Blockchain and NFTs

What Is A DAO And How Do They Work?

In this article, we’ll take you through all you need to know about DAOs - what they are, how they work, and how to get involved.

July 25, 2022

Blockchain technology opens up a world of new possibilities for business-minded people revolutionizing the way we buy, share, and keep our money. DAOs, short for Decentralized Autonomous Organizations, are an increasingly important part of the blockchain world.

What is a DAO?

A DAO, or decentralized autonomous organization, brings together a group of people in an entity where there is no central authority. DAO is managed entirely by its individual members.

Critical decisions about the future of the project, such as technical upgrades and treasury allocations, are made by all members of a community. Then they come together to vote on each proposal. After achieving some predefined level of consensus, the proposals are then accepted and enforced by the rules instantiated within the smart contract.

Community members organize work through smart contracts, which are the backbone of a DAO, and rules are enforced on the blockchain. These rules are digital agreements that contain all terms and conditions of a given transaction or decision. A smart contract contains pieces of code that automatically execute every time a set of criteria is met. Now, there is a wide range of blockchains for participants to deploy the contracts, such as Ethereum (ETH).

In other words, it is a company without a CEO where all workers have an equal say and equal shares, and where all decisions are made by taking into account the opinions of the whole group. Here computer software becomes responsible for implementing changes based on what the employees have decided.

Internet users should buy governance tokens to become DAO members (of whatever crypto token the DAO is written to run on). This will let them have a say in community decisions and vote on them. The flat hierarchy approach leads to more efficient and transparent governance and outcomes.

DAOs are fully autonomous, meaning the outcomes of votes are tallied without the need for human vote-counting, and the resulting action is automatically carried out. As the DAO’s code is transparent and everyone can see it, it is easy to work with people you don’t know, no matter where they are in the world. You don’t have to worry about whether they’re trustworthy, and you don’t need to add layers of intermediaries and escrows to reduce fraud.

As DAOs function similarly to for-profit and nonprofit businesses, Wyoming passed a law earlier in 2021 recognizing DAOs as limited liability companies. This paves the way for a DAO to be recognized as a legitimate type of business.

How Does a DAO Work?

When a DAO is first created, the rules of the organization are written (or established) in the form of smart contracts that are set up to automatically fulfill the terms when certain actions are completed. The treasury, or pool of assets is governed by smart contracts, so no one can spend or take the money represented in the treasury without a vote from all the members.

Smart contracts first appeared on the Ethereum blockchain, which remains the platform of choice for the majority of DAOs. But they are now commonplace across many blockchains.

As we know, anyone who has participation tokens can become a DAO member. Being a DAO member you will have an active say and hold voting rights on key decisions like how to spend donations and implement the DAO’s rules.

These decentralized autonomous organizations have built-in treasuries to store digital currency. Members can access it upon approval by the group and all related decisions are made collectively.

How is a DAO Created?

Below are the three crucial steps to follow when creating a DAO:

1. Creating a Smart Contract

The developers of the DAO code the smart contract with all the rules, policies, and objectives that will be applicable to the organization. Note that this stage requires an extensive testing phase of the code as, once developers are done creating and launching the DAOs, the rules they set can only be changed through a group voting system. Attention to detail is key.

2. Raising Funds

DAOs run on a shared cache of virtual currency that is raised among its members. When you buy into the organization, you’re agreeing to purchase a number of tokens in exchange for a stake in the group and the decision-making process. Governance rules can also be established in this phase.

3. Launch

When all the foundations are in place, the DAO’s code is deployed onto the blockchain. From here, the original developers no longer retain control of the project, and stakeholders take over and start deciding on the future of the organization.

How to Get Involved

We should note that not all DAOs operate with the same purpose so the first step is figuring out the core function of each DAO. For DAOs focused on technical governance, it’s important to understand what sort of voting rights are granted to token holders and what kind of proposals are at stake.

Some DAOs (for example Uniswap) allow token holders to vote on distributing a portion of the fees that the protocol collects amongst themselves. In other protocols such as Compound, token holders can vote on distributing these protocol fees towards bug fixes and system upgrades.

This approach allows all the people who are interested in the project to join ad hoc and receive compensation for their work by way of DAO grant-funded projects (DAOs regularly post these sorts of ad hoc projects on their Discord server).

Other DAOs focus more on treasury pooling and allocation. For example, SharkDAO exists primarily to facilitate the pooling of individual token holders’ funds as a means to acquire rare NFTs that would otherwise be too expensive for the common person (in this case, the goal is to acquire Nouns, which can sell for well over $250,000). This approach provides new opportunities for individuals to leverage the power of a collective pool of assets.

One of the key points here is the transparency within a DAO. One can easily observe the details of each proposal and the voting records of particular token holders. Even individuals with an entrepreneurial mind can freely submit proposals to help lead the future development of a protocol.

There are different levels of DAO participation. You can choose to swap into governance tokens and pay attention to Snapshot votes; you can join the DAO’s Discord and take on actual projects where you’re compensated for your contribution; you can even invest in DAOs of interest by networking at conferences. You yourself choose how involved you want to be.

To sum up, DAOs are designed so that participants can be complete strangers and they do not need to “trust” one another. The blockchain’s code that includes the contract terms, as well as all participants’ actions, is public and permanent.

Implementing a DAO structure can prove to be a successful strategy and can lead to more positive outcomes that can bring even greater benefits to all types of structures member-owned communities and projects.