Decentralized-Autonomous-Organization (DAO)
What is a DAO?
Decentralized-Autonomous-Organization (DAO): can be seen as the most complex form of a smart contract, where the
bylaws of the decentralized organization are
embedded into the code of the smart contract, using
complex token governance rules.
Historically, the Bitcoin network was considered the first true
autonomous corporation, that was coordinated solely through a
distributed consensus protocol, which anybody was free to adopt. Today,
DAOs moved up the technology stack, thereby becoming fully virtualized
through software. In case of a Bitcoin-style autonomous corporation, a
complex stack of technologies and human-machine systems has to be put in
place in order to create a functioning autonomous infrastructure.
Decentralized-Autonomous-Organization (DAO): At today’s evolutionary stage, a
DAO materializes as a smart contract
– a piece of code – executed on top of an increasingly opaque stack of
distributed networking and consensus technology like the Ethereum
blockchain or similar blockchains.
Blockchain Technology Stack Of Ethereum and similar Blockchains (Inspired by Florian Glatz)
Decentralized Organizations (DO)
The idea of a decentralized organization takes the concept of
traditional organizations and decentralizes it. Instead of a
hierarchical structure managed by a set of humans interacting in person
and controlling property via the legal system, a decentralized
organization involves a set of people interacting with each other
according to a protocol specified in code and enforced on the
blockchain.
Decentralized-Autonomous-Organization (DAO): may or may not make use of the
legal system for some protection of its physical property, but even this
such usage is secondary. For example, one can take the
shareholder-owned corporation above, and transplant it entirely on the
blockchain; a long-running blockchain-based contract maintains a record
of each individual’s holdings of their shares, and on-blockchain voting
would allow the shareholders to select the positions of the board of
directors and the employees.
Smart property systems can also be integrated into the blockchain
directly, potentially allowing DOs to control vehicles, safety deposit
boxes and buildings.
DAOs are the holy grail of DOs: it
is an entity that lives on the internet and exists autonomously, but
also heavily relies on hiring individuals to perform certain tasks that
the automaton itself cannot do.
Disrupting Governance with DAOs
Governance is the way rules, norms and actions of how people interact
with each other are structured, sustained, regulated and held
accountable. It regulates the process of decision-making among the
actors involved in a collective problem that leads to the creation,
reinforcement, or reproduction of social norms and institutions. The
degree of formality depends on the internal rules of a given
organization and, externally, with its business partners. As such,
governance may take many forms, driven by many different motivations and
with many different results.
Governance refers to all processes of governing, whether by a
government, market or network, family, tribe – formal or informal –
through the laws, norms, power or language. Blockchain can disrupt
traditional governance structures of all kinds, and challenge the way we
currently think about governance.
With large parts of our society traditionally organized in top-down
command and control ways, blockchain promises for more decentralized and
spontaneous coordination instead of rigid structures by addressing two
problems of traditional governance structures (1) Principal-Agent
Dilemma, and high (2) transaction costs of coordination.
Smart Contracts in a trustless trust environment – and DAOs are the
most complex form of a smart contract – tackle an age-old problem of
governance, which in political science and economics is referred to as
the principal-agent problem. This dilemma occurs when the agent – a
person or entity – is able to make decisions on behalf of, or impacting,
a so-called principal – another person or entity. In such setups, moral
hazard occurs when one person takes more risks because someone else
bears the cost of those risks, usually when there is an underlying
information asymmetry in play. If the risk-taking party to a transaction
knows more about its intentions than the party paying the consequences
of the risk, agents are motivated to act in their own best interests,
which are contrary to those of their principals.
Blockchain and smart contracts reduce transaction costs and levels of
bureaucracy and introduce the possibility of finding new ways of
aligning interests and governing groups of people in a much more
decentral way than we know today.
How DAOs work
Decentralized Autonomous Organisations (DAOs) run through rules
encoded as computer programs called smart contracts. It is an entity
that lives on the internet and exists autonomously, but also heavily
relies on hiring individuals to perform certain tasks that the automaton
itself cannot do.
- Tokens of Transaction: In
order to exist a DAO needs some kind of internal property that is
valuable in some way, and it has the ability to use that property as a
mechanism for rewarding certain activities. The funding takes place
directly upon creation of the organization. DAOs do not have a
hierarchical structure, nor executives or management.
- Autonomous: Once
deployed the entity is independent of its creators and cannot be
influenced by outside forces. DAOs are open source, thus transparent and
incorruptible. A DAO’s financial transaction record and program rules
are maintained on a blockchain. This approach eliminates the need to
involve a bilaterally accepted trusted third party in a financial
transaction.
- Consensus: In
order to withdraw or move funds from a DAO, a majority of its
stakeholders (this percentage could be specified in the code of the DAO)
must agree on the decision. Even if bugs are found in the code, they
could not be corrected until a voting procedure has taken place and the
majority of voters agreed on it, which could leave known security holes
open to exploitation.
- Contractors: A
DAO cannot build a product, write code or develop hardware. It needs a
contractor to accomplish its goals. Contractors get appointed via voting
of token holders.
- Proposals: Proposals
are the primary way for making decisions in a DAO. To avoid people
overloading the network with proposals, a DAO could require a monetary
deposit to prevent people from spamming the network.
- Voting: After
submitting a proposal, voting takes place. DAOs allow people to exchange
economic value with anyone in the world, like investing, money raising,
lending, borrowing, without the need of an intermediary, just by
trusting the code.
All cryptocurrencies which use public blockchains are DAOs
(Bitcoin, Ethereum, Dash, Digix, etc.). Modern DAOs are complex smart
contracts on top of a blockchain.
The DAO was an example of a DAO on top of the Ethereum blockchain.
DAOs as Crowdfunding Vehicles
Since smart contracts run on top of public blockchain networks such
as Ethereum, they can be programmed to collect and manage real economic
value in arbitrarily large amounts referred to as ICO.
The DAO was
an example for such an ICO. Its aim was to be a decentralized
autonomous investment fund without fund managers. In the biggest ICO at
its time, TheDAO ended up collecting an equivalent of 150m USD in
cryptocurrency. Everybody willing to invest was guaranteed a
proportional share of the future revenues of the company. Additionally,
those shares could be traded for any other asset listed on
cryptocurrency exchanges, spanning across both fiat and
cryptocurrencies.
Despite The DAO experiment ending prematurely with a spectacular and
highly controversial “hack” and a subsequent hardfork of the Ethereum
Blockchain, the idea of a new kind of crowdfunding model, based on
blockchain token issuance as ownership shares in the funding target’s
future success, ignited the minds of entrepreneurs worldwide and has
ever since sparked an ICO frenzy.
Voting Process of TheDAO – Source: https://daohub.org
A growing number of startups are beginning to raise risk capital to
fund the development of individual products, services or protocols, in a
way that shares the future success of the company with its users and
investors. Instead of complex, uncertain and strictly-regulated legal
contractual relationships between investors and founders, those startups
rely fully on DAO-type smart contracts to manage those relationships.
Circumventing legal systems and thereby legality itself, is, however,
not the primary interest of most of those startups. Instead, it is the
much lower barrier to entry as well as the new untapped market potential
that motivates entrepreneurs to go down the route of token crowd sales.
Ideals of a new kind of sharing economy, where the users of a service
are at the same time its owners, give those startups moral grounds for
venturing into legally gray areas.
Need for Legal Certainty
Startups trying to operate as DAOs are in need of a legal framework
that allows them to conduct business not only within the closed world of
a blockchain network but to interact with the physical world, the world
of traditional financial instruments and that of intellectual property.
To achieve this goal, two major barriers need to be overcome.
Firstly, startups need to know which kinds of regulations apply in
which jurisdiction when selling cryptographic tokens, that may in some
form represent a stake in future profits. The potential applicability of
contemporary securities regulation is self-evident. Secondly, startups
need a workable legal contractual framework, which allows DAOs to be
embedded into our current institutional framework around the three
above-mentioned fields of physical and intellectual property as well as
traditional finance.
Both of those open problems are tough because they require a lawyer’s
intuition in a field, that has before only ever been the subject of
science fiction literature. To an appreciable extent, however, partial
answers may be developed by a suitably staffed entity, that is
experienced in solving complex compliance issues arising in areas such
as international private, financial, trade, corporate and tax law.
