Decentralized Autonomous Organization

Written by Alireza Aghaee Shahrbabaki, PhD student at Bocconi University, Milan.

What is a DAO?

A Decentralized Autonomous Organization, DAO hereafter, is an organization that automates its operations. The DAOs’ rules and transactions are maintained on a blockchain, which promotes information transparency among stakeholders, while smart contract's code controls the implementation of the DAOs’ regulations.

DAO governance is run by token holders, entities who are in possession of these governance tokens in a cryptocurrency wallet are qualified to participate in the DAO’s operation and voting. Similar to any other digital asset, DAO membership can be traded. Governance is carried out by a series of proposals that members vote on through the blockchain, and having more governance tokens typically equates to having more voting power (see more on voting mechanisms on DAO). Members’ contributions to a DAO’s organizational objectives may occasionally be recorded and internally paid.

While it is not hard to define DAOs in technical terms or from an economic point of view, such definition from a legal or social standpoint is proven to be challenging. Like most other new technologies, legislators and governments wait for a proper establishment of these entities before they take a firm position towards them, whether friendly or hostile. The lack of legal jurisdiction positions towards DAOs worldwide has resulted in attempts to fit DAOs in the existing legal formats when applicable, such as associations, foundations, or general partnerships. Hassan and Filippi (2021) lists and discusses the different definitions of DAOs used both in academics and industry. They assert that most academic definitions include the following distinctive characteristics:

• DAOs enable people to coordinate and self-govern online. Although no minimum group size is specified, the term “organization" is commonly understood to refer to a group of people working together toward a shared objective rather than a legally recognized organization.
• Deployment on a blockchain, arguably always a public blockchain.
• The smart contract code for a DAO specifies the rules for human interaction — however, it is unclear to what degree other governance mechanisms may affect or override such code.
• Self-execution of smart contracts, independent of the will of involved parties.
• Independence from central control.
• Transparency, cryptographic security, decentralization.

DAO may be used to do a wide variety of purposes. A DAO may be used to construct a virtual entity that acts as a crowd-funding platform, a ride-sharing platform, a completely automated firm, or a fully automated decision-making mechanism, among other things. It is critical to recognize that a DAO is not a specific business model or organization but rather a term that may relate to a broad range of things.

The Ethereum blockchain gave birth to the Ethereum virtual machine (EVM), which can be used to run various decentralized applications (dAPPs) on top of it. These dApps incorporate advanced smart contracts, which might be produced by developers outside the Ethereum core team, extending the technology’s reach. In this sense, a DAO can be regarded as a complex dynamic collection of different but interwoven smart contracts. Since the introduction of Ethereum, a seemingly unending stream of dApps have been created, many of which have their own native unit, often referred to as cryptotokens or appcoins (Burniske and Tatar (2018))). While Ethereum blockchain seems to be the most popular platform for dApps and hence DAOs, many other DAOs work on different blockchains. For instance, Rootstock, a host for smart contracts, runs on the Bitcoin blockchain.

Some examples of DAO

Speaking about DAOs, one should be cautious to avoid mistaking DAO as an umbrella term to refer to all Decentralized Autonomous Organizations with “The DAO," which was the first DAO established in 2016 on the Ethereum blockchain. The DAO has an informative story behind it that led to the creation of the Ethereum classic. In a nutshell, Only two months after its introduction, a hacker exploited a flaw in the code of The DAO and stole 3.6 million ether, which was valued at roughly $70 million at the time.

Despite the early mishap, DAOs have continued to proliferate. Some DAOs are in charge of stable coins like DAI (managed by MakerDAO), which is tied to the US dollar. Owners of tokens vote on how interest rate mechanisms function that helps keep the price stable and fine-tune supply and demand. Some others such as SpiceDAO buy tangible assets. Another group of DAOs such as PleasrDAO, speculate on cryptocurrencies and non-fungible tokens (NFTs). Many DAOs seem to have been created to handle wagers in a virtual casino like Augur. The following table lists a few other famous DAOs.

In the following table we list some examples of DAO instances

Name	Token	Use cases	Network	Launch	Status
The DAO	DAO	Venture capital	Ethereum	April 2016	Defunct late 2016
Dash	DASH	Anonymous transactions	Dash	May 2015	Operational
Augur	REP	Prediction market, betting	Ethereum	July 2018	Operational
Steem	STEEM	Data distribution, Social media	Steem	March 2016	Operational
Uniswap	UNI	Decentralized Exchange	Ethereum	November 2018	Operational
Maker	MKR	Stable Coin, DeFi	Ethereum	December 2017	Operational

Economics of information and the DAO

Classic agency theory depicts an ideal scenario in which a single “entrepreneur-manager" makes optimal choices and then implements them, functioning as both principle and agent for his benefit. If there is a separation between ownership and management, agents will pursue their own interests independent from the interests of the principals in the absence of proper incentives (Fama and Jensen, (1983); Shapiro, (2000)). The DAO suggests a “next-best-case" of Agency Theory, in which numerous entrepreneur-managers have no need to trust one another but can nonetheless act as a single-minded entrepreneur-manager (Morrison et al., (2020)). Because the blockchain became the vehicle for managing trust, players don’t have to trust anybody else except the system.

Tinn (2018) observes that the blockchain technology makes it possible to design financing contracts that are based on reliable and up-to-date records of transactions and develops a theoretical model that uses dynamic contract theory to derive optimal financing contracts in this new environment.

Open issues

In line of principle, a DAO might be financed relying on these alternative financing contracts but their optimal use cannot be characterized without a precise extension of the theory of property rights. Halonen-Akatwijuka and Hart (2013) hypothesize that incomplete contract terms may make renegotiation less costly or more efficient. For example, it is necessary to rule the renegotiation issues that might arise in the presence of DAO distress. Renegotiation clauses are relevant to clearly define stakeholder rights in the presence of ambiguities that might arise, for example, from coding weaknesses as it happened in the famous case of "The DAO".