Decentralized autonomous organizations, or DAOs, are such a potentially seismic innovation the only way to properly put them in perspective is to go back to the origins of humanity. But hey, no pressure, DAOs.

Humans have long relied on groups and systems of people to further their objectives. By working together, groups can achieve more than the sum of each individual's independent actions.

For our collaborative efforts to work, there needs to be coordination. Throughout our history, the go-to method for achieving order has been through centralized points of control — which is why our organizations have traditionally possessed some form of hierarchical structure.

With this approach, decision-making is in the hands of the few. In companies, organizations, and democratic systems of governance, theoretically the interests and inputs of others throughout the organization aren’t ignored — but we know well that theory hasn’t always played out so well in practice. A centralized structure may not be to everyone’s advantage, but it has traditionally been easier to implement and sustain than trying to find a way to collect and act on consensus among a large group of people.

But just as the internet forever changed the way we exchange information, web3 technologies are creating a new era for how future organizations will be formed. An era where all the members of an organization can be owners of the organizations, with the power to decide its future course. 

These community-owned projects are known as decentralized autonomous organizations (DAO). They are, in essence, an organization governed by computer code. The code is the law, and there is no need for a central authority. And everything takes place on an open-source blockchain, allowing for greater transparency and the ability to automate changes.

DAOs represent a huge innovation and the potential to drastically shift the way organizations are structured and governed. The use cases for the DAO governance model are nearly endless as they gradually make their way into many different sectors of society. (A DAO recently even tried to buy the U.S. Constitution.)

In this guide, we will break down everything you need to know about DAOs including what they are, how they work, and how you can join one or many. We will also take a look at a few of the most interesting active DAOs to get a sense of their current (and future) use and impact.

A Complete Explanation of DAOs

What is a DAO?

A DAO (decentralized autonomous organization) is a community-owned and managed organization that is governed by computer code. To better understand the benefits of these systems and what they allow members to achieve, let’s look at each letter of the acronym to see how it applies to DAOs.

Decentralized 

The first characteristic of a DAO is decentralization. DAOs do not follow a hierarchical structure the way traditional organizations do. There are no executives or centralized sources of power. Instead, DAOs are digital-based organizations collectively owned and managed by their members. Decisions are made via proposals that reach a consensus agreement (done via voting) rather than executive action.

Because there are no centralized points of control, DAOs must run on a decentralized infrastructure like a permissionless blockchain. The blockchain enables the disparate group of actors to manage a treasury and record financial transactions in a secure trustworthy fashion. It also brings transparency as anyone can view the code and all activities on the blockchain.

Autonomous 

With a DAO, all the rules used to govern the organization are pre-programmed into code (called smart contracts). Because the operating rules are programmed, they can be automatically applied the moment the specified conditions are met.

For example, consider an organization that wants to use its funds for a specific project. With a DAO, the moment the collective agrees to use the funds, the DAO’s corresponding smart contract will automatically release the funds from the DAO’s treasury. There is no need for a third party, and once in motion, the process can not be stopped.

To get a better sense of the impact of a DAO’s autonomous nature, it’s helpful to compare DAOs to traditional organizations. With a traditional organization, stakeholders do not have the means to automatically implement changes. After a decision is made, the stakeholders must take manual action to ensure that the decisions are actually put in place. This typically involves issuing a string of orders that must move through a chain of command.

Going back to our example of an organization wanting to disburse funds — with a traditional setup, there are many steps needed to release the funds. At the very least you would need to get approval, send the request to the appropriate party, send the transaction details to the bank, and update your records once it's complete.

DAOs solve this problem as the smart contract code can perform many of the decisions and routine operations that a typical organization needs to function. Plus, with pre-programmed parameters, any ambiguity around the interpretation or enforcement of rules is eliminated.

Organization

DAOs are an organization in the traditional sense of the word as they enable people to work together to pool their resources and efforts towards a common objective. However, members of a DAO are not part of a legal entity or subject to any legal contracts. The only governing law is the rules laid out in the DAOs smart contracts. Once a DAO is funded and active, decisions about how it operates become a communal process governed by the DAO’s consensus rules.

How does a DAO work?

The underlying mechanics of how a DAO operates varies from project to project. That said, there are several key components each DAO needs to function. The first is a blockchain. This decentralized system of nodes is necessary to facilitate governance by disparate stakeholders. The blockchain is also where the DAO runs the smart contracts containing the operating rules and all transaction records.

Smart contracts

Smart contracts are the foundation of a functioning DAO. These digital contracts are programmed, algorithmic protocols that contain agreements between different parties. They exist on the blockchain and are where the DAO stores its rules for the organization. The DAO’s treasury is stored on a smart contract as well.

“Smart” contracts are named such as they contain self-executing lines of code that fire when pre-specified conditions are met. They are quite useful for automating redundant processes and reducing the need for human input.

The simplest example of a smart contract transaction is a two-party sale between a buyer and a seller. After the parties agree to a sale, the blockchain verifies the legitimacy of the transaction and the smart contract releases the funds to the seller’s address.

DAOs use an interconnected web of smart contracts to automate as much as possible. Once a contract is live on the blockchain, only the collective’s vote can change the rules. If anyone tries to do anything not specified in the code of the smart contract, it will fail. 

Tokens

The other essential piece to a DAO is tokens. Most DAOs use a token-based model to incentivize participation and manage governance. Like smart contracts, the tokens exist on the blockchain, allowing them to be easily tracked and audited by independent parties.

You can essentially view tokens as shares in the DAO. The tokens give you the power to vote on decisions that impact the course of the project. The more tokens you own, the more control you have over the DAO. You can exercise your say to influence things like:

• Protocol upgrades

• Services and products to include on the roadmap

• What expenses to pay using the DAO funds

• How to distribute profits to DAO members

Voting

DAOs use a consensus mechanism to make decisions and initiate changes for the platform. Users can submit a proposal for the changes they want and the rest of the collective can vote whether or not to approve it. Owning the project’s governance token is usually a requirement for voting in a DAO.

The exact method of consensus varies across projects, both in terms of the votes needed for a proposal to be approved and who is able to submit a proposal. Below are some of the consensus mechanisms most common among DAOs:

• Token-based quorum voting: With quorum voting, a certain threshold of voters is needed for a proposal to pass. When a decision reaches the vote threshold, it is automatically approved and implemented. If a vote fails to reach the quorum threshold, the proposal is disapproved.

• Permissioned relative majority: Relative majority is the most basic voting mechanism. You simply compare the total number of votes on a proposal and proceed with the highest. Unfortunately, a simple relative majority isn’t a good option for a DAO as it's too susceptible to attack. DAOs can prevent this problem by requiring all proposals to be sponsored by a member (i.e., permissioned). 

• Holographic consensus: This voting mechanism was first used by DAOstack [1]. It applies a prediction market to each proposal. Users can stake funds, predicting whether a proposal will pass or fail. If a proposal is predicted to pass, it becomes boosted, meaning the voting changes from 50% quorum to relative majority. This mechanism makes it easier to pass proposals with staked funds.

• Conviction voting: With this voting mechanism, people stake their voting power on proposals. When a proposal receives enough voting power, it is cleared to pass. The thought behind this voting mechanism is to prevent large holders from squeezing out the minority voters. Large holders must choose how to stake their voting power and cannot use their majority to dominate every decision.

How do I start a DAO?

There are some standard phases a DAO must follow to ensure a smooth launch and the long-term viability of the project:

1. Creating the smart contracts

Before a DAO can go live, the organization’s rules must be defined and coded into a series of smart contracts. Because any future changes will need to be passed by the collective, this is an important first step in the DAO’s long-term sustainability.

Given this initial setup requirement, DAOs can never be completely autonomous. No matter what, some human input is needed to decide what to vote for. Only after these inputs can the autonomous system simply ensure that the rules are automatically followed.

2. Funding

After the founders create its operating rules, the DAO needs to receive funding before it can launch. Because of this, the DAO’s smart contract system tends to include the distribution of the native token used for governance. People who are interested in participating in the DAO can then buy the token (or potentially earn it through various actions) and the DAO receives the funding needed to deploy the project. 

3. Deployment

Once a DAO receives enough funding to deploy, the authority for all decision-making passes to the consensus model defined in the platform’s smart contracts. When it does, token holders become stakeholders with voting rights and the ability to make proposals on how the DAO should operate. Assuming a well-made governance and incentive structure, each member’s actions should be motivated to benefit the DAO as a whole.

What are potential use cases for DAOs?

DAOs can serve a myriad of purposes — really, the only limit is going to be people’s imagination (and willingness to cede power to smart contracts rather than executives). While you can find successful DAOs across multiple sectors including insurance, sports betting, and data management, most of their current use is dominated by Defi.

By forming their project as DAO, decentralized finance (Defi) platforms are able to offer users yield farming, crypto lending, and other services that would elicit heavy regulation and scrutiny if done by a traditional company.

The gradual rise of DAOs in traditional sectors gives us a taste. They are nearly endless as any system that relies on collective input can exist as a DAO. Here are some of the ways DAOs can be applied to the systems we use today:

• Charitable organizations where members need to approve donations

• Venture capital firms owned by a collective

• Real estate transactions executed without the need for intermediaries

• Social media platforms owned by the users and/or creators

• Ridesharing services that connects riders to independent drivers

• Groups looking to pull off major projects requiring lots of funding and enthusiasm (e.g., buying a copy of the Constitution)

DAOs even have the potential to disrupt the most fundamental organization in our lives today: the government. With a DAO, all of a nation’s laws could be immutably recorded and openly available on the blockchain. Citizens could vote directly for changes to laws, rather than giving much of that control to elected politicians.

When a proposal passes, the smart contract would automatically update the law accordingly. With such a system, you do not need to worry about making sure elected officials actually serve the people's interests as all the voting power is in the hands of the collective.

How long until we entrust our lawmaking to smart contracts? It’s really tough to say and probably not imminent in the very near future. But it’s clear that a well-executed DAO governance model can provide a more efficient alternative to many of our existing systems. The first logical step will probably be a city governed by a DAO, and we’ll see how things go from there.

5 of the Most Interesting DAOs in Operation Today

DAOs have come a long way since their inception. In a certain sense, the Bitcoin network could be considered the first DAO. While somewhat basic compared to newer DAOs, it is a decentralized system governed by a consensus protocol, and tokens are used to incentivize network security.

DAOs as we know them today first surfaced in 2016 with the appropriately titled (but super confusing in some ways) DAO called “DAO,” built on the Ethereum blockchain. You may be familiar with the original DAO, as a lesson in some of the potential risks of digital-based organizations. Hackers exploited vulnerabilities in the codebase to steal what was worth $150 million in Ether at the time. The Ethereum blockchain eventually had to initiate a hard fork to restore the stolen funds [2].

Not the most auspicious beginnings, but much has changed since then both in terms of how DAOs are structured and their uses. DAO creators have come up with innovative ways to reward members and ensure a fair, transparent, and safe system.

Let’s examine five of the most interesting DAOs, live and open for members.

Compound - crypto lending and borrowing

Compound is an algorithmic interest rate protocol built on the Ethereum blockchain. The protocol can be used for a variety of financial applications. Today it is mainly used as a way for crypto holders to earn interest through lending their assets or borrowing against their assets as collateral.

Compound uses the COMP token to handle governance and reward participation in the DAO.  By holding the COMP token, you can vote on proposals that impact the protocol including:

• Adding and removing markets

• Interest rate models

• The collateral factor for assets

Anyone can create a proposal to change aspects of the protocol by locking 100 COMP in an address. If the user’s address is delegated 65,000 COMP, the proposal will go up for a vote. After a three-day voting window, proposals with at least 400,000 positive votes are queued for two days before being implemented.

You can buy the COMP token at several popular exchanges including Coinbase, Binance, Kraken, and FTX.

MakerDAO - collateral-backed lending

MakerDAO is a decentralized lending protocol built on the Ethereum blockchain. The protocol enables users to issue collateral-backed loans without a financial intermediary. While originally centralized, the MakerDAO Foundation moved to a decentralized model in 2020 to pass full ownership of the project to the community. Now, all on-chain voting is restricted to holders of the project’s governance token MKR.

MakerDAO uses two types of voting systems; Governance Poll and Executive Votes. The Governance Polls determine community sentiment on a proposal prior to it going up for Executive Votes. 

As their name implies, Executive Votes are used to execute changes to the Maker Protocol. Executive voting uses a Continuous Approval Voting' model. This means that competing proposals can be introduced at a time. If a member wants to change their position on a certain stance, they simply need to reallocate their stake to the new proposal.

Some of the types of changes users can vote on include adding or removing collateral types or vault types as well as adjustments to the global system parameters.

The MKR token is available on all major exchanges.

UniSwap - decentralized crypto trading protocol

Uniswap is the world’s most popular decentralized exchange (DEX). Like MakerDAO, the protocol did not start as DAO. Uniswap officially became decentralized in 2020 with the release of the UNI governance token which allows holders to vote on decisions regarding important aspects of the platform.

To vote on a Uniswap proposal, you need to delegate your UNI to an address in order to bind its voting power. The platform uses a quorum consensus mechanism for passing proposals. If a proposal receives 4% of the total UNI supply in favorable votes, it is approved and queued for implementation.

Illuvium - DAO-based video game

Illuvium is a fully decentralized blockchain-based video game that uses a DAO for its governance model. The game is still in development, but you can shop for in-game NFTs and the platform’s governance token, ILV.

There are two ways that ILV token holders can guide the course of the platform. The first is by voting on Illuvium Proposals that are added to the platform’s Github repository. The proposals allow members to make suggestions for marketplace fees, new systems, expansions, character sets.

The second is by nominating and electing members to the Illuvinati Council. The council is a group of community representatives that is able to make technical changes to the platform. By adding council members to the voting mechanism, the platform is able to reduce the voting power of large $ILV holders.

SuperRare - NFT marketplace

SuperRare is an NFT marketplace featuring high-quality digital art pieces. The platform is governed by RARE token holders who collectively make up the SuperRare DAO. By holding the RARE users can allocate funds from the Community Treasury and make decisions regarding key platform parameters.

Community members can recommend changes and upgrades to the platform by submitting a SuperRare Improvement Proposal on the governance forum. To submit a proposal, you need to delegate 100,000 RARE tokens to a designated address. It then goes to a vote where it needs to receive at least 10 million RARE in votes with at least 51% of the votes in favor of the proposal.

The Future of DAOs

Through technology and well-planned incentives, a DAO brings efficiency, transparency, and fairer management to our organizations. With this new approach to collaborating, we now have a way to create and sustain groups designed to benefit everyone involved.

As blockchain technology improves and legal uncertainty gets clarified, look for DAOs to play a pivotal role in how we form our future organizations of all types.