What are DAOs?

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robertstevens

Robert has reported for a variety of international publications including the Associated Press, The Guardian, Vice, and Decrypt. Current areas of interest include the political economy of technology, cryptocurrencies, and privacy. Robert has a Bachelor of Science from UCL, and a Master's degree from the University of Oxford's Internet Institute.

DAOs are decentralized autonomous organizations: online-only groups that let people organize themselves like corporations. DAOs let their often anonymous members coordinate on matters as diverse as spending treasury funds, hiring employees, upgrading a complicated piece of software, and running an art gallery.

The concept of the DAO has been around for years but blew up in 2020 and 2021 once again when online communities needed to govern the ever-growing decentralized finance protocols they had invested in, or wanted a mechanism that would let them pool cryptocurrencies and work toward a common goal.

To help them coordinate, DAOs run on smart contracts—bits of computer code attached to blockchains, often Ethereum. Votes are dependent on how much cryptocurrency members of the DAO have pledged in favor of a specific outcome, just like how shareholder equity works in public corporations.

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The actual discussions usually take place on online forums or chat apps, like Discord or Telegram. Once a proposal has passed, the blockchain signs it into law and earmarks it for the project under consideration.

DAOs now control billions of dollars worth of funds and have accomplished some spectacular feats.

History of the DAO

The first DAO started in April, 2016, on the Ethereum blockchain network. It was called, simply, the DAO, and was intended to function as a kind of venture capital fund run entirely on the blockchain.

It was pitched as a game-changer for financial investing: “a new breed of human organization never before attempted,” in the project’s own words. Investors would use ETH to buy DAO tokens and use smart contracts to vote on which crypto projects should receive investment.

Back in 2016, as is still the case today, Ethereum was the second-largest blockchain network. The DAO held 14% of all Ethereum tokens in circulation just a month after it launched, according to The Economist, worth about $150 million, from more than 11,000 investors, according to crypto exchange Gemini. The smart contracts were developed by a German company called Slock.it.

The DAO was, however, a massive failure and forced the crypto community to put DAOs on the backburner for several years. A month later, hackers exploited a known vulnerability in the code of the DAO to steal about $50 million. The vulnerability had been pointed out by prominent computer scientists in May, just before the project stopped raising money and had been criticized for growing too quickly and sucking up too much money in the process.

The fallout was massive. To remedy the situation, some members of the Ethereum community, among them Ethereum co-founder Vitalik Buterin, proposed to roll back the Ethereum blockchain—the ledger that records all transactions, including the theft—to nullify the consequences of the hack. Other members of the Ethereum community thought that the consequences should be carried forward, since one of the founding principles of blockchains is the immutability of the ledger.

Since consensus couldn’t be reached, Ethereum “forked,” or split, into two separate networks, with one version of Ethereum erasing the damage done by the DAO hack and the other keeping it on its ledger. The erased version ended up winning out, and that version is what is referred to as Ethereum today; the other version, now known as Ethereum Classic, is far smaller.

The U.S. Securities and Exchange Commission also investigated the DAO. In a report on July 25, 2017, the SEC ruled that the tokens sold in the fundraise constituted securities under federal laws and that “those participating in unregistered offerings also may be liable for violations of the securities laws.”

The SEC’s report set a precedent that would be used in many court cases, and made it much more difficult to raise funds through crypto fundraising sales, known in the industry as Initial Coin Offerings, or ICOs.

The DAO report encouraged new blockchain companies to become “sufficiently decentralized” before they released tokens from fundraising efforts. To do that, crypto companies raising selling tokens in crypto crowdsales began to replace themselves with DAOs over time to avoid incurring the wrath of the SEC.

DAOs today

Although the first DAO crashed and burned, the concept of decentralized governance has prevailed. On May 10, 2021, four years after the first DAO, crypto industry insiders estimated that DAOs controlled about $1 billion, a 100-fold increase compared to the year before.

There are, very roughly, two kinds of DAOs that exist today. The first is what we might call the “sufficiently decentralized” DAO. This is the kind of DAO that marks the eventual fulfillment of the promise on dozens of decentralized finance companies’ roadmaps—that the company will replace its line of C-suite executives with a decentralized board, and anyone who holds the project’s token can vote on proposals to upgrade the network.

The closest thing to this kind of DAO in the non-crypto world is the traditional public company. A private company takes all decisions by itself and then, when the executives have got the engine running smoothly, they turn the company public. In the process, they raise a lot of money by issuing new stock through an Initial Public Offering. Public companies often put certain matters, like the hiring and firing of a new CEO or issuing a report on racial diversity, to equity holders.

The difference with the DAO is that lots of decentralized finance protocols want their code to become so self-sufficient that the community can regulate it entirely, without any need for a CEO. While public companies often don’t let the shareholders vote on much, the DAO is responsible for running the entire operation and taking all major decisions.

This type of DAO might be called “sufficiently decentralized” because the motivation to hand over power to DAOs is not just about the principle of decentralization, it is partly a legal issue.

The phrase “sufficiently decentralized” comes from a June, 2018, speech from William Hinman, who at the time directed the SEC’s Division of Corporation Finance. Hinman said crypto projects that are “sufficiently decentralized” can’t be sued by the SEC because they can’t be considered to be run by a company. Although the SEC has not issued specific guidance around what might constitute sufficient decentralization, the crypto community agreed that one way this could be done is to hand over control to a DAO. (The SEC’s new chairman, Gary Gensler, has poured cold water on this idea, saying it is nothing but theatre).

Lots of popular decentralized finance projects now run partly, if not entirely, through DAOs; the founders either play an entirely passive role or have no greater rights than any other token holder. Examples of the “sufficiently decentralized” DAO might include Uniswap, Compound, Aave, or Synthetix. These DAOs are incredibly important for the projects they control. Votes can require millions of dollars and the support of the majority of the network to pass.

As an example of a proposal passed by a DAO, one proposal on Uniswap wanted to fund a crypto lobbying group to educate politicians about the myriad benefits of crypto (and Uniswap). The proposal, filed by the Harvard Law Blockchain & FinTech Initiative, was eventually approved, and the DeFi Education Fund won $10 million. Despite saying that it would allocate the funds over 4-5 years, HarvardBFI sold half of the funds immediately, to much criticism.

The second type of DAO might clumsily be called the ”pure DAO.“ This is a DAO formed to unite anonymous individuals who want to spend cryptocurrencies on a common goal. They function just like the aforementioned “sufficiently decentralized DAOs,” but tend to be smaller and more specialized than the broader DeFi DAO. This type of DAO became popular in 2021, when crypto enthusiasts found like-minded people online who were willing to pledge money toward a common cause.

An example of this kind of DAO is PleasrDAO, a DAO that was formed exclusively to invest in NFT art. NFTs, or non-fungible tokens, are cryptocurrency tokens that represent ownership of an asset, like digital art. People in PleasrDAO put down their money and invest in NFTs as a group; the DAO then owns the art and members can vote on what to do with the tokens, like selling them or renting them out.

PleasrDAO started when a group of people was bidding against each other to buy an NFT from a pseudonymous digital artist called Pplpleasr. The bids on the NFT, a high-quality advertisement for Uniswap, were getting too high for the bidders, so they grouped together, created a DAO, and used their combined funds to buy the NFT.

The DAO has since invested in lots of other NFTs. It bought Tim Berners-Lee’s NFT for $5.4 million, used NFTs as collateral for a $3.5 million loan and bought a Dogecoin meme for $4 million. Said Santiago Santos, a PleasrDAO member and former partner at a huge crypto venture capital fund called ParaFi Capital, told crypto publication Decrypt: “We purchase and collect pieces which we believe are timeless and priceless mementos of digital and crypto culture.”

Last Updated September 7, 2021

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