A Definitive Guide To DAOs
What is the Future of Work? We’ve been talking about this for quite some time now. It’s interesting to see varied opinions where some say work will become zoom/web native with occasional work from the office or physical setups. It becomes even more interesting when Web3 enthusiasts chip in to comment that we might become web-native and crypto native. What do they mean by that?
Web3 has become a breeding ground for bringing together people with similar thoughts and striving for a change on an equal platform. What started on Facebook, Twitter, and closed rooms has now taken the form of organisations that are meant to work solely on the blockchain and want to radically change or alter the notions of organisations in the real world. One such concept is that of ‘DAOs’.
A DAO is a “decentralised autonomous organisation”, but you might have heard that already. It’s a vanilla term for a collective of people deciding to pool resources into a smart contract and then use some form of decision-making mechanism (voting) for allocating those resources.
DAOs are Web3 counterparts to limited liability companies and cooperatives when structuring. In essence, they are flat organisations with little to no middle management. A better word for it would be ‘holacracy’ - where there are no assigned roles, and members have the flexibility to take on various tasks and move between teams freely.
DAOs differ from other generic organisations because the organisation’s resources are stored in a smart contract on the blockchain. The smart contract rules determine access to those resources or any other contract it interacts with.
Over the past few years, we’ve seen DAOs emerge as preferred structures for managing grant-giving and investments in the Ethereum ecosystem. DAOs have seen their fair share of ups and downs since their inception, but two significant events introduced a larger audience to the concept.
‘The DAO’ Debacle
The first time the idea of an on-chain organisation gathered steam was in 2016. German blockchain startup Slock.it had an ambitious goal—to build a humanless venture capital firm that would allow investors to make all the decisions through smart contracts. There would be no leaders, no authorities. Only rules are coded by humans and executed by computer protocols. This organisation was called - The DAO.
It was launched on April 30th and, by May 21st, had raised $150 million from roughly 11,000 investors in what was considered the most prominent crowdfunding effort in history. But then it got hacked.
On June 17th, someone started siphoning money out of the DAO. By the end, the hacker, who said that he was simply taking advantage of a technical loophole in the DAO, had amassed $50 million in ether, based on the then exchange rates.
The onus of dealing with the issue fell on the core developers who designed and ran Ethereum, even though they didn’t have anything to do with this setup or the fraud that happened. The path they took to resolve this was called a “fork.”
The fork was a decentralised network’s version of a reset button. It entailed rolling back the entire Ethereum network to a previous day and was meant to eliminate the DAO and move all the money into a smart contract that would only reimburse investors.
The core developers of Ethereum unilaterally decided to essentially create a new version of the network with different rules than the original. Then, miners, exchanges, and other significant apps built on it needed to decide if they wanted to be a part of the new version of Ethereum or the original. Hence, the fork.
ConstitutionDAO and the rebirth of DAOs in 2021
ConstitutionDAO was formed in November 2021 to purchase one of the 13 original copies of the United States Constitution at an auction from the high-end auction house - Sotheby’s.
Jonah Elrich and 30 other members started the movement. They formed the DAO and offered worldwide the ability to donate to it using the Ethereum blockchain. In exchange, they’d get the right to vote on what to do with this copy of the Constitution and what the organisation should do in the future.
The group raised $47 million from 4000+ members in Ether but lost to Ken Griffin, the chief executive of the hedge fund Citadel’s offer of $43.2 million. The group had gone to the extent of offering the donors its own governance token, $PEOPLE, which would give them voting rights and other added advantages as they figured out their way and formed an actual LLC to comply with Sotheby’s KYC requirements.
Having lost the auction, the core team decided to wind down. Thus the tokens possess no rights, governance, or utility other than redeeming them for Ethereum from the smart contract at a ratio of 1,000,000:1—the same ratio at which contributions were made to the initial crowdfund to buy the Constitution. More than $1 million was spent in gas fees contributing to ConstitutionDAO. It is estimated more than $3 million would be spent in gas fees when refunding the donations back to the eth addresses.
While ConstituitionDAO failed in its attempt, it amassed massive media attention and raised awareness about DAOs as a whole. The Overton Window for crypto native organisations shifted for the better.
Recipe of a DAO
Now that you know why DAOs are in the news, let’s dive into the making of a DAO. A few underlying principles need to be met for a DAO to thrive or even be called a DAO. What are these?
Smart contract setup: Before a DAO can be deployed, the underlying rules must be defined and coded in a series of smart contracts. Any changes to the DAO’s operational workflows, governance system, and incentive structures will need a voting system for validation - this phase is arguably the most critical step. A thriving and sustainable, and autonomous DAO needs to work on stabilising its core thesis utilising a carefully coded smart contract.
Funding: After establishing governing smart contracts, the DAO needs funds to operate. The treasury is the most important resource that a DAO has because while the smart contract lays the framework, the funding facilitates real-world action. This includes but is not limited to the creation and distribution of some form of internal property, such as a native token that the DAO can spend, utilised in voting mechanisms, or used to incentivise certain activities.
Deployment: Once a DAO receives enough funding, all decisions are made via a consensus vote. As a result, all token holders become stakeholders who can make proposals regarding the DAO’s future and funds. It is an evolving process, just like any other organisation with funds. Deployment is very much a result of how well the workings of the DAO are coordinated and an all-inclusive economic benefit for the members. Suppose the token distribution policy and consensus mechanisms defined in its underlying smart contract architecture are well-designed. In that case, the DAO’s stakeholders will naturally work towards the most beneficial outcome for the entire DAO network.
What purpose do these ingredients or processes serve when we talk about the core concepts of Web3?
Tokenisation: Today, DAOs are operated on open-source platforms. One might join a DAO by simply becoming a part of their discord server, but this doesn’t make one a stakeholder in the workings of the DAO. Thus, DAOs utilize blockchain-based tokens to represent voting rights. As a result, only token holders can participate in network governance.
Self-enforcement: DAOs utilise smart contracts that automate organisational rules. These smart contracts can significantly reduce — or even eliminate — the need for intermediaries that might compromise decentralised decision-making.
Automatisation: A single smart contract is only capable of handling simple transactions. DAO frameworks must define a complex set of smart contracts that enable multi-party interactions — without human involvement.
Decentralised infrastructure: Although DAOs utilise decentralised governance, the underlying network must also exist on distributed infrastructure. Without adequate decentralisation, governance can be exploited by those with significant enough computing power.
Transparent data: Blockchain helps DAOs function successfully as decentralised governance mechanisms. Immutability helps protocols transparently communicate organisational processes and data.
Trust mechanism: Smart contract conditions and other protocol mechanisms codify a certain degree of trust into DAOs. As a result, various agreements between network stakeholders can occur without involving third parties.
Therefore, the resulting DAO organisation can operate independently from its creators or central authority. Since DAOs are open source, all of their rules, transactions, and activities are recorded on the blockchain and can be reviewed by anyone, which generally ensures complete transparency and immutability. In short, a DAO’s stakeholders are bound together by a common goal. They will vote to advance by pursuing specific network incentives defined by the DAO’s underlying consensus policies.
A DAO's assets can be controlled by stakeholders directly via a token. Stakeholders can be pseudonymous and based anywhere in the world. These pseudonymous stakeholders have to unanimously decide and allocate a DAO's assets for anything, including hiring employees. DAOs, consisting of hundreds of known and pseudonymous members, have legitimately hired employees based on community reputation alone.
While discussing Web3, we need to emphasise that decentralisation is not an absolute milestone that can be achieved by tweaking systems and pulling levers across tech and economics. Rather, it’s a spectrum. Contrary to many peoples’ beliefs, the most successful or talked about projects and startups operating in the space are relatively centralised in their approach and decision making even though they’re building on and for web3.
Exchanges like Coinbase, CoinDCX, WazirX and many others are centralized in everything. The company’s board and the CEO decide which coins should be listed and any other decision regarding the org’s future and workings.
But there are also instances of exchanges popularly known as Decentralized Exchanges (DeX) like Uniswap and Sushiswap, which are relatively decentralised, and it’s the people who decide which coins should be listed on the exchange. But even then, they are not in any means a DAO. In the case of Uniswap, it was only last year that they structured themselves into a DAO and launched their tokens (UNI). Sushiswap is also yet to become a DAO. It’s still working on its governance framework and tokenization process.
A few more takeaways::
Even though the name suggests that DAOs are automated, a lot of manual heavy lifting needs to be taken care of from the policy and decision-making side. Only the operations can be automated.
Governance token is one of them and not the only prerequisite to label any Web3 related org. as a DAO
Decentralisation of decision making, i.e., handing over the power to the people to pave the course of action, can be done without being a DAO.
Only when the handing over ownership is being discussed, the idea of DAO might come into the picture.
If a self-proclaimed web3 expert is asked about the future of blockchain, they’ll often talk of governance and DAOs in the very same breath. The reason is that the very concept of a decentralised organisational structure challenges the traditional approach of running a company in today’s world, where a bunch of folks are at the top of the pyramid deciding the course of action for all stakeholders.
Incentivisation: A system where no one person is leading the pack, and every member of the organisation is participating in some capacity in the decision-making process needs incentivisation for everyone to keep them aligned with the overall goal of the DAO and direct their efforts towards the same. Here are some of the methods of incentivisation as suggested by a16z that DAOs have put in place and are seeing initial success
Yield Farming - Yield farming occurs when users are rewarded for performing actions like lending, borrowing, staking, or providing other forms of asset liquidity — and the reward comes in the form of a token representing a piece of ownership of the protocol itself. Recipients can either accumulate that ownership, counting on a rise in the value of the protocol, or they can sell it on the open market, compounding their action and increasing their yield. Liquidity mining is when a yield farmer gets a new token and the expected return (the "mining" part) in exchange for the farmer's liquidity.
Airdrops - A prominent example is an airdrop, or delivery of tokens to current or former users’ wallets to spread awareness, build ownership, or reward early users retroactively. For example, the decentralised trading protocol Uniswap launched the UNI token, which was granted retrospectively to everyone who had ever used the Uniswap protocol. This airdrop led to some early users earning tens of millions of dollars worth of UNI.
Coordination: Since DAOs require high participation by design, the friction of getting everyone aboard on decisions should be minimised and smoothened from a time perspective and the standpoint of equity, equality, and safe upkeep of the interests of the members. The voting process of on-chain governance takes place on the blockchain, using some form of governance tokens. Here, three different models are standard:
Company model: One governance token represents one vote. These tokens can be transferred and traded on the open market.
Membership model: Each member of an organisation gets assigned only one vote via a membership token. These tokens are non-transferable and, in most cases, even revocable.
Reputation model: This system can be seen as a company and membership model mix. One reputation token represents one vote, like a company token. However, reputation tokens are not transferable, like membership tokens.
An exciting aspect about Web3 and DAOs is that they shouldn’t be only viewed from a tech and finance perspective. Reimagining decision making through democratisation is a phenomenon that has significant societal relevance. These communities are experimenting with never tried before mechanisms for voting, and the tech aspect is used to reduce the friction. A majority of DAOs have been looking at voting from various methods.
Treasury Management: Funds, once accumulated, need to be used from a first-principles approach and should primarily attain a few prime objectives. Structuring and solving for an infinite time horizon is the prime objective. Diversifying assets and having more inflows than outflows is the only way to keep the stakeholders’ interests aligned from an economic point of view.
Spending: DAOs need to spend the funds accumulated on grants to individuals and groups contributing through new projects, which will improve the ecosystem of the protocol and empower the network of devs.
Asset Allocation: This is a tricky and crucial part of treasury management. Since we’re currently somewhere between web2 and web3 - considerable thought is needed when investing in stablecoins. There are several benefits of investing in stablecoins. Some of them being
Maintain or ramp up spending in the event of a significant market drawdown
Allow governance contributors, grant recipients, and security bounty recipients to be wholly or partly paid in stablecoins
Diversifying assets will become even more crucial soon as we see protocol level mergers and DAOs negotiating with significant stakeholders. Thus, it will become the standard token of acceptance for the proceedings.
Borrowing: This might include securing credit through issuance of bonds or even a protocol to protocol loan with interest. Borrowing might seem a viable option in the following situations:
The cost of capital is cheap when funding is done via debt and not the issuance of tokens
The members are not ready to dilute liquidity and ownership by issuing tokens
When the plan is to keep the tokens vested for long and avoid distribution during destructive market cycles
The legal construct of DAOs is relatively new and unrecognised in most jurisdictions across the globe. At the same time, there is a demand by folks in the space not only to recognise DAOs as legal organisations but also regarding the inclusion of smart contracts under the local contract laws. Thus, as of now, it’s slightly tricky to get into any agreement regarding a DAO from a legal perspective.
What is significant is that there have been attempts earlier to bridge the gap between DAOs and the real world, like when 'The DAO' established an affiliate company in Switzerland under DAO. Link allows 'The DAO' to enter into contracts and the contractors to raise invoices.
The Cayman Islands Foundation Companies Law, 2017 may also be used to set up an affiliate foundation company for DAOs as an offshore entity. By definition, “A foundation company under the law is a flexible vehicle that operates like an incorporated trust, allowing it to function like a civil-law foundation or common-law trust while retaining the separate legal personality and limited liability of a company.”
When a DAO is looked at from the lens of a limited liability partnership, then the liability of partners under a general partnership is unlimited, making each member responsible for the actions of all the other members of a DAO. This means that If a DAO doesn't have assets to satisfy its debts or legal obligations, members’ assets may be used to fulfil such obligations.
The US state of Wyoming recently passed the "Wyoming Decentralized Autonomous organisation Supplement". The new law adds to the current Wyoming Limited Liability Company Act recognising DAOs as limited liability companies (LLC). This makes Wyoming the only jurisdiction with an express recognition for a DAO and limited liability for its members. Express recognition would allow benefits such as the ability to enter into contracts, sue in its name (and be sued) and hold property. But there is still a very long way to get DAOs legal recognition and, more importantly, bring lawmakers and creators on the same page.
Types of DAOs
Despite its issues, DAOs are being adopted at an incredible pace and tested at all levels across industries. Here are some of the DAOs and the use cases that they’re being implemented out of them.
Developers are schooled in remote collaboration through tools like Github. They are optimisers, the most critical resource for building Web3 infrastructure, so it’s no surprise that developers have been among the first to structure themselves as DAOs.
BadgerDAO: BadgerDAO is a community dedicated to bringing Bitcoin to DeFi, especially providing $BTC collateral. Most Bitcoin bridges into DeFi are centralised, so, without a legal entity, BadgerDAO members have collaborated to fund and build a synthetic instrument called $DIGG, which tracks the price of Bitcoin using an elastic supply to adhere to the peg. They have also created a yield aggregator called $SETT, focused on wrapped $BTC assets. Governance of the DAO, including its treasury, is mediated by the $BADGER token: any vote requires 10% of the outstanding tokens to participate and a 50% quorum after seven days.
These DAOs are used as an ownership and governance mechanism for lending platforms, yield optimisers, and more to maintain and evolve the underlying platform reasonably and in a decentralised manner.
MakerDAO: MakerDAO is a decentralised lending network built on the Ethereum blockchain and is the protocol behind the stablecoin DAI. The MakerDAO Foundation initiated processes in April 2020 to achieve complete decentralisation and pass full ownership onto its distributed network of project stakeholders. This was done by giving control of the undistributed supply of the project’s governance token (MKR) to MKR holders at large, establishing a process of electing paid contributors, and improving the voter participation process to benefit smaller stakeholders.
Attracting more capital than ever, art has changed the Web3 space. The most high-profile adopters so far have been Christie’s & Sotheby’s auction houses, which have both sold NFTs and offer some crypto payment options. People are now more actively looking at art pieces from an investment perspective, and thus some of the top minds of the industry are working on multiple ways of expanding this asset class and have formed collectives to invest, some of which are:
KnownOrigin: KnownOrigin is an NFT marketplace that tested the concept of an art DAO in 2019 with OsakaDAO. Functioning as a decentralised collective of patrons, they raised $900 in pledges and then, playing the role of a gallery, they sold everything for a 56% profit. 5% of that money went back to the artists (in addition to their original commission fee), and the rest remained with the DAO’s treasury, to be deployed at the members’ discretion.
PleasrDAO: PleasrDAO began as a Telegram group to buy an NFT on Foundation called x*y=k, created by an artist called pplpleasr. The piece eventually sold for 310 ETH ($525,000) and seeded a DAO that now owns some of the most iconic NFTs in crypto.
Flamingo DAO: A sub-DAO that sprouted out of The LAO mentioned above. The Flamingo DAO focuses exclusively on NFTs as investment opportunities and to support the ever-growing metaverse and NFT sector – which they believe will revolutionise the world of digital ownership.
These social DAOs could take the form of any social circle, which often shares a common interest – they could be knowledgeable investors, it could just be buddies who hang out in a group chat or real life. One of the most notable social DAO is:
Friends with Benefits: An exclusive social club, which one can only join by owning a certain number of the FWB token. Consisting primarily of web3 artists, operators and enthusiasts, Friends With Benefits DAO members gain exclusive access to token-gated events, mastermind discussions and more. It even has its gallery and auction platform for digital collectables!
Investment DAOs are similar to traditional investment funds that operate with pooled capital. However, rather than a single centralised party calling the shots, investment DAO token holders can vote on what the pool of funds is invested in. The advantages of asset management under a DAO structure also apply to venture funding, and they’re actively being put to the test by DAOs like:
AngelDAO: Closely resembling a small family office, AngelDAO consists of four founders with equal voting rights who pool their skills to identify and manage investment opportunities within distributed systems and decentralised finance. Because their administrative burden is limited to the DAO and their finances, the founders have more time to contribute to the projects they invest in with technical, marketing and community support.
DuckDAO: DuckDAO is going further by building out an entire ecosystem of yield farming, staking and NFTs around their incubator service and leveraging the resources of their ~25,000 members to support ~50 investments.
The LAO: The LAO is structured as a member-directed venture capital fund in the US. It is registered as a Delaware limited liability company (LLC) compliant with US laws but carries out its functions via a DApp and smart contracts.
Joining a DAO
Now that you know what DAOs are and how they operate, the next obvious question is how to become a member of a DAO. There are various ways to become a part of a DAO, from contributing as a writer and helping with some of the content that a DAO might be trying to figure out or through graphic designing, contributing as a dev, video editor, or even providing legal expertise and communications outreach.
While this stands true for some of the newer DAOs, there are a completely different set of rules for the popular ones, and they keep changing from DAO to DAO. For instance
To join FWB, one must hold at least 75 $FWB cryptocurrency tokens
Membership in The LAO is currently limited to accredited investors, as defined under U.S. law. The total number of members will be capped at a maximum of 99 members on a First Come; First Served basis
It is relatively simple to become a part of the Flamingo DAO only if your application is approved. To become a community member, you need to fill in the form, pass KYC, AML identity verification, and get permission before you can join
Discord chat servers are usually the go-to communications hub for DAOs, and will usually be organised into multiple working groups. A simplified process would look something like this:
Setup an .eth/.sol ENS and metamask wallet for yourself as you would require one incase of bounties, airdrops and exchange of tokens
Find DAOs where the goal matches on lines similar to your thoughts about the space
The community should be thriving with a chatty, vibrant discord server, following on social platforms and the founding members having credibility.
Find a space for yourself where you think you can contribute and create opportunities, not for yourself but to help the ecosystem grow.
Suppose you’re interested in joining a DAO and learning more about Web3. In that case, you can have a look at SuperTeam DAO - formed by India’s top stand-up comic turned angel investor and Youtuber Tanmay Bhat and Akshay BD. The DAO aims to support projects on the Solana blockchain network through grants and mentorship support across growth, operations, and design. They’re supported by Solana Labs (parent organisation of Solana) and have constantly been putting out bounties for writers, designers and devs.
Now that we know so much about DAOs and the moonshot they’re aiming for, it’s time to rework and unlearn our ideas of how communities work and embrace the internet and global first approach. The pace at which DAOs have been thriving, you never know you might enrol yourself in one or even start working for one soon.
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