This week’s story: a simple guide to DAOs

This week’s story: a simple guide to DAOs

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Simple guide to DAOs

Autonomous Organizations, or DAOs, are largely acclaimed as the future of companies. They are also regularly accused of being an empty hype with few real benefits.

Let’s try to understand what a DAO is really about.

What is a DAO

A DAO is a set of blockchain-based smart contracts that allow people to collectively raise and deploy money or achieve another pre-set goal. DAOs are fuelled by their tokens: a user buying a token contributes to DAO’s treasury and receives in return the voting right that they can exercise for any important decision, like investing DAO’s funds, distributing dividends etc.

DAO is a major breakthrough in the way people organize themselves: the traditional notion of trust (and the administration-related bureaucracy supposed to enforce it) is replaced with trustless and transparent smart contracts, that, once deployed on a blockchain, cannot be changed. This allows people who don’t even know each other put together their money and efforts in order to achieve a common goal. Sometimes this goal is hard-coded into the DAO’s smart contract (like sending funds raised for charity to the intended recipient), sometimes it is voted for by the community (like investing in an NFT). The key difference with the traditional organization is that, assuming that the smart contract is correct, the room for fraud is very little. Also, unlike traditional organizations, DAO is ruled by the owners of its tokens and not by a centralized authority like a board of directors.

The first DAO was created on Ethereum in 2016 and called simply “The DAO”. It is famous mostly for being hacked and pushing the whole Ethereum network to rewrite the blockchain from the block before the hack (and subsequently creating Ethereum Classic by users who did not agree with the fork).

Nowadays DAOs are ubiquitous, mostly because they have become so easy to create. Tools like DAOhaus and Aragon allow to launch a DAO with pre-set characteristics (a DAO for providing services, investing, governing a protocol…). Apps like Gnosis Safe and Syndicate allow to manage DAO’s treasury, while Snapshot and alike enable an easy voting.

DAO types

Just like traditional organizations follow the economy, DAOs develop alongside the web3 and become increasingly specialized. This is how we at D.Center would classify them today:

DeFi DAOsMakerDAO was the first DeFi DAO created in 2017 as a core layer and a management center for the first algorithmic dollar-pegged stablecoin DAI. On a side note, it was also the first investment of the famous VC firm Andreessen Horowitz’ crypto fund, who bought 6% of MKR tokens back in 2018 for $15 million. Today A16z crypto funds amount to $7.6 billion.

Since then, a multitude of DeFi DAOs have seen the day, popping up alongside DeFi protocols like Uniswap, Compound, and Solend.

Investment DAOs. Using DAO as an investment fund is probably the most obvious approach. People pool in funds to buy an expensive asset – like Constitution DAO that aimed at buying a rare copy of the American Constitution, or to make a series of investments – like Red DAO specializing in digital fashion that bought several Dolce&Gabbana NFTs, or to participate in the art movement – like Flamingo DAO that purchases NFTs of digital artists like Fewocious.

More complex forms of investment DAOs include Venture DAOs that buy tokenized stakes in crypto startups, like MetaCartel DAO.

Charity DAOs. DAOs can also be used to raise funds for charity, like Ukraine DAO that auctioned off a simple NFT of the Ukrainian flag for $6.75 million, sending funds to Ukraine’s official crypto wallet to help it combat the russian invasion.

Media DAOs. The impact is not always measured in money, at least not immediately. Some DAOs, like the Bankless DAO, gather a community of crypto enthusiasts, writers and educators who produce quality content and get BANK tokens in return.

Ecosystem DAOs. In traditional companies, business development is decided upon by the board of directors. In the web3 space it can be outsourced to the community, where token holders can vote on supporting companies and protocols enriching their ecosystem. For example, Aave Grants DAO can decide on giving grants to developers who submit meaningful proposals on improving Aave protocol, and ApeCoin DAO can vote on the distribution of its Ecosystem Fund, created to support new projects involving BAYC NFTs and the upcoming Otherside metaverse.

DAO controversies

It’s not all rose, of course.

In its newest report released this week Chainalysis analyzed the distribution of ten major DAOs’ governance tokens and found that less than 1% of all holders have 90% of voting power.

This also means that between 1 in 1’000 and 1 in 10’000 of these ten DAOs’ holders have enough tokens to create a proposal, and between 1 in 10’000 and 1 in 30’000 holders have enough tokens to single-handedly pass it.

We reckon that this concerns mostly DeFi DAOs, where the founding team still holds most of the tokens, but still it is incredibly centralized – way too centralized for the initial promise of DAO to reinvent organization.

The recent troubles of Solend, a lending DeFi protocol built on Solana, is a great illustration of these dangers. Solend had a problem with a whale who deposited a big amount of SOL to borrow stablecoins, representing 95% of the platform’s total borrowings. As SOL price was dropping, the collateral became at risk of liquidation, which could potentially send SOL price even lower and hurt other SOL holders and Solana in general. Solend team did not find anything better than to call for a Solend DAO vote to temporarily modify the smart contract in order to take over the whale’s account and execute the liquidation OTC, which would not affect the market.

The proposal passed in just 6 hours with 1.1 million “yes” votes to 30k of “no” votes. However, over 1 million of “yes” came from a single user, and without their vote the proposal wouldn’t have even reached the necessary 1% quorum.

The community backlash was impressive, and Solend DAO has passed and approved the motion to rescind the previous proposal, while also increasing the voting time to 24 hours. The incident, however, has raised many questions as to DAO’s governance.

For those who worry about Solend – it all ended fine, with Binance’s CZ helping to find and contact the whale in question, who since has decreased his exposure at Solend.

The future of DAO

We believe that issues like Solend help advance the space and teach users to pose the right questions about a DAO they intend to join.

Like any other web3 tool, DAOs will not magically reinvent the world, but knowing their possibilities and limitations, many new opportunities appear.

One of such opportunities could be hybrid DAO – a structure where a centralized company delegates some of its decision taking to a DAO, allowing its community in and thus increasing customer engagement. Creating a DAO with a clearly set function and distributing governance tokens to loyal customers can push the business culture towards the client, and we believe that could be a winning strategy, especially for B2C companies.