A DAO, or Decentralized Autonomous Organization, operates as an entity governed by code, usually on a blockchain network, with decisions made by its members through voting mechanisms. Here's how it generally works:

1. Creation: A DAO is typically created by deploying smart contracts on a blockchain. These contracts outline the rules, governance structure, and functions of the organization. For instance, a DAO might involve rules for voting on proposals, allocating funds, or making decisions.

2. Token Holders: Members of a DAO hold tokens that represent their ownership or stake in the organization. Token holders often have voting rights proportional to the number of tokens they hold, giving them a say in the DAO's decisions.

3. Proposals and Voting: Anyone within the DAO ecosystem can propose changes, initiatives, or decisions. These proposals are often submitted through the blockchain, and token holders can vote on them using their tokens. The voting process is transparent and recorded on the blockchain.

4. Smart Contracts Execution: Once a proposal is approved through the voting mechanism, smart contracts automatically execute the decision. For instance, if the proposal involves allocating funds, the smart contract will transfer the specified amount to the designated address.

5. Transparency and Accountability: All transactions, proposals, and voting outcomes are recorded on the blockchain, ensuring transparency and accountability within the organization.

6. Autonomy: DAOs aim to operate autonomously, with little to no human intervention once the rules and smart contracts are set in motion. This autonomy is achieved through code execution based on predefined rules and conditions.

7. Challenges: DAOs face challenges such as security vulnerabilities in smart contracts, governance disputes, scalability concerns, and regulatory uncertainties.

 

Pros

  • A variety of individuals can collectively come together from around the work to act as a single entity.

  • More individuals have a voice in the planning, strategy, and operations of the entity.

  • As votes on the blockchain are publicly-viewable, tokenholders are naturally incentivized to act more responsibly.

  • Members of a DAO may feel empowered to collaborate with like-minded individuals with similar goals within a single community.

Cons

  • It often takes longer for decisions to be made as there are more voting participants.

  • There is often more burden to educate users as the collective voting population are diverse with varying ranges of education and knowledge.

  • More time is needed to cast votes or gather users due to the decentralized nature of the entity.

  • Severe exploits such as theft of treasury reserves are possible if the DAO's security is not properly established and maintained.

DAO Example: The DAO

The DAO was an organization that was designed to be automated and decentralized. It acted as a form of venture capital fund, based on open-source code and without a typical management structure or board of directors. To be fully decentralized, the DAO was unaffiliated with any particular nation-state, though it made use of the ethereum network.

The DAO launched in late April 2016 thanks to a month-long crowd sale of tokens that raised more than $150 million in funds.3 At the time, the launch was the largest crowdfunding campaign of all time.

Why Did The DAO Get Disbanded?

By May 2016, the DAO held a massive percentage of all ether tokens that had been issued up to that point (up to 14%, according to reporting by The Economist).4 At roughly the same time, however, a paper was published which addressed several potential security vulnerabilities, cautioning investors from voting on future investment projects until those issues had been resolved.

Later, in June 2016, hackers attacked the DAO based on these vulnerabilities. The hackers gained access to 3.6 million ETH, worth about $50 million at the time.5 This prompted a massive and contentious argument among DAO investors, with some individuals suggesting various ways of addressing the hack and others calling for the DAO to be permanently disbanded. This incident also figured prominently in the hard forking of ethereum that took place shortly thereafter.

What Are Some Criticisms of The DAO?

According to IEEE Spectrum, the DAO was vulnerable to programming errors and attack vectors.6 The fact that the organization was charting new territory in terms of regulation and corporate law likely did not make the process any easier. The ramifications of the structure of the organization were potentially numerous: investors were concerned that they would be held liable for actions taken by the DAO as a broader organization.

 


In summary, DAOs function as decentralized entities governed by code and operate based on the collective decisions of their members. Through smart contracts and token-based governance, they aim to create transparent, autonomous, and community-driven organizations on the blockchain.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.