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Introduction
A decentralized autonomous organization referred to as DAO for short is an organization built on rules encoded as a computer program that is frequently transparent, controlled by the organization’s members, and uninfluenced by a central government. DAOs are member-owned communities with no centralized leadership that keep financial transaction records and program rules on a blockchain.
The DAO, which amassed 3.6 million ether (ETH) and was hacked and drained of US$50 million in cryptocurrency, is a well-known example of this type of business organization. The hack was reversed in the weeks that followed, and the money was restored, thanks to a hard fork of the Ethereum blockchain. The majority of Ethereum miners and clients migrated to the new fork, while the original chain was renamed Ethereum Classic.
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How do they work?
In order for DAOs to properly operate they rely on “smart contracts” which are sophisticated software programs and algorithms designed to take into account different circumstances and possible options that a user may take in order to enact certain rules.
This enables actions to be taken and decisions that would otherwise be centralized to be divided up amongst the various peers in the network to allow for decentralization and fair rules for all users.
Pros & Cons of the approach
Pros
Autonomous:
An autonomous structure means that consensus (decision making) can be made quickly across all nodes on the network as opposed to traditional centralized structures with a top-down approach which can take a long time to make a decision.
Equality:
With investors having the chance to influence decisions about how to manage the future of the organizations, these projects can offer users opportunities for everyone to contribute to the overall project.
Any stakeholder can make suggestions for protocol updates or improvements, and everyone in the DAO can view them and voice their opinions through decentralized governance. This brings about more equality and access that would otherwise be unavailable to most end-users of a product.
Neutrality:
DAOs offer an organization a neutral setting devoid of managers or middlemen with significant power. A collection of predetermined rules and policies are encoded in code to form smart contracts, and the DAO handles their execution automatically.
This ensures that predefined activities take place when they should with less chance of bias from differing personalities in management. This can become a valuable advantage for an organization’s workflow operating in the Blockchain.
For additional neutrality and to be transparent the software code for the “consensus” component is usually made open source meaning the code is shared online for other programmers to analyze and verify its integrity.
Reduction in costs & increased efficiency
DAOs are a low-cost solution for decentralized organizations because they eliminate intermediaries and lower transaction costs. Many processes can be automated using smart contracts, reducing the need for manual intervention and saving time and resources.
As a result, DAOs are an appealing choice for organizations looking to cut costs while increasing efficiency and transparency whilst achieving scale with their applications.
A supply chain management DAO, for example, could use smart contracts to automate the tracking of products and payments, eliminating the need for intermediaries (e.g. Kickstarter or GoFundMe) and manual intervention.
A crowdfunding DAO would help to automate the fundraising process and openly distribute funds, lowering transaction costs and increasing transparency between everyone involved.
Cons
Potential regulatory questions:
DAOs function in a legal and regulatory grey area, creating uncertainty and the possibility of legal challenges. Because they operate in numerous jurisdictions, determining which laws and regulations pertaining to them and how they can comply with them can be difficult.
Furthermore, DAOs may encounter regulatory challenges as regulators try to classify and regulate their operations which can vary in different areas and potentially interfere with the functionality of the whole project or for some users in certain regions.
Potential code security vulnerabilities:
Because of their dependence on smart contracts and their decentralized nature. Code exploits, Phishing, Supply chain breaches, and governance errors are some examples of vulnerabilities that may arise.
The DAO which was mentioned above was hacked back in 2016. This security breach resulted in the theft of millions of dollars worth of cryptocurrency assets.
This incident highlighted DAOs’ possible risks and vulnerabilities. Various security measures and best practices have been created since then to improve DAO security alongside conventional measures like 2FA however the risk of vulnerabilities remains if the code is misconfigured or the project has design flaws.
Potential for consolidation of voting power in the network
Despite setting out to be decentralized and peer-to-peer with equality in mind they often rely on DAO tokens to participate which means that investors or groups who can accumulate enough tokens and control enough nodes of the network can influence the decision-making process of the DAO.
This is known as a 51% attack where an individual or individual(s) is able to control enough nodes where they effectively control the platform.
This can be mitigated early on when the DAO is been created and the consensus protocol is designed to ensure early members cannot accumulate too much power but it is still an inherent risk.
How do DAOs make money?
A DAO project can raise money in a few different ways such as:
Donations
Some projects accept donations from individuals or businesses to support the ongoing growth and promotion of the DAO project.
Token trading
A DAO begins by raising funds by exchanging cash for its native token. This native token represents the distribution of voting power and ownership among members. The value of the native token will rise if a DAO is successful similar to a company on the stock market with its IPO (Initial Public Offering).
Investments
If the members of the DAO agree the project can make investments which in turn have the potential to generate profits for the members of the network.
FAQs about the topic:
Who controls a DAO crypto?
Governance. Tokens or NFTs that grant voting rights are used to coordinate DAO governance. Membership in a DAO is restricted to those who have proven ownership of these governance tokens in a Bitcoin wallet, and membership can be traded.
Is Bitcoin a DAO?
No, whilst Bitcoin started out in a similar way to a DAO its Blockchain network has expanded considerably and it is no longer considered a DAO by current standards but instead one of the many Cryptocurrencies. When the Bitcoin network wants to update the protocol, the network must agree.
Conclusion
We hope you found this resource page to be helpful and learned more about the technology that makes up a DAO. For other content like this be sure to check out the links below as well as our tech blog and business services for more.
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