would want to structure your DAO. The foremost factor worth evaluating before you launch a DAO is if your business will benefit in a true sense from it.

2. Deciding the Type of DAO to Build

There is a whole range of types of DAOs, and preferring one certain type over another completely depends on your specific needs and goals. Protocol DAOs, venture DAOs, media DAOs, entertainment DAOs, and grant DAOs are some of its types to name a few. Once you know the type of DAO you opt for based on the suitability for your business, you can move on to the next step.

3. DAO Token Allocation

Knowing what it is that you intend to accomplish with your DAO and the type that you would want to build, you should think about DAO token allocation in a strategic manner. Your decision should reflect your long-term vision and the kind of relationship you would build with your community.

DAO tokens are useful for creating rewards and incentives, and they encourage voting on the direction of the DAO. Since tokens are the primary reason for users to feel involved and invested in your company’s success, you should define ways in which you would want to use tokens so that it adds to your goals and result in success.

4. Determining DAO Token Supply, Allocation, and Rewards

When determining token supply, it is extremely important to find the sweet spot so that your tokens achieve maximum trade to their potential. For instance, while low-priced cryptocurrencies have less volume and lower monthly and quarterly returns, they are more traded as they have a greater number of coins.

However, the whole process of DAO allocation and supply is dependent on your specific goals and community. One thing to remember is that your tokens have higher chances of trade if they’re a safe bet, meaning a reasonable number. The next crucial aspect pertaining to DAO tokens is to ensure you strike a balance between rewarding your community while ensuring your community treasury has enough balance.

5. Building the DAO

After following all the above-mentioned steps, it is time to build the DAO. when building your DAO, there are two ways to go about it. You can either build your own system or leverage DAO start-up templates and tools for various functions, such as setting the legal framework up, minting tools, creating a name for the DAO, and deciding on teams and the founding members.

Some Ethereum tools worth leveraging to establish the DAO structure are Colony, Syndicate, Aragon, DAOstack, and Orca Protocol among others. Building DAO includes steps, such as setting the DAO, setting up the treasury tools to manage tokens, fundraising, and at-scale operations of the treasury.

6. Establishing the DAO Treasury

It is essential to manage the DAO funds used for strategic investments and operational expenses, which is why you should establish the DAO treasury as the next step after token supply and allocation. And for DAOs, there is a need to secure DAO capital in a way that prevents a single party from making unilateral decisions on spending of the funds. To ensure this, you can use treasury management tools, such as Multis, Superfluid, Coinshift, Parcel, etc.

While it is possible to switch to a different treasure tool at any point in time, it is best to choose the right one from the start. When you choose the right treasury option, you get to safeguard your funds and distribute them when the need arises.

7. Building a Community

Finally, once the DAO has been deployed and launched, you should build a successful community, as it is the community that decides the success of your DAO. Therefore, it is important to take proactive steps toward building one. There are various tools that can be used, from Twitter, Discord, Medium, Mirror, Telegram, and other tools that can be used for DAO communication towards community building.

Can DAOs Work in the Real World?

Theoretically, the concept of DAO ticks several boxes that make it look like an ideal decentralization solution. It has definitely transformed how the world of cryptocurrencies works, but it is significantly short of proving its usefulness for real-world corporations. In real-world organizations, we cannot imagine completely replacing human managers with artificial intelligence. While useful as supplementary support, artificial intelligence falls short of intuitively understanding and taking steps to solve many problems.

For instance, in case of disruption of operations at a manufacturing unit, a smart contract may not be able to determine the ideal time to resume order placements. However, a human manager might be able to consider small and bigger challenges and come up with the right decision more efficiently. Moreover, while AI can be trusted with solving trust issues with transactions, it requires a human being to be able to create and retain trust in organizations and communities.

Therefore, it is safe to say that despite impressive characteristics and applications, DAOs are far from working in the real world. DAOs need to go through significant changes and we need bigger strides in the world of technology to be able to adopt DAOs at scale.

Frequently Asked Questions

1. How does a DAO make money?

The initial step to raising capital in a DAO system is through trading fiat in exchange for the native token. People who invest in the tokens are incentivized by giving them the power to vote and ownership that is proportionate to their investment. When a DAO achieves success, it can then increase the value of the tokens. This helps tackle the issues related to generating capital. Another way of making money is through investing in assets when a majority of members approve such measures.

2. How does DAO work in a blockchain?

DAOs use smart contracts to work in a blockchain. These smart contracts are made of chunks of code that help execute operations automatically when a set of criteria are met. While Ethereum was the first blockchain to use smart contracts, it is deployed on various other blockchains these days. 

3. How much does it cost to start a DAO?

The cost of forming a DAO as an LLC is $100 in fees, and a fee of $60 is incurred each year when the annual report is released. However, since Ethereum prices keep fluctuating, the cost for setting up DAO and generating tokens keeps varying. 

4. What is an example of a DAO?

Dash is one of the examples of a Decentralized Autonomous Organization, which is an open-source cryptocurrency. A subset of its users run its DAO operations, and these users are called ‘masternodes’. Dash is an altcoin, which branched from the bitcoin protocol. 

Conclusion

While DAOs can be immensely beneficial and have the scope for future growth, there’s a need for people to first have a comprehensive understanding of blockchains and how they work. Furthermore, setting up and launching a DAO also demands familiarity with the working of blockchain and how to leverage the blockchain technology. Aspiring professionals in the area of blockchain greatly benefit from online courses, such as Simplilearn’s Blockchain Course aimed at helping individuals learn theoretical concepts and master practical skills to work on blockchain-powered solutions like DAOs. 

If you have any questions or doubts, feel free to post them in the comments section below. Our team will get back to you at the earliest.