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What are DAOs and How Do They Work?

  • Yashoda Gandhi
  • Mar 22, 2022
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Because there is so much hype surrounding blockchain, cryptocurrencies, and NFTs, it can be difficult to see the technology's true utility. It's difficult to understand a crypto coin or an NFT's intrinsic value when their prices are based primarily on their value as a speculative instrument.


Understanding the utility of DAOs, or decentralized autonomous organizations, is a little easier, despite the fact that the concept is still very new and has only been tried in a few different types of organizations so far. So, let's take a closer look at the DAO concept.


What are DAOs?


A decentralized autonomous organization (DAO) is a blockchain-based method of organizing people and their interests on the internet. The blockchain is a distributed ledger system that can only be accessed through the internet. 


To ensure that everything written to it ("blocks") can be verified, it employs a sophisticated cryptography system. This ledger, which is typically maintained by a group of internet elves known as "miners," can be used to store smart contracts, which are essentially an organization's legal bylaws.


The DAO was a decentralized, self-organizing organization. It operated as a venture capital fund, with no traditional management structure or board of directors, and based on open-source code. Despite using the Ethereum network, the DAO was unaffiliated with any particular nation-state in order to be fully decentralized.


Why establish an organization like the DAO? The DAO's creators believed that by delegating decision-making authority to an automated system and a crowdsourced process, they would be able to eliminate human error and manipulation of investor funds. 


The ether-powered DAO was created to allow investors to send money anonymously from anywhere in the world. The DAO would then issue tokens to those owners, allowing them to vote on potential projects.


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Why is DAO Needed?


DAOs have several advantages over traditional organizations because they are internet-native. DAOs have a significant advantage due to the lack of trust required between two parties. While traditional organizations require a high level of trust in the people behind them, particularly from investors, DAOs only require the code to be trusted.


Because the code is publicly available and can be thoroughly tested before release, it is easier to trust it. Every action taken by a DAO after its launch must be approved by the community and must be completely transparent and verifiable.


In such an organization, there is no hierarchical structure. Nonetheless, it is capable of completing tasks and growing while being controlled by stakeholders via its native token. 


Because there is no hierarchy, any stakeholder can propose an innovative idea that will be considered and improved upon by the entire group. Internal conflicts are frequently easily resolved by using the voting system in accordance with the smart contract's pre-written rules.


DAOs enable investors to pool their funds, allowing them to invest in early-stage startups and decentralized projects while sharing the risk and any profits that may result.



How does DAO Work?


To understand DAOs, you must first understand the technology that powers them. The majority of DAOs rely on blockchain technology and smart contracts, which are code collections that run on the blockchain.


A blockchain is a digital ledger that is decentralized. While blockchains are most commonly known for publicly documenting transactions of various cryptocurrencies, such as bitcoin, and other digital assets, such as NFTs, they can also be used in a variety of other ways. 


The blockchain can serve as a backbone for DAOs, preserving the structure and rules of each on-chain.Each action or vote in the DAO is represented by some type of Blockchain transaction. 


The address (in Ethereum, it's Ethereum address) represents the members here. These addresses can be owned by a person, a robot, an IoT device, or even another DAO. As a result, it is ideal for a fully automated system to run the entire organization.


Each member receives a token that represents the DAO's shares; these tokens can also be used to vote in the DAO to make a decision. The token is simply another type of contract that runs on top of Blockchain. The more tokens an address has, the more power he has over the DAO.


Each member will be able to submit a proposal to make certain decisions. These choices include; Change the CEO or Fire the CEO? Hire a vendor to obtain his or her services. Make use of a lawyer. Pay someone a certain amount of ethers/USD as a salary or bonus. Distribute the share to someone because that person or address adds more value.


Because the DAO is nothing more than a democracy running on the Blockchain, voting power can be optionally delegated to someone whom a member trusts more. In fact, this is the same as voting by proxy in a real organization. It can also raise funds through crowd-sourced funding by issuing tokens/shares to anyone who pays them money.



Applications of DAO


DAOs have nearly limitless applications. At the moment, the most popular application is for DApp governance. The decentralized nature of DeFi does not end at the network level.


Developers can create DAOs with simple methods for proposing small or large changes to the platform, and token holders can vote on whether it passes. Two of the most common types of DApps that use DAOs are decentralized exchanges (DEXes) and lending platforms.


The current DAO landscape in Coopahtroopa's framework is shown below :

The image shows the current DAO landscape in Coopahtroopa's framework

Current DAO Landscape (Source)

Metaverse video games are also becoming increasingly popular, with many opting for decentralization by establishing a DAO. Members of the Decentraland DAO can vote on changes to the game and its item ecosystem via the Decentraland DAO.


A rival metaverse game, The Sandbox, is frequently referred to as decentralized, but it is not at the time of writing. Despite the fact that the first major DAO was a crowdfunded venture capital group, comparable investing-focused projects have received less attention. They are, however, becoming increasingly common.


NFT-based investing DAOs have recently exploded, as has the entire NFT market. DAOs, such as HeadDAO, are constantly innovating and discovering new ways to improve the technology. 



Examples of DAO


You could establish a DAO to raise funds for a charitable organization, or you could establish an investment firm in which all members contribute funds in exchange for equity in a company or project. 


Each participating member may pay a set amount of cryptocurrency, which determines how many tokens they receive from the DAO. The pay-in and pay-out may occur in accordance with a schedule specified in the smart contract.


The popular cryptocurrency Bitcoin can be considered a DAO, in which people enter into agreements to buy and sell the cryptocurrency on a set of terms, and everything is tracked on the Bitcoin blockchain.


The Ethereum network, the second-largest blockchain, hosts the vast majority of DAOs currently in existence. According to Ethereum, a DAO is "an internet-native business that its members collectively own and manage." They have built-in treasuries that no one can access without the permission of the group. 


Decisions are made through proposals and voting. In other words, the DAO is run by its members rather than a central administrator, and any currency movement into or out of the DAO's coffers must be approved by them.


For example, in November, a group of crypto enthusiasts launched the ConstitutionDAO DAO in order to raise funds to purchase one of the thirteen first printings of the United States Constitution. The group did not win one of the Constitutions that Sotheby's auctioned off, but they did raise $47 million for the cause in a short period of time.


Another DAO, LinksDAO, is raising funds to purchase and build its own crowdfunded golf course. The group raised more than $10.5 million by selling club memberships in the form of non-fungible tokens (NFTs) and is now sold out. The owners of the NFTs receive a stake in the club as well as the right to vote on how the golf club is developed.


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DAOs are designed so that participants do not need to "trust" one another. They can, in fact, be complete strangers. This is because participants either fulfill or do not fulfill the smart contract's obligations. 


The contract terms, as well as all actions taken by participants, are written into the blockchain's code, where the information is public and permanent. A DAO's decision-making power is distributed to all participants and automated to reduce the need for day-to-day administration.


Despite their name, today's DAOs are not completely decentralized or democratic. They continue to rely on the participants' trust in the group of humans who established the DAO, as well as its goals and general terms. That group of humans must also be trusted to choose an appropriate governance model. 


In some models, every participant who contributes crypto–no matter how much–is given a single token, which represents one vote in future DAO decisions. 


However, in some DAOs, granting a participant who contributed a large amount of cryptocurrency the same say in important matters as someone who contributed a small amount may be considered unfair.

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