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What Is A Decentralized Autonomous Organization (DAO) And Why Does It Matter?

Blockchain technology and smart contract technology allow for the creation of autonomous governance. Often referred to as Decentralized Autonomous Organizations, or DAOs, these concepts introduce community empowerment and transparency. It is an exciting development and opportunity for the broader industry, although one that may prove complicated to make successful.

What Is A Decentralized Autonomous Organization Exactly?

The concept of a Decentralized Autonomous Organization is straightforward to explain: it serves as an organization governed by computer code and programs and community members. It can function entirely autonomously at all times, removing the need for central authorities, CEOs, or other intermediaries.

Pulling off such an autonomous organization would not be possible without the use of innovative technologies. Smart contracts, which serve as an extension of the blockchain, can interface with external information and execute commands accordingly. Although projects often incentivize community members and stakeholders to play a more active role in this process, none of these processes require human intervention.

The transparent nature of a DAO comes into play regarding rules and transaction records. All information resides on the blockchain for everyone to see. Stakeholders can vote on the DAO’s rules and requirements. Making decisions as a part of an autonomous organization occurs through proposals that community members submit. If a proposal achieves the necessary threshold to be accepted, it will be implemented automatically. 

The Crucial Differences

One may see similarities between the inner workings of a DAO and traditional corporations. The big difference is how a DAO has decentralization and foregoes the conventional hierarchical structure favoring openness and accessibility. With no bureaucracy to contend with, DAOs can use economic incentives to align interests between the organization and its members. Game theory plays a crucial role in this process. 

Contrary to what one may think, the members of a Decentralized Autonomous organization have no formal contract or ties to the organization. Instead, they find themselves drawn to these concepts through a common goal or incentives. All of the rules are found within the open-source software governing the organization.

One caveat to consider is the borderless nature of DAOs. Although these organizations operate beyond traditional borders, it also makes it challenging to address legality and legal issues. Different rules may apply depending on the jurisdiction of operation, creating a very complex landscape. 

The decentralized and autonomous nature of a DAO makes it easier to remove the position of “single authority making all the decisions.” Instead, no single party can control it, as a community makes all decisions of participants. In theory, all actors want the best outcome for the network as a whole, rather than something that enriches the individual. Whether that will be the outcome depends on the governance rules of the DAO and how they are designed. 

One could argue that a Decentralized Autonomous Organization is an “operating system for global transparent and open collaboration. Both individuals and institutions can work together without knowing about one another’s existence. Nor do they need to trust one another., as the protocol allows for “blind trust” in other participants.

Exploring The Principal-Agent Problem

As is often the case where innovative technologies are concerned, every solution aims to tackle a long-standing existing problem. For DAOs, that problem comes in the form of the principal-agent dilemma. It is a common concept: someone has the power to make decisions on behalf of another person or entity. If that decision-maker has an incentive to act selfishly, they may disregard the interests of the other person or entity altogether. 

In such a situation, the decision-maker can take risks on behalf of the person or entity they decide for. However, there may be some information asymmetry between both parties. For instance, the other person or entity may never know they are being taken advantage of as they may not have access to all the details. 

A real-world example of the principal-agent problem is not hard to find. Elected officials, brokers, or any other centralized figurehead can – at any moment – act in self-interest only without people becoming aware of it. It is for this reason that decentralization and distribution of power are crucial for our modern society.

The blockchain enables much better transparency and different incentive models to distribute power rather than consolidate it. As incentives within a DAO are aligned, and information asymmetry is kept to an absolute minimum, there is a very low risk of corruption, selfish behavior, or shady dealings.

Examples Of A Decentralized Autonomous Organization

Over the years, there have been numerous attempts at creating a DAO in various forms. One can even consider the Bitcoin network as a decentralized autonomous organization, as it operates in a decentralized manner and eliminates any hierarchy between ecosystem participants. The underpinning consensus protocol ensures there is no need for “superusers” capable of making decisions for the rest of the network.

As a protocol, Bitcoin defines the organization’s rules while the native bitcoin currency is an incentive to keep the ecosystem safe from harm. A simple yet efficient method to ensure collaboration between participants ensures the network remains operational in a decentralized and autonomous manner. 

In the Bitcoin ecosystem, all participants share the common goal of storing and transferring value without any intermediaries. It is an elementary form of a Decentralized Autonomous Organization, even though the concept can achieve many more purposes. 

As the concept of a DAO evolves and developers experiment with new ideas, new use cases are explored. Token governance, decentralized VC funding, or even alternative social media platforms can all benefit from the DAO structure. Some teams even explore the option of leveraging a Decentralized Autonomous Organization approach for the Internet of Things (IoT).

One interesting development in this industry is the creation of a Decentralized Autonomous Corporation, or DAC. It is a “subset” of the DAO capable of providing similar services to regular companies. However, it has no corporate business structure, despite operating as a company. 

In the future, self-owning cars can provide ridesharing services as part of a DAC and operate autonomously without human involvement. They can still interact with humans and other devices to provide services and collect payments. However, everything can – in theory – be operated via a blockchain and smart contracts.  

Ethereum’s The DAO 

At its core, a Decentralized Autonomous Organization remains a very ambitious project that can prove incredibly challenging to leverage correctly. The Ethereum ecosystem was home to “The DAO” at one point, a collection of complex smart contracts to provide autonomous venture fund services. Its native token was sold during an Initial Coin Offering and provides ownership stake and voting rights. 

Unfortunately, this venture was short-lived when a hacker drained funds. To rectify the situation, the Etheruem developers rolled back transactions, splitting the ecosystem into two chains. It is this event that resulted in Ethereum and Etheruem Classic moving on as two separate ecosystems. Etheruem Classic’s blockchain still has the fraudulent transactions associated with The DAO in its record, whereas Ethereum does not. 

The Issues Of Running A DAO

As innovative as a Decentralized Autonomous Organization may be on paper, the concept still faces many hurdles. 

Legality Issues

There is currently no regulatory framework to indicate DAOs are legal or illegal. Every jurisdiction can draft its own set of rules regarding this matter, although it doesn’t appear to be on the priority list at this time. The longer this uncertainty remains, the less appealing it will be to create or embrace a DAO. 

Coordinated Attacks Remain Possible

While a DAO focuses on decentralization, transparency, and immutability, it will also remain a target for coordinated attacks. This new “organizational structure” introduces extra risks and drawbacks that would otherwise not be present. 

Some Centralization Aspects

Contrary to what everyone may think, a Decentralized Autonomous Organization cannot always be 100% autonomous or decentralized. Certain aspects of the organization may require a degree of centralization to make sense.

Opening up the floodgates to broader participation is only one facet of running an organization. Governance rules, for example, will always be a form of centralization. While community members can adjust those rules over time if need be, the initial set of rules will always be created by “someone” on behalf of others. 

Closing Thoughts

There are many benefits to exploring a Decentralized Autonomous Organization. Creating broader participation in organizations by sacrificing some decentralization will prove beneficial in the long run. It is also a great use case for blockchain technology and smart contracts in the real world, as new use cases await. With its automated governance rules, participants will always have an incentive to choose the most beneficial path for the ecosystem.

As the Bitcoin network remains a simplistic example of a DAO – and remains successful after 11 years – there is a valid example of how to approach this concept. Introducing more complexities, however, will pose challenges regarding legality, coordinated attacks, and centralization.  Building an efficient set of consensus rules is a lot more challenging than people give it credit for. 

One cannot take the technological and social challenges associated with a Decentralized Autonomous organization lightly. There is a reason why very few of these DAOs exist outside of the cryptocurrency industry today. The concept has a lot of merit and potential but remains in the very early stages of research and development for now.

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