Decentralized Autonomous Organizations

By: Digital Asset Management Firm Etherbridge

EXECUTIVE SUMMARY

• Decentralised Autonomous Organisations, or more simply, DAO’s, are the next frontier of human coordination
• A DAO is an internet native coordination structure governed by code that allows like-minded people to come together and pool their resources to achieve some common goal
• DAO’s really do represent the new frontier in human coordination. Never before have we had the ability to collaborate with people across the globe in a trust-minimised fashion

DETAILS

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Decentralised Autonomous Organisations

Human coordination. Coordination is at the centre of everything we do. We spend our lives trying to best coordinate our resources to produce something of value that can adequately serve society’s needs, and we are rewarded as a result. 

It has taken humans millennia to reach the point we are at currently, and this has been made possible by technology. From the printing press and double-entry bookkeeping to railroads, ships and the internet, these all were technologies that enabled us as humans to expand our ability to coordinate across both time and space. 

Decentralised Autonomous Organisations, or more simply, DAO’s, are the next frontier of human coordination. They are the first way we can truly coordinate on a global scale and therefore represent our best chance at providing a democratic platform on which people can build their lives. 

What is a DAO?

A DAO leverages blockchain and a collection of smart contracts to facilitate the mechanics of governance whereby allowing a decentralised group of participants to fund and produce community-owned goods and services collectively. Or, more simply, a DAO is an internet native coordination structure governed by code that allows like-minded people to come together and pool their resources to achieve some common goal. 

A DAO itself isn’t that different to the corporations and businesses of today. They can provide both digital and real-world based goods or services; however, the governance structure can be significantly more decentralised and provide stakeholders with the chance to participate meaningfully in the system. A DAO uses economic incentives to align the interests of everyone within the organisation as the rules are transparent and written in open-source software governed by mathematics and computer science. 

“Instead of a hierarchical structure managed by a set of humans interacting in person and controlling property via the legal system, a decentralised organisation involves a set of humans interacting with each other according to a protocol specified in code, and enforced on the blockchain.” – Vitalik Buterin

Comparing a DAO to a traditional organisation helps understand the nuanced differences between the two:

Source: Ethereum.org

The above also shows how DAO’s propose a solution to the Principle-agent problem. The fundamental dilemma behind the problem is that when one person or entity (the agent) can make decisions or take action on behalf of another person or entity (the principal), how can we ensure that the agent doesn’t act in their own self-interest? This is an example of moral hazard and extends from small companies to nation-states across all fields. This problem most commonly arises when the two parties have different interests, or there is information asymmetry between them, and the principle lacks the ability to fully see and track the agent’s decisions as they are made. Currently, court systems and legal contracts address the problems associated with moral hazards in society; however, DAO’s significantly reduce the costs and risks of managing them.

What Types of DAO’s Exist?

DAO’s themselves are flexible. Therefore, they can be as simple as people pooling funds together to purchase assets to extremely complicated governance structures like nation-states. 

It is argued that the first example of a DAO in practice, although very simple, was actually Bitcoin. The Bitcoin network implements rules as to how the network operates, and bitcoin is used as the economic incentive to keep the chain secure. Daniel Larimer proposed the idea that Bitcoin was a new type of decentralised company:

• Shares are bitcoin
• Shareholders are bitcoin owners
• Employees are miners and node operators
• Payroll is the bitcoin reward for adding blocks to the chain
• Marketers are anyone trying to sell bitcoin 

Bitcoin itself, however, is extremely limited in what it can do. Therefore, an alternative was needed to provide real expressiveness and utility to end-users, and this is where Ethereum fitted in. Vitalik Buterin actually mentioned DAO’s in the first paragraph of the Ethereum whitepaper published in 2013. He understood what Ethereum would enable and how having Turing-complete smart contracts would open up possibilities that we haven’t even imagined yet. 

That is what makes DAO’s so flexible; you can program them to do anything in any way you want, given enough resources and time. 

So what types of DAO’s can therefore exist? Well, it’s similar to asking what types of companies or LLC’s can exist? This answer will change depending on who you ask. However, we can generally split DAO’s into two broad category groups, those that are technically inclined and those that are socially inclined. One thing to bear in mind though is that these categories are not mutually exclusive and can therefore be a blend as well.

Technical DAO’s generally help operate or govern a protocol of some kind and focus on building on-chain, while social DAO’s generally focus on bringing a group of people together for some specific or general reason. We have DAO’s concentrating on particular sectors within these two broad groups, including media, social, protocol, collector, service, investment, grant, and operating DAO systems.  

Source: Coin98 Analytics

As you can see, most of the notable DAO’s that currently exist fall into the protocol, social and service categories. We are going to give brief examples of all three to better understand what they do.

Protocol DAO’s

As stated previously, protocol DAO’s generally are collaborative groups that help build a specific protocol. A great example is MakerDAO; the DAO is responsible for the wellbeing of the Maker protocol. They actually have one of the most advanced DAO structures of all protocol DAO’s. They have 15 core units, all with their own budget and mandate. They can pay people contributing to the DAO for independent work done, propose upgrades to the protocol itself, market it, and many other functions. However, all these are voted on and agreed upon by holders of the Maker token. Uniswap, Compound, Aave, and yearn.finance are also good examples of protocol DAO’s however, they all have their own unique structures and governance approaches. 

Service DAO’s

Service DAO’s are very broad as they can really provide any service that you could imagine. Currently, they almost act as human capital aggregators. They bring together people with particular skills to achieve an outcome. An excellent example in this category is Yield Guild Games (YGG). YGG is what we call a play-to-earn gaming guild. It brings a variety of players together to earn tokens by playing blockchain-based or NFT games such as Axie Infinity and The Sandbox. 

A DAO such as YGG also enables people who hold assets in these games to actually lend them to other people or active players in the guild, and these players, who may not have been able to afford the asset in the first place, can now participate and share in the reward earned while playing. This has proved to be a prevalent business model in the space, and we have seen significant adoption of certain games like Axie Infinity because of it. People in countries such as the Philippines have even been able to earn two to three times the local minimum salary just through playing these games. While this isn’t the only thing YGG does, it is an excellent example of leveraging a DAO to bring people from all countries together to achieve something specific. 

Social DAO’s

Social DAO’s also have the potential to change how we interact and live. Something like CabinDAO offers a one-month residency program funded and operated by the DAO where people can physically go and stay at the cabins they have built close to Austin, Texas. 

We have even seen ETHDenver, the largest and longest-running Ethereum event in the world, start a DAO called SporkDAO. The DAO will completely run the event in the future; they plan on offering a share of profits to DAO members, using DAO funds to back early-stage ETH based projects and even support the State of Colorado using Web3 technology to solve real-world problems. 

These projects can bridge the real world and digital on a scale previously not possible, yet this obviously comes with its own issues from legal to security.

Issues Facing DAO’s

Legal

Currently, the regulatory environment surrounding DAO’s is a very grey area. There are very few jurisdictions that recognise them as legal entities, and therefore they face obvious hurdles when it comes to doing business in a specific country. This uncertainty is probably the most significant barrier to adoption for DAO’s currently. Nevertheless, we are seeing certain places around the world that have started to embrace these new businesses and social structures, such as Malta or Wyoming in the United States. We also do expect to see this trend continue over the next few years.

Centralisation of Members

If one token = one vote, then some members who joined very early may have outsized voting power in the DAO, and while this isn’t necessarily a bad thing as they may have a more vested interest in making the DAO itself successful, you start to reencounter the Principal-agent problem. However, we have seen many of the bigger DAO’s following a “progressive decentralisation”, where more and more tokens end up in the hands of smaller holders over time. 

Apathy

Humans are very often apathetic. They don’t want or care to vote on something. You can even see it in general elections, where a 50% turnout is usually considered good. Therefore, if people aren’t willing to participate in the governance of the DAO, then a few members may take charge again.

Security

Once your DAO’s code has been deployed on a blockchain, it becomes challenging to alter. Therefore ensuring there aren’t any bugs or potential areas of attack is paramount. In a centralised system, these fixes can be fast and easy; it is a lot harder in a decentralised fashion. A great example of this is The DAO attack. Ethereum itself had to do a hard fork due to poorly written code that resulted in millions of dollars in funds being stolen from over 11 000 investors. 

Conclusion

DAO’s really do represent the new frontier in human coordination. Never before have we had the ability to collaborate with people across the globe in a trust-minimised fashion. DAO’s possess the ability to direct value back to holders and participants of the DAO in unique, new and interesting ways. We believe that they will transform the traditional model of centralised business and organisations into fairer, more competitive internet native structures that better serve the communities needs and desires. 

Yes, they still have their issues, and their proliferation across society will still take some time; however, DAO’s are setting the stage for exciting, new types of governance and ownership that promise a more transparent and democratic future. 

Extract from:  https://etherbridge.substack.com/p/decentralised-autonomous-organisations

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Originally Posted on November 28, 2021 – Decentralised Autonomous Organisations