Understanding DAOs in 5 Minutes

4 min readOct 26, 2021

By Pranay Singh Bayas

Blockchains are already transforming our banking system. Blockchains could also open the door to new forms of organizations that may operate independently without the need for coordination by a central authority. Decentralized autonomous organizations, or DAOs, have been around for quite some time. Let’s take a look at what they are and why they are the next big thing in the crypto world.

What are DAOs?

DAO stands for “Decentralized Autonomous Organization.” Let’s break this down into simpler terms.

Decentralized- This means there is no central leadership, and decisions are decided by several people rather than one.

Autonomous — The concept takes on a life of its own and can encourage people to make itself happen.

Organization — It can have its own set of regulations, such as managing its finances.

It’s an open-source blockchain technology regulated by a set of rules devised by its elected members that automatically carry out specific acts without using a central authority. A DAO can interact with external data and execute orders via smart contracts. It is generally run by a group of stakeholders who are compensated through a token mechanism. A DAO’s rules and transaction records are transparently available on the blockchain. A vote among stakeholders usually sets rules. Proposals are the most common mechanism for a DAO to make decisions. A proposal is accepted if it is approved by a majority of stakeholders.

Explaining DAOs in Simple Language

DAOs are a powerful and secure method to collaborate with like-minded people all across the world. Consider them an internet-native business that members jointly own and govern. They have built-in treasuries to which no one can have access without the group’s permission. Proposals and voting are used to make decisions, ensuring that everyone in the organization participates.

DAOs can convert a group chat into a community-focused towards success.

Why DAOs?

DAO’s code is 100% transparent and verifiable by anyone. This brings up a plethora of new possibilities for international collaboration and coordination.

DAOs are a framework for human cooperation that is transparent, inclusive, and global.

DAOs make use of cryptocurrencies to allow individuals all around the globe to pool their money.

DAOs empower individuals to pool their resources and use them to accomplish a shared goal.

Comparison between Traditional Organizations and DAOs

Traditional Organizations -

  1. The majority of the time, it is hierarchical.
  2. The activities are private and limited to the general public.
  3. Requires human involvement, which is susceptible to manipulation.
  4. Companies are not always transparent and not always global.

Decentralized Autonomous Organization -

  1. It is totally democratized.
  2. All the activities are entirely open to the public.
  3. The services are handled automatically and decentralized.
  4. DAOs are transparent and global.

Working and Structure behind DAOs

Blockchain technology and smart contracts, which are compilations of code that operate on the blockchain, are used by DAOs. A DAO’s smart contract is its backbone. The contract establishes the organization’s rules and safeguards the group’s treasury. No one can modify the rules of the contract once it is live on Ethereum except by voting. As the smart contract also establishes the treasury, no one can use the funds without the group’s permission. They do not require a central authority; rather, the group makes the decisions collectively, and transactions are automatically authorized when votes are passed. Transparency is the most crucial feature of DAOs as every decision made by the DAO is proposed, analyzed, voted on, and publicly recorded.

Each DAO is different, but when you join a DAO, you usually agree to the code. You often acquire governance tokens, cryptocurrencies attached to a specific project, to gain voting power or membership in a DAO. If a DAO does not deploy governance tokens, it may take other payment types, such as ETH. Members can also work for their DAO in addition to voting.

Tackling the Principal-Agent Dilemma

Another crucial benefit of DAOs is that they provide a solution to the principal-agent dilemma. When a person (agent) has the authority to make choices and conduct auctions on behalf of another person (principal), the agent may disregard the principal’s interests if he is driven to work by his self-interest. The agent is ready to take a risk on behalf of the principal, for example, managers representing shareholders, brokers representing investors, etc.

DAOs overcome the principal-agent problem by providing a higher level of transparency facilitated by blockchains, as well as incentive mechanisms and community governance.

Stakeholders are not compelled to join a DAO, and they do so only after learning the rules that govern it. They don’t have to trust anybody operating on their behalf because they’re part of a group with common objectives. Everyone in the group will want to see the network flourish as they have a stake in it, and all transactions are on a blockchain, making DAOs’ operations transparent.

Famous Examples of DAOs-

  • The DAO” organization is one of the earliest examples. It was made up of a series of smart contracts that ran on the Ethereum blockchain. Hackers attacked the DAO in June 2016, gaining access to 3.6 million ETH due to programming errors.
  • Bitcoin Network- Bitcoin miners are incentivized to secure the network. It works in a decentralized manner and is not governed by any central authority.
  • Dash and Decentraland are other famous examples.

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