The initial premise of cryptocurrency was to disintermediate corporate institutions that control money issuance. It has since evolved to encompass blockchain technology that in turn has a host of applications. Most of these projects are run by a decentralized autonomous organization (DAO).
They replace humans with code that acts similarly to a venture capital fund by allocating resources as it sees fit. The DAO doesn’t represent the interests of any one individual, corporate entity, or government and instead provides a more democratized leadership model based on community participation.
Early DAOs in the 2010s faced criticism due to widespread security concerns. In fact, it was a $50 million hack in the project simply called “The DAO” that caused the most notable hard fork in the Ethereum ($ETH) code.
That hiccup didn’t stop overall progress though. The DAO became ever more popular and in the 2020s Decentralized Finance (DeFi) rose to prominence. ConstitutionDAO, for example, raised over $40 million in a short timeframe using entirely grassroots marketing. It wasn’t long before Kickstarter got in on the action by beginning development of its own DAO.
Here’s everything you need to know about how these protocols are defining the future of DeFi.
Is Bitcoin A DAO?
Bitcoin ($BTC) is the original DAO. It’s a fully functional project that runs autonomously through a consensus protocol. All financial transactions are recorded on the blockchain’s distributed ledger and require no validation from a third-party acting as a governing authority.
Ethereum expanded upon these capabilities by building a smart contract network that lets anyone build their own DAO on top. A typical corporation would have a C-suite and Board of Directors in charge of making decisions for the company as a whole. Although the board admittedly runs on a voting majority too, this hierarchy places all the power within a small group.
By contrast, the DAO is structured very differently. The DAO acts as a committee that requires the voting pool to meet certain thresholds to make decisions, such as determining financial allocation.
Not only that, but they’re fully transparent and public with all transactions, meaning you can track activity from anywhere in the world. DAOs can be a powerful way to replace the existing corporate structure built on the back of venture capital.
Anatomy of a DAO
In order for a small business to scale into an enterprise, seed capital, venture funding and/or growth equity is often needed. Early stage investors, venture capitalists and growth equity investors provide fuel to help entrepreneurs grow businesses at the expense of owning equity in return.
DAOs invert the power differential between capital allocators and entrepreneurs by democratizing access to funding so that a community vote is needed to allocate funds to projects.
Decisions are made via hard-coded rules that remove the corruption of having a large amount of power thrust into the hands of a few people. The majority consensus wins, and that fundamentally changes the way corporations are run.
While it may sound ideal, as explained above the initial DAO was a disaster. And that leads to some valid criticisms of this innovative new form of governance.
How A DAO Got Hacked: $14 Billion Theft
An original DAO (“the DAO”) was founded in April 2016 and within weeks held about 14 percent of the total ether supply at the time. However, a paper was published that highlighted security concerns in the DAO’s architecture. By June of that year, hackers stole 3.6 million ETH. That was worth about $50 million at the time, although it would be worth over $14 billion today.
Of course, that doesn’t account for the Ethereum fork that occurred as the DAO began to crumble. Some investors expressed personal liability concerns for the actions of the entity, and the SEC issued a July 2017 report determining the DAO’s tokens were an illegal security. By then, it was de-listed from several large crypto exchanges.
Like angel investors, DAO investors face liquidity and liability problems that could be costly. Still, the integration of crypto into mainstream financial apps means DAOs are again on the rise.
Popular DAOs to Watch
Although the DAO was the “Zune of blockchains“, it did prove the capabilities of blockchain beyond the technology. Decentralized, autonomous governance has been applied to a variety of use cases that continue to expand. Here are some high-profile DAOs to watch.
Crypto exchanges can charge fees and add an unnecessary middleman to the process of trading coins.
Uniswap is a DeFi protocol that enables automated crypto transactions for tokens on Ethereum’s smart contract network.
Unlike centralized exchanges like Coinbase Global (NASDAQ:COIN), which are governed by a single entity, Uniswap is a decentralized exchange (DEX).
This dual-layer protocol was built in 2018 and is fully compatible with all ERC-20 tokens, along with wallets like MetaMask. Users maintain full control of their funds without giving custodial control to a centralized exchange.
Staking your tokens into the liquidity pool earns rewards, and its UNI governance token provides voting rights in the Uniswap DAO.
EduDAO runs on the larger BitDAO ecosystem. Both aim to revolutionize traditional VC funding.
EduDAO is a combined effort from blockchain groups at eight schools, including Berkeley, Harvard, MIT, and Oxford. Each school org has its own DAO, which in turn receives financing from the $11 million in annual funding from BitDAO.
By combining their efforts, these school groups share research amongst each other and with the public. This open access to Ivy League intelligence should prove to be a valuable resource in the long term.
MakerDAO is a decentralized organization that created the two-token Maker/Dai system.
Dai is a stablecoin pegged to the value of the US Dollar. It’s collateralized by ether and governed by hodlers of the Maker token, which votes on the hardcoded rules that the entire ecosystem abides by.
This allows the DAO to act like a financial institution and facilitates collateral-backed loans with the need for a third-party intermediary. Users can stake or lend crypto assets to earn money through this smart-contract lending protocol.
What Is a DAO In Crypto? The Bottom Line
The original DAO (Bitcoin) is still around today, but the first DAO to make headlines did so for all the wrong reasons when a philosophically sound idea on paper met real-world hackers. That didn’t stop organizations from learning from the mistakes made and evolving the DAO concept to a variety of projects.
DAOs exist with goals ranging from buying expensive things previously only accessible to the ultra-wealthy to spreading information to the world. Each has its own rules and governance structure, just like corporations. There is no telling what DAOs will accomplish in the future, but they’re already making waves and proving their power today.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.