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What is a DAO?
A Decentralized Autonomous Organization also known as a DAO is a form of governance where decisions are made based on open-source code that can only be changed by proposals and votes from the members of the DAO. This means that a DAO will not be controlled by a central authority. Instead, the leadership is distributed among a wide range of members who have a stake in the DAO. The term and concept of “DAO” was coined and proposed by EOS founder Dan Larimer and Ethereum developer Vitalik Buterin in 2013.
Example of a DAO
There are several well-known examples of DAOs. For example, we recognize MakerDAO (DAI), Compound (COMP), yearn.finance (YFI) and Uniswap (UNI). On these platforms, anyone with governance tokens can obtain voting rights and possibly make a proposal about the future of the protocol.
How does a DAO work?
The core element of the DAO is the underlying smart contract. All rules regarding the organization and funds are determined in this contract. Smart contracts can send and receive money which means that DAOs do not need a central authority to complete these actions. Once the smart contract goes live, it becomes immutable and no one can change the code individually. The tamper-proof and public nature of the smart contract ensures that the DAO can provide a secure and transparent network. Participation is possible in a variety of ways and participants are free to make suggestions about the future of the DAO.
How to become a member of a DAO?
There are two different ways to become a member of a DAO. Members of the DAO can determine what will be voted on regarding important developments of the DAO.
- Membership by means of governance tokens: Tokens will be available on (decentralized) exchanges or can be earned by providing liquidity (LP). The more tokens, the more voting rights. This way is freely accessible to everyone.
- Membership by share in DAO: Share can be obtained by minimum deposit and approval of the DAO. This “semi-open” form is used in investment or other profession-specific forms of DAOs.
Advantages and disadvantages of DAO
- Efficiency: A DAO will immediately distribute funds appropriately and proportionally to the share. New projects find funds immediately in this efficient way.
- Accessible to everyone: Anyone can participate and become a member of a DAO. All you need is an internet connection and a share in the DAO.
- Voting rights: A DAO will reward investors through governance tokens. This is similar to the dividends shareholders receive with their stake in a company.
- Vulnerabilities: Because DAOs are built on smart contracts, human negligence or bugs may cause problems. A protocol with many funds may be in the crosshairs of cybercriminals.
- Partisan Governance: A vote will pass when the majority is reached. It is possible that individuals with a lot of influence will vote in their own favor.
- Unclear Legislation: The DAO is a form of governance that is accessible all over the Internet. This can cause laws and rules to be broken in certain countries. The DAOs find themselves in a grey area regarding legal frameworks on security laws and corporate rights.
- Difficult to change code: Because any change to the code can only be added after consensus, some changes will be slow. This inability to change code quickly and smoothly makes the DAO vulnerable.
A Decentralized Autonomous Organization (DAO) was created to put decisions in the proverbial hands of smart contracts, where the core idea is that decentralized and democratic code is more reliable than a central authority.
We find that the explosion of Decentralized Finance (DeFi) has led to a huge increase in DAOs. Yet there is still much room for growth. Issues of security, structure and legality will undoubtedly challenge the future of DAOs.
Will this new form of governance be the beginning of a financial revolution? Or is the DAO something of a passing fancy?