The introduction of blockchain technology, and the cryptocurrencies that fuel it, has opened up new organizational governance structures. In contrast to opaque, top-down corporate hierarchies, groups can now operate transparently and democratically. Plus, by automating actions through computer code, groups can reduce the cost and risk of errors associated with using intermediaries. All of this has allowed for the creation of decentralized autonomous organizations, or DAOs.
This article will explain more about what a decentralized autonomous organization is. It will discuss how DAOs work and why organizations would want to use them as governance models. Then it will demonstrate how DAOs can be—and are being—used.
What is a Decentralized Autonomous Organization (DAO)?
A DAO, or decentralized autonomous organization, is an organization or collective that has no central leadership. Instead, all members are bound by rules that involve acting in the organization’s best interests. All members also play roles in managing and making decisions regarding the organization.
How Does a Decentralized Autonomous Organization Work?
Decentralized autonomous organizations rely heavily on blockchain technology, cryptocurrencies, and smart contracts to work.
The use of blockchain allows DAOs to be open source. That means anyone is allowed to look up how a particular DAO operates, such as:
- What its purpose is
- What rules members must follow
- What is required to join the organization and vote on issues
- How members voted on past decisions
- Who has stake in the organization, and how much
The use of cryptocurrencies allows for distributing voting powers in the DAO based on each member’s financial stake in the organization. Typically, the more cryptocurrency a member holds, the more weight their vote carries.
The use of smart contracts—pre-agreed business actions, written in computer code, that execute when relevant conditions are met—allows a DAO to automate some of its transactional processes based on other activities in the blockchain. For example, the outcome of a vote may automatically trigger a smart contract that either increases or decreases the amount of cryptocurrency circulating on the blockchain network.
The Benefits of Decentralized Autonomous Organizations
So why would a group of people want to create a decentralized autonomous organization, or DAO, as opposed to a regular corporation, for example? Well, there are several things that DAOs can do that traditional business entities may not be able to. They include:
- Automate processes: One of the most attractive features of DAOs is that their smart contracts allow for automatically executing certain actions according to specific logic. This cuts down on intermediary parties, which have a chance of committing human error or manipulating transactions for their own benefit.
- Offer security by design: With the way blockchain technology works, records of actions in the network have to be validated by a majority of users. In addition, altering or removing these records requires majority user approval. This guards against bad actors trying to change or erase records in a way that benefits themselves instead of the group.
- Allow for democratic decision-making: The ability to make choices affecting the direction of a DAO isn’t concentrated in a single person or small group. All members of the DAO get a say in how the organization should be run.
- Incentivize members to participate: As long as a DAO’s member has an amount of the DAO’s native cryptocurrency, they can effect change. Though their power may be limited, they can still perform a number of functions that can further the DAO’s goals. These include voting on issues, as well as taking an amount of cryptocurrency out of circulation to increase the token’s overall value.
- Operate transparently: Because DAOs run on open-source blockchain networks, all members—and even the public—can see how each other member votes and otherwise acts in the network. In theory, this discourages members from acting selfishly or against the goals of the group in order to protect their positions and reputations.
- Foster connections without borders: Like other internet constructs, DAOs allow people around the world to effortlessly join communities with common interests and goals. Regardless of geographical, legal, and political barriers, people can have a say in how an organization is run while also potentially protecting their true identities.
Based on these advantages, one might ask: what is a decentralized autonomous organization used for? The following section highlights some prominent ways DAOs are being utilized.
Decentralized Autonomous Organization Use Cases
DAOs are typically at their best when they’re focused on fulfilling a specific purpose. Fortunately, people have found the governance structure of DAOs to be very suitable to several niches, and are finding many more applications all the time. Here are a few current common ones.
- Crowdfunding: A DAO can be a good way to raise money from disparate sources towards specific goals. This is because it offers a transparent democratic platform where members’ actions and decisions are made public. Also, if the venture is successful, the DAO’s native cryptocurrency increases in value, which can provide profits to members. Both of these points incentivize members to act in the best interests of the group.
- Decentralized app (dApp) investment: Similar to crowdfunding, a DAO can also be useful as a democratic platform for investing in companies that build decentralized apps (dApps). Members can vote on and choose which projects they want to back, and receive a portion of those apps’ cryptocurrencies according to how much they staked. Then, if an app is successful, its cryptocurrency’s value increases, meaning those who chose to invest in it profit.
- Metaverse governance: A “metaverse” is a virtual 3D space that simulates (at least some) real-world activities. A DAO can provide an effective governance model for metaverses because it’s transparent (due to living on a blockchain) and allows diverse groups of users to have shared ownership and control over their world (which high investment costs may otherwise make unfeasible). For example, they can vote on adding new features or changing existing features, and manage transactions between the virtual and real worlds.
- Decentralized finance (DeFi) management: DAOs are seeing increasing use in managing decentralized applications due to their utilization of smart contracts. In finance applications, for instance, this allows transactions to be completed faster, more securely, and with less cost because there are no intermediaries who may make errors or commit fraud when handling exchanges. Meanwhile, DAO members can focus on managing the general overall functioning of the system.
- Art creation and curation: DAOs are also commonly seen as governance models in art curation communities. Through collective fractional ownership via non-fungible tokens (NFTs), artists can support each other’s creative processes. Meanwhile, they retain some control over their own works, and can profit when others invest in and trade their creations.
So what do these decentralized autonomous organization use cases look like in practice? The following section will cover some well-known DAOs to illustrate.
Decentralized Autonomous Organization Examples to Learn From
To practically demonstrate what DAOs can be used for, here are a few famous and upcoming DAOs: what they’re used for, and what lessons can be taken from them.
One of the first decentralized autonomous organizations to gain significant public attention was simply called The DAO. It was a decentralized venture capital firm that launched on the Ethereum blockchain in April of 2016, after it completed one of the largest crowdfunding campaigns in history (over $150 million US).
It didn’t last long, however. Questions soon emerged regarding The DAO’s legal and financial mechanics, as well as its vulnerability to security breaches and programming errors. To make matters worse, in June of 2016, cybercriminals took advantage of the identified vulnerabilities to hack The DAO and steal over 3.6 million Ether (Ethereum’s cryptocurrency) from its treasury.
This attack, combined with the contentious debate regarding how to address it that followed, caused many cryptocurrency exchanges to drop The DAO’s native cryptocurrency by autumn of 2016. That effectively marked the end of The DAO.
ConstitutionDAO and PleasrDAO
These are two DAOs that utilize the combined purchasing power of their members to collect rare and/or culturally significant artifacts.
ConstitutionDAO was created in November of 2021 to raise money for winning an original copy of the United States Constitution in an auction. Though it was unsuccessful, at least one other iteration of the group has tried a similar venture. It has shown the potential strength of using DAOs for coordinating crowdfunding projects.
PleasrDAO is a decentralized group of art collectors. They count among their possessions the only existing copy of the album Once Upon a Time in Shaolin by American hip-hop group Wu-Tang Clan. They bought the album for over $4 million US.
MakerDAO and Uniswap
These DAOs are examples of decentralized finance (DeFi) platforms that have achieved widespread adoption. Organization members work together to manage the overall system’s operations. Meanwhile, smart contracts take care of actual transactions without the need for intermediaries such as banks, brokerage firms, or currency exchanges.
MakerDAO was created in 2017 and governs Dai, a stablecoin (i.e. a cryptocurrency with a value pegged to that of another asset). Dai’s value is managed to be as close as possible to that of one US dollar.
Uniswap is a decentralized cryptocurrency exchange that was launched in 2018. As of October 2020, it was one of the largest decentralized exchanges, along with one of the largest crypto exchanges in general.
Fintech Fraud DAO
Fintech Fraud DAO is an up-and-coming DAO meant for financial institutions. Its purpose is for members to share anonymized data on end customers in order to collectively identify suspicious activity patterns. Then they can intervene before that activity turns into wide-scale fraud, money laundering, or other financial crime.
The idea is to have a group of financial institutions all working with the same data on the same platform. This allows them to catch would-be criminals who try to conceal their activities by performing transactions at multiple different financial institutions in the group.
For updates on the progress of the Fintech Fraud DAO, visit our project blog.
Keep DAOs Safe with Financial Crime-Fighting Tools from Unit21
In the current fraud prevention landscape, organizations need to detect and prevent fraud from occurring on their platform themselves. This means identifying fraud when it happens, and then developing a system for stopping them—and preventing further attacks.
For organizations, the problem is this always requires a heavy lift—teams need to invest resources that allow them to alert on suspicious activity, investigate the activity, and then update their fraud system. To make matters worse, as soon as the fraudster is stopped, they simply move on to the next platform (one where the organization is none the wiser about their intentions or past behavior). This leaves each organization susceptible for a period of time while they work out who the fraudster is.
But it doesn’t have to be that way. What if organizations worked together, sharing data about fraudulent users with each other?
The Fintech Fraud DAO enables members to share—and get access to—anonymized data on users’ good and bad activity, making it easier for them to actually prevent fraud. Members know whether a user is trustworthy before they are onboarded to their system, and have the option to take action before the user gets the chance to commit fraud. With this information at their fingertips, organizations can actually prevent the fraudster from accessing the platform in the first place.
Not only that, but the organizations don’t have to dedicate the time and effort into identifying the fraudster themselves, which can be extremely time-consuming and costly. Most importantly, this gives members the ability to actually prevent fraud before it occurs. Rather than being stuck having to react to bad behavior after the fact, teams can leverage the DAO network’s data to pre-emptively identify fraudsters and stop them from accessing their platform.
Interested? Check out the Fintech Fraud DAO today and learn how you can become a member.