What exactly is a DAO and how does it work?

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With blockchain technology expanding its branches to everything from businesses to games, it has also created a new form of organization: the DAO, or Decentralized Autonomous Organization. This form of organization is evolving the way many industries work. But first, what is DAO?

Animated figures connecting with each other via DAOs

What is a DAO?

A DAO is basically an organization where control is in the hands of its members rather than in a hierarchical structure. It follows the core principle of blockchain, which is decentralisation. The organization works according to a smart contract with participants using governance tokens to vote on various topics.

Any community can customize and program a DAO to function seamlessly:

Firstly, the governance mechanism is based on a smart contract, which is a form of code. Smart contracts are open protocols programed to execute automatically. Additionally, they are publicly accessible and verifiable. Therefore, any member of the organization can easily view the smart contract. After this, members use governance tokens to take part in decision-making for that particular decentralized organization. Finally, the outcome is determined via the degree of participation and voting preference. 

In 2016, some developers created the DAO to automate and facilitate Ethereum transactions. The creators believed that they could eliminate human error or manipulation by putting decision-making power in the hands of an automated system. However, due to vulnerabilities in its code, hackers attacked the DAO and stole $50 million worth of ETH. 

What are the different types of DAO? 

  • AMM (Protocol) DAO

AMM (automated market marker) DAOs use smart contracts to provide financial services to members.

One of the major examples of AMM DAO is Makerdao, which includes around 1000 projects. Other popular examples include Uniswap and Aave Protocols. These decentralized exchanges work as crypto exchange aggregators. Therefore, they constantly look for market liquidity from different DEXs and receive lower token swap rates than just one single DEX. 

  • Grant DAO

Grant DAOs work by collecting funds in a single “Grant Pool” and allocating these funds based on a community vote. The primary aim of these DAOs is to fund emerging DeFi projects. Aave Protocol, for instance, uses Grants infrastructure to nurture and build its community of DeFi projects. 

Symbol of AAVE protocol which is an example of Grant DAO
  • Social DAO

While socially interacting in the crypto space, Social Decentralized Autonomous organizations use their community governance system to focus on common social interests such as arts and music. A popular example is Friends with Benefits (FWB), a community that focuses on unifying artists and cultural creators.

  • Investment DAO

Investment DAOs are decentralized organizations where members raise money for various DeFi activities. These DAOs also promote transparency and democratise investing. Some examples include the Meta Cartel  DAO, which invests in Ethereum projects, and The Krause House, which invests in NBA teams.

Symbol of Krause house DAO which is an example of investment DAO
  • Collector DAO

The Collector DAO is focused on purchasing NFTs. This also includes the distribution of ownership of blue-chip NFTs or other digital assets equally among all community members. For instance, Pleasr DAO purchased the original Doge meme NFT for $4 million with the involvement of all its members.

Symbol of PleasrDAO which is an example of collector DAO

NFTs and DAOs

DAOs usually have good collective ownership if combined with NFTs. Fans and creators of the NFT project can decide its course of action. For example, the Gutter Cat Gang DAO enables its members to vote on certain decisions, such as community project initiatives. Also, NFT creators can run a collective via a DAO where they can raise funds or market their project. 

NFT in black background

The Benefits of DAOs

All DAOs function with transparency when it comes to decision making. Another advantage is that DAOs are accessible from all over the world and they also have lower barriers to entry than traditional companies. Overall, DAOs operate on a much more economical scale since many tools used in building DAOs are open source. Lastly, DAOs give each member of the community a voice, which makes it more effective and encourages experts to invest in the system they are building.

The Disadvantages of DAOs

DAOs run on a spread-out structure, so there’s no authority figure or chain of command. This makes them slower to operate. Likewise, disagreements within the community sometimes even lead to division. More importantly, DAOs are still prone to potential security vulnerabilities that restrict many enthusiasts from entering such organizations. 

Future of DAOs

In the last few years, DAOs have made lots of improvements in terms of technical innovations, governance mechanisms, and voting solutions. Moreover, DAOs are active in creative industries, from fashion brands to filmmaking communities.

By the same token, investment DAOs are becoming a popular choice. Some even predict that DAOs can replace many traditional organizations if current issues with security and structure are resolved fully.