Updated: Nov 16, 2022
Decentralized autonomous organizations, or DAO, are member-owned organizations that are free from any external influence of centralized bodies. The rules governing the functionalities of DAOs are created by the participating members and encoded as computer software. DAOs are also known as decentralized autonomous corporations.
With the rise of the “decentralized universe”, DAOs are popping all over the world. But what are they really? What makes them decentralized? How do they work?
In this UNICHED article, we will answer all those questions. We will understand the differences between traditional organizations and DAOs, understand their functioning, and set some expectations.
Let’s get started by understanding how they differ from traditional organizations.
How are DAOs different from traditional organizations?
Rules of engagement between the members
In the case of traditional organizations, the interaction between the members and the members and the organization is governed by a contract. This contract is enforced and followed strictly through different departments within the organization. If the contract is broken, or a party doesn’t fulfill their side of the bargain, the legal court intervenes.
In the case of DAOs, the rules of engagement are not only mutually decided but each of them is mutually enforced too. Fellow members of the DAO are rewarded with native currency within the blockchain for upholding and protecting the rules of the DAO.
Traditional organizations, typically, have a top-down approach where authority decreases as we go down the hierarchy. Simultaneously, the number of members increases as we go down the hierarchy.
In DAO, the members of the organization are on the same level with equivalent authority for each participating member. The Authority of each participating member could also be determined collectively.
Ownership and clearance
The members occupying the base-level hierarchical positions in traditional organizations have the least amount of ownership and clearance. Further up, the clearance to data and organizational ownership rapidly increases.
A DAO cannot be ‘owned’ by any member within it once created. The ownership of the code is not limited to one individual, even the creator after it has been created and deployed. Similarly, the clearance to data of a DAO is not limited to an individual, but it is something that is mutually decided and agreed upon.
DAOs are open-source, transparent, and decentralized. Some blogs describe a DAO as an internet tribe. These features of a DAO make it incorruptible in theory. Let’s see how a DAO works.
How does a DAO work?
A decentralized autonomous system is different from a traditional corporation as we have seen so far. Hence, the way a DAO works is also quite unique.
The rules and regulations that determine the working of a DAO are known as smart contracts. A smart contract is a program that will execute when certain conditions are met. These smart contracts are created by the participating members of the DAO. They are also open to auditing and are transparent so that every new member can gain an understanding if they want to join the DAO.
A DAO receives funding when native tokens are exchanged for fiat or cryptocurrency. This fund is stored in the DAO treasury. The rules around how many tokens will be in total and how many tokens can be owned by one in the DAO blockchain will be determined by the participating members of the organization.
After the smart contracts are formed and tokens are sold, the code is executed onto the blockchain. This code is not owned by anyone including the person who created it. The participating members have ‘rights’ on the code and can alter it but that is decided by an internal, mutually-agreed voting system. The weightage of votes is determined by the number of tokens a person has.
Legal risks with DAO
The first legal risk that a DAO can encounter while handling funds is interference from the state. Of course, the smart contracts won’t be affected in any way, but if the tokens are branded as ‘digital assets’, then they might be taxable. With countries like India and USA taxing cryptocurrency as they are interpreted as an “asset”, the point around DAOs’ funds is critical to understand.
Another challenge that DAOs can encounter is regarding the legality of the nature of the function of the DAO. For instance, if the transactions carried out by decentralized financial institutions are interpreted as illegal, then the DAO will be deemed the same.
The risk of getting hacked is still a huge problem with the digital world. Although, in theory, these DAOs are unhackable, there is still a risk. To top it off, the investors and their investments are protected by DAOs’ smart contract and nothing else. In an unlikely event that the investment vanishes overnight, there will be no one to go to.
Just like the decentralized universes, DAOs are quite new and the rules around their operation are still evolving. Before jumping on the bandwagon and investing, it is recommended that you take a look at certain examples and understand whether it is valuable in your situation. We hope that we have answered some of your questions about DAOs in this article.