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A Definitive Guide On Decentralized Autonomous Organization (DAO)

The crypto community talks a lot about Decentralized Autonomous Organization (DAO). A lot of people who are new to the crypto space often find themselves wondering what exactly is DAO. Basically, DAOs are sort of systems of governance that are powered by a community. They tend to be independent of governments and other third parties. Also, the organizational and business model of Decentralized Autonomous Organizations is quite different from regular organizations. In this article, we are going to discuss everything you need to know about Decentralized Autonomous Organization (DAO), including what it is, how it functions, as well as how you can create a DAO yourself. So, without further ado, let’s dive into it!

What is DAO?

DAO stands for Decentralized Autonomous Organization. As the name suggests, it's a decentralized organization. This means there isn't a central authority controlling the operations of a decentralized organization. Now you must be wondering how it operates if there isn't a third-party or central authority, right? Well, it's run by the community, and each member of the community has the same authority. Now you must be wondering how a DAO makes decisions if everyone in the community has the same authority. To put it simply, it works like a democratic system where decisions are based on the majority rule. Let’s take a look at some of the key characteristics of a DAO:

  • Self-sustaining: DAOs are sustained by members staking tokens in liquidity pools. Members also run crowdfunding campaigns to attract investment from several investors, including venture capitalists.

  • Non-hierarchical: The decentralized nature of the DAO means that the organization is run by the community members holding the tokens instead of a central authority. This also ensures that there is no hierarchal management like business managers, presidents, or executives in a DAO.

  • Various Usage: DAOs are incredibly flexible in how they can be used. They can be used in making digital tokens, NFTs, and even decentralized applications.

  • Open Source: The source code and rules for any DOA are stored within a smart contract which is visible to all the members of the community. Therefore, all the community members can see all the historical data in a DOA, including the record of transactions and changes in the protocol since its inception. This makes decentralized organizations highly transparent.

  • On-chain Governance: In order to propose any sort of changes in the protocol or to make any decisions, members need to stake a specific number of tokens. Once a proposal has been submitted, it is then voted on by other members of the organization to decide the matter.

The First DAO

The first DAO was created by Simon Jentzsch and Christoph back in 2016. They created the DAO to act as a venture capitalist fund. Unfortunately, this DAO fell victim to a security loophole in its smart contract code. This loophole was exploited by the DAO's members, who managed to siphon 1/3 of the organization’s entire funds. This exploitation led to the collapse of the organization and a hard fork in the Ethereum Blockchain. The first DAO was also unable to meet the regulatory laws set out by the Securities and Exchange Commission (SEC). As a result, it was classified as an unregistered security.

How Does A DAO Function?

The building block of any DAO is a smart contract. Basically, smart contracts are digital contracts that run only when certain predefined conditions are fulfilled. Smart contracts are designed to be executed on their own, meaning they don’t need any human intervention. The code of a smart contract can be altered if a member of a DAO submits a proposal and the majority of the community members approve it by participating in a voting procedure.

How To Create A DAO?

We have now gone through the fundamentals of what DAOs are, what purpose they serve, and how they function. Now, let's go through a simplified step-by-step guide on how to create and launch a DAO.

1- The Basic Roles

The first step of creating a DAO is defining a non-hierarchical set of roles for each member of the organization. These roles need to be clearly defined and can vary from DAO to DAO. Some of the most common roles include:

  • Token Holders: Token holders are the members who power the DAO by maintaining a pool of the organization’s native tokens. Their efforts are rewarded by providing them with more native tokens depending on their participation within the community. Apart from owning native tokens, token holders also submit proposals and participate in voting procedures.

  • Developers: These members maintain the overall code of the organization, including the smart contracts that are being executed and updated.

  • Curators: This role was primarily made to prevent 51% attacks. There’s a bit of debate on whether curators are actually relevant or not. Their main purpose is to go through addresses from which smart contract proposals come and whitelist them.

  • Financial Managers: A DAO can end up amassing a large amount of funds. These funds need to be managed by people who have financial expertise and can carry out tasks revolving around financial reporting, funds management, diversification, etc.

  • Community Managers: These members are tasked with responsibilities that help build and maintain the DAO’s overall community. They interact with new members, operate a DAO’s social media, and basically manage the digital landscape of an entire DAO.

These are some of the most common roles that can be found in multiple DAOs. Depending on the nature of a DAOs, a variety of other roles can be formed as well.

2- Developing Smart Contracts

Once the non-hierarchical structure of a DAO has been finalized, the next step involves developing smart contracts on which the DAO will run. Developers write smart contracts and execute them on a DAO’s chosen Blockchain. The Ethereum Blockchain is the most popular choice for DAOs; however, other Blockchains such as Solana can be used for this purpose as well. Smart contract creation can take from days to months, depending on the complexity of the DAO and how many times its smart contracts need to be tested and refined.

3- Funding

After a DAO’s smart contracts are ready to roll, it’s time for the organization to raise funding. This can either be done by members of the DAO injecting liquidity or through a token sale. The latter is a more popular option since it also helps recruit more members.

4- DAO Deployment

Once a DAO’s structure, smart contracts, and funding are all ready, the organization can be deployed on the chosen Blockchain. After deployment, it begins functioning as a fully-functional decentralized organization. However, an important point to note is that deployment isn't the final step in launching a DAO. DAOs need to be monitored and maintained post-launch. As the organization functions, bugs can occur, and security flaws can arise.

This is where smart contract editing comes into play. In order to maintain a DAO and improve its code, members have to submit proposals to alter the smart contract code. These proposals are submitted and then voted on by the entire community. Identifying gaps in a DAO's code and fixing them can be a time-sensitive issue. It’s because malicious parties are always on the lookout for security gaps to exploit.

5- DAOs: Legal Structure & Regulatory Laws

DAOs are usually concentrated in regions with crypto-friendly policies (such as the state of Wyoming in the USA). In 2021, a law was passed in Wyoming that allowed for the creation of fully legal DAOs. The DAO LLC law recognized DAOs as member/algorithmically managed organizations that would receive the same level of benefits as LLC (Limited Liability Companies) entities. This law means that DAOs are subject to all benefits and regulations applied to LLCs.

Popular DAOs

Right now, there are a number of DAOs with a multitude of members. Let’s take a look at some of the most popular DAOs.

  1. Uniswap (UNI): UNI is one of the most active DAOs with an automated trading mechanism that is self-sustaining. This DAO’s native token, the UNI, sits at the very top of the Coinmarketcap.

  2. Aave (AAVE): The AAVE DAO functions as a lending protocol. Lenders can add funds to liquidity pools and earn interest from the platform. These pools are utilized by people borrowing funds to form crypto collaterals. Borrowers receive flash loans against these crypto collaterals.

  3. BitDAO (BIT): BitDAO has one of the largest member counts in the world. This DAO’s native token (BIT) is what powers and drives the entire organization. BitDAO’s primary goal is to develop a highly capable decentralized platform that leverages next-gen web3 organizations and Defi entities.

  4. MakerDAO (MKR): This DAO was launched back in 2017. It functions by issuing DAI (a stablecoin) that is pegged to the US dollar. The DAI stablecoin itself is managed by the MakerDAO community.

DAOs: Benefits and Limitations

DAOs hold a lot of potential due to their wide range of use cases. Decentralized organizations can be used for generating funds and investments, borrowing or lending capital, and for decentralized trading. The reason why DAOs are so popular in the crypto community is because of how they can be utilized in Defi and other spaces.

The downside of DAOs is that they are too ahead of their time. Currently, there's a very little legal framework and infrastructure to support their usage. Also, security issues are common in DAOs, and fixing these issues is quite slow due to the entire voting process. Security flaws can turn into massive trouble for DAO members since funds can be lost/stolen through them.

Other limitations include:

  • The majority voting approach can result in an adverse impact on the lowest common denominator in the group.

  • Technical vulnerabilities can be difficult to tackle.

  • For profit, DAOs have to deal with a slew of regulatory laws that hinder their functioning and development.

DAO: The Future

DAOs hold a tremendous amount of promise. They have the ability to potentially change the way traditional hierarchical organizations function. Unfortunately, there’s still a long way to go before DAOs become mature enough to be used on a larger scale. By the end of this article, you should have a better understanding of what exactly DAOs are and why they are so popular right now. If you're still unsure about the usages of DAOs or want to develop and launch your own DAO, you can always reach out to our Blockchain experts. Here at IIInigence, we have a number of experienced Blockchain experts who can help you deploy and maintain DAOs.