How DAOs may radically reshape all forms of human organization.
What is a DAO?
One of the most important social developments of the 20th century was the emergence of the large corporation. Companies like Ford, GM, and McDonald’s came into existence. These companies unleashed unprecedented economic growth.
Corporations enabled tens of thousands of people to work together in harmony – some at a factory, others at their desk. Steep and rigid hierarchies were needed for such institutions to run smoothly. Essential to the cooperation of thousands of people was a strong legal framework and property rights.
DAOs or Decentralized Autonomous Organizations aspire to replace the corporation of yesteryear. Rather than operating with a strong legal framework and in specific geographies, DAOs have their rules of operations enforced by smart contracts on the blockchain. DAOs operate outside any governmental jurisdiction. This means that no government is necessary to protect property and employment rights.
Just as cryptocurrency does away with the need for governments to back currencies, DAOs do away with the need for organizations to be structured around government-enforced legal contracts.
How do DAOs work?
Like traditional companies, someone needs to own a DAO. Public companies like Amazon or Volkswagen solve this through stocks or equity. If you want to own a share of Amazon, simply buy Amazon stock.
Decentralized Autonomous Organizations signify ownership using tokens, analogous to stocks, but sometimes representing only governance rights rather than underlying ownership. Possession of such a token is saved and recorded on blockchain, much like with Bitcoin or Ether.
There is no CEO to make top-down decisions. Instead, any decision made by DAOs is democratized. This means that anyone who owns a token has a vote on any decision the DAO makes. The more tokens you own, the more powerful your vote.
Direct democracy can be inefficient, however. As a result, many DAOs don’t allow *all* decisions to be made by their stakeholders, sometimes acting more like a representative republic than a democracy. In some cases, certain decisions are restricted to founders or only people with a minimum ownership of, e.g. 5%. This allows many small decisions to be made with greater efficiency, like the hiring and compensation of contributors. Then, only big decisions are made by the entire community, like large budgetary changes. Each DAO can set its own rules just as companies have different governance structures.
Given that these rules are transparently accessible to individuals considering buying share tokens, they don’t pose a huge problem to investors. In fact, the stability that these rules offer can often be a draw for a DAO.
Constitutional origins of DAOs
The abstract idea of the Decentralized Autonomous Organization is not a new one.
You could argue that the Federalist Papers, a series of 77 essays by Alexander Hamilton, John Jay and James Maddison in 1787, set out all the key principles of DAOs.
These argued that central authority should be limited, that power should be distributed to the people wherever possible – and that if that contract was broken, the people should have the right to overthrow their government through force.
Even further back, England’s Magna Carta, signed by King John in 1215, gave a group of individuals (admittedly, a small group of aristocrats) the right to challenge the monarchy and hold it to account. This was the first moment in the West that a nation built checks and balances into their constitution.
The philosophy behind DAOs sits strongly in this tradition of the rights of individuals to hold central authority to account. Indeed, DAOs could cut out central authority altogether – creating organizations that are operated for their stakeholders, by their stakeholders.
Benefits of DAOs
DAOs aspire to overcome a lot of nuisances and inefficiencies associated with traditional companies.
Firstly, they overcome a lot of the bureaucracy that is normally required to start a company. Since DAOs exist outside legal jurisdictions, much less legal overhead is required. This also means that there are lower barriers to entry. If a traditional company is registered in the United States, but wants to hire someone from Iran, there are many legal complications involved. The applicant may need a visa, or some other form of work authorization. Not so with DAOs.
Additionally, DAOs democratize decision-making substantially. Instead of the hierarchical system typical of big corporations, DAOs let all token holders have a say. Think of FC Barcelona for example. Every year, the club releases new jerseys. The design is picked by a handful of people in the club, but they never consult their large fan base. Now and then, the fans end up with shirts they hate. A DAO solves this problem, by requiring a vote – by the community, for the community – on the new design.
This ties to another advantage of DAOs. Since the community and contributors can easily hold a share of the organization, they have skin in the game. This means the community is very interested in the success and prospering of the DAO. DAOs open up the possibility of employee ownership to far more companies, without the complicated mechanisms normally needed for that.
Drawbacks of DAOs
DAOs are not perfect systems, though. They also have significant drawbacks.
Firstly, minority owners are at the mercy of majoritarian sentiment. Imagine that you own a 2% share in a DAO and someone else has a 55% stake. Your investment will be entirely at their mercy. They could pass a rule saying that you have to give up your share or need to pay additional money just to hold onto it. If one person or group can take control of a majority of shares on their own, the minority stakeholders are at risk.
Secondly, because effectively every issue requires each shareholder to form an opinion, decisions are made very slowly. This means it’s difficult to take advantage of time sensitive business opportunities or to protect and update software when vulnerabilities are discovered.
Finally, DAOs are currently largely unregulated. That means that there is no way to ensure that they are remaining compliant with the law and steering clear of criminal activity. Moreover, even if a breach was discovered, there is no centralized management structure to hold accountable. As a result, DAOs are largely unprotected.
Vulnerabilities of public decision making
Famously, a DAO known as the Constitution DAO, quickly found out the drawbacks of public decision-making. In December 2021, they tried to buy an original copy of the US Constitution from Sotheby’s as an investment. As with any DAO, they discussed their rules and how much they were willing to bid, eventually settling on the figure of $47 million.
Little did they know that a hedge fund manager swept in and bought the Constitution for a small amount more. He was able to do this because he joined the DAO and was able to see all the public discussions. As you can tell, the public nature of conversations in DAOs blocks the corporate secrecy that is often seen as a necessary prerequisite for beating competition. Only time will tell if DAOs are able to strike the right balance between open accountability and corporate competition.
How do DAOs conduct business?
DAOs are predicated on using existing permissionless blockchain technology, which allows for the use of smart contracts. As a result, a DAO could run on a blockchain like Ethereum, but couldn’t run on Bitcoin.
In conventional businesses, central management creates a set of rules, which are then interpreted by the company’s employees. However, in a DAO, the rules can be automatically implemented and enforced on the blockchain.
For example, an investment bank might say that 20% of its finances must be invested in education, 20% in gold, 40% in technology and 20% in food services. In a conventional investment bank, the employees will then find companies fitting those categories, release the funds and make the investment. This will take time and, equally important, the employees can choose to misinterpret or disagree with the strategy. However, using smart contracts, a DAO investment bank would automatically and immediately invest in those fields once a policy decision has been reached.
DAOs as employers
Even though much of the business in Web3 aims to be conducted automatically through algorithmic decision making, some DAOs might still need employees. They are still able to hire them like any other company or corporation.
One advantage of DAOs is that they are decentralized in nature. This means that they can hire employees from anywhere in the world, giving them access to labor at competitive prices and allowing them to hire a workforce with significant diversity of thought. Additionally, most DAOs allow employees to simultaneously contribute to multiple DAOs, creating an interesting cross-pollination across the industry. Imagine if someone worked part-time for Apple and Google simultaneously – while possible, this is very rare in Web2.
However, a disadvantage of DAOs from an employment perspective is that it can be challenging to get them to conform to employment law since there is no way of finding their owners or bringing them to account. It’s possible that a DAO might have no physical assets in a country, so it’s impossible for countries to confiscate assets as punishment. Moreover, given the prevalence of things like Virtual Private Networks (VPNs), it is almost impossible to ban a DAO from a country by restricting access to its services.
Uses of DAOs
So far, DAOs have already been used to create whole strings of companies. One prominent example is Nexus Mutual, which offers insurance using smart contracts. Because there aren’t many time-sensitive decisions that need to be made in insurance, with much of the legworth being done automatically through the use of computer algorithms and calculations, Nexus Mutual was well positioned to enter a DAO structure.
However, the vast majority of DAOs are currently focused on investing in Web3 development. This is because there is a large overlap between investors willing to explore other aspects of Web3 and ones who are interested in Decentralized Autonomous Organizations. Over time, the function of DAOs is expected to expand beyond simply investing in other aspects of Web3. Already a number of regional or hobby DAOs are growing, including the City of Austin’s ATX DAO or LinksDAO for golfers.
The ethics and politics of DAOs
One of the potential problems identified with the exclusion of the government from Web3 is that it could exacerbate inequality. There are clear reasons why tax avoidance will be significantly easier under DAOs. Many of the more controversial aspects of small-government economics – such as a lack of regulation, limits to worker’s rights, and the emergence of monopolies – could also be exacerbated in a DAO economy.
All of these factors could lead to an economy where a small section of society hoards large amounts of wealth.
However, there are very potent arguments that DAOs will promote equality of opportunity. First, there is much less red-tape and bureaucracy involved with starting a business. Additionally, it is feasible for a kid with a great idea in Venezuela or Bangladesh to acquire funding and start building a new enterprise, or to get hired by a DAO. Your passport and access to legacy banking infrastructure matter much less.
Similarly, while they are harder to regulate, there’s no reason why DAOs are unable to give rights to their employees. In fact, collective ownership and smart contracts could mean these rights are enshrined in a more secure way than when they are dependent upon government legislation – which is often subject to lobbying, or ideology that not everyone is on board with.
Famous examples of DAOs
One of the best known DAOs is BeetsDAO. Founded by Jordan Garbis and Sasha Rosewood, Beets is a group that launches and purchases music-based NFTs – essentially as a group investment fund. One of their most famous projects involved launching an NFT in collaboration with Snoop Dogg and Nyan Cat which netted $250,000 when sold.
Another famous DAO is Decentraland, who aim to invest collectively in the purchase of Metaverse property. To date, Decentraland has taken control of more than 98,000 different parcels of virtual real estate and have recently sold a parcel of land for $2.43 million.
Many DAOs exist to pool together capital from individuals for investment, including FlamingoDAO for NFTs, NeptuneDAO for DeFi, and countless smaller groups of investors. Social DAOs like Friends With Benefits exist for networking in the Web3 industry, and many localized city-specific DAOs like ATX DAO in Austin or Andrew Yang’s national Lobby3 DAO work with regulators to educate and advance legislation for DAOs and Web3 more broadly.
Essentially, any cause, club, or community can create their own DAO if they believe the structure is beneficial to achieve their goals.
