Beginner’s Guide to DAOs – The Next Big Evolution in Blockchain

Beginner’s Guide / 02.02.2020

As a malleable concept, the definition of an ‘organization’ has been redefined, altered, and modified based on the roles it has come to play. The concept has gone through an evolution of functionality. The definition of an Organization evolves as humans need change.

Although it is affected by human needs evolution, every organization needs an infrastructure, a base to develop. Its decision-making process can characterize the Infrastructure of a particular organization. A ‘traditional’ organization is known to be built on a top-down hierarchy model, enabling that particular organization’s functioning.

Blockchain, a mechanism to distribute and decentralize trust, can also function as an infrastructure for organizations. A Blockchain-based infrastructure can be modified to accommodate organizations that can benefit from a distributed decision-making process.

An organization that runs without hierarchy, without a top-down model, solidified by code can be built on a Blockchain.

Decentralized Autonomous Organizations – DAOs

DAO stands for Decentralized/Distributed Autonomous Organization. As the name would imply, this means that rules and decisions related to a particular organization formed on a blockchain are handled by many individuals from all over the world. It is direct opposition to the idea of a small subset of individuals running a company from Silicon Valley.

Compared with traditional organizations, DAOs quite solves an age-old problem, known as the principal-agent dilemma.

The principal-agent dilemma is a trust-based problem. There is always room for exploitation in a centralized hierarchy where a minority is responsible for controlling a majority without any oversight. Examples of such foul play could be seen among managers who act against shareholders or politicians’ interests that act against citizens’ interests.

With DAO, built on a blockchain-based infrastructure, there comes a solution for the principal-agent dilemma. It ensures that by altering the incentive mechanisms, i.e., rewarding honesty and penalizing misuse of trust, no single person or entity can take advantage of the network. In such an infrastructure, every entity works for the betterment of every other entity within the organization. It is a self-sufficient community.

The idea of a decentralized organization takes the same concept of an organization and decentralizes it. Bitcoin represents the first real-world implementation of a decentralized autonomous organization. It offered its participants a new paradigm for organizational design. One can imagine working for a global, boundary-less community, whose routine tasks are powered by a software protocol instead of agent-based oversight by managers and employees.

DAOs in Real Life

Dash – The First True DAO

Starting as Xcoin, then changing to DarkCoin before eventually settling onto what it is today, Dash was formed in 2014 by Evan Duffield. Evan envisioned an open, user-friendly protocol, scalable, and most importantly, valued privacy over everything else. Originally forked from Bitcoin’s source code, it didn’t take Dash long to produce its own autonomy and identity.

All governance within the network is handled through the decentralized mechanism. The community pushing proposals, miners securing the network, and finally nodes evaluating the proposal through their voting rights. Proposals, once approved, are funded by the Dash Treasury Fund. This made Dash one of the first truly functioning Decentralized Autonomous Organization (DAO). Dash had managed to develop a self-regulating committee and budgeting management system to help in the everyday activities and upgrades. The innovation was developed to push the idea of collective vision forward.

The DeFi Ecosystem – Next Big Finance Innovation

The biggest upcoming innovation in the DAO sphere is the advent of the DeFi or Decentralized Finance. Decentralized Finance is the concept wherein projects are built to automate, secure, and decentralize traditional financial processes like Banking, investing, loans, etc.

The DeFi ecosystem is currently mostly focused on the Ethereum Blockchain. The Ethereum chain, with its large number of developers, greater computation power, and high scalability, has managed to gather huge interest in financial projects. As of January 2020, around $700 million worth of funds were either locked, staked, or used for DeFi products. Evidently, this number is set to rise exponentially as the Ethereum blockchain’s capabilities and DeFi in general gain more traction.

MakerDAO – Advent of Decentralized Stable Coins

One such example of a DeFi project built on the Ethereum blockchain is MakerDAO. MakerDAO is an autonomous organization on the Ethereum chain that specializes in the Stablecoins. DAI – the stable coin built by Maker is the decentralized community’s answer to centralized and questionable Stablecoins such as the USDT or USD Tether. The community makes all decisions and changes to the stable coin protocol of enthusiasts linked through the DAO.

Along with stablecoins, MakerDAO also provides loans and credit to its users. Users are allowed to stake coins on the platforms to open their own credit lines. Interest is paid to the stakers who lock funds with Maker. Although, it is heavily argued that Maker is not quite “stable” as it says because the interest rate on stakes and loans varies wildly due to fluctuations in the price or MKR (MakerDAO’s token) and it’s base blockchain Ethereum.

There is yet a huge way to go for MakerDAO to cement its place in the DeFi sector. But the innovations that a decentralized community such as MakerDAO can produce go way beyond the skepticism it now faces.

The Ethereum DAO Hack

The biggest scandal concerning a DAO was the Ethereum DAO hack of 2016. Usually referred to as “THE DAO,” the project was created by the slock. It was a virtual venture capital fund that was to be governed by the investors of the DAO. The concept was so profoundly innovative that it received about $150 million worth of Ether by May 2016. The entire community of blockchain enthusiasts was looking at it with wide eyes. But then, in June 2016, the news broke out. The DAO was hacked off all of its funds.

It is said that the hack single-handedly slowed down the progress of innovation in DAOs, which made people more skeptical than ever before. A small mistake in the codebase leads to the monumental disappearance of about $150 million worth of Ethereum. With this, we can speculate that as the threat of fraud rises with the increase in complexity. Any slight mistake will lead to the collapse of the entire community. It questions the rising dependence on DAOs.

Conclusion

The concept of a Decentralized Autonomous Organization, governed not by an agent-based hierarchy but by all the organization members, is uniquely innovative. Traditionally, one could not imagine such an organization functioning in real life as the problem lies in trusting many unknown people. A hierarchy-based model was the best fit as it reduced the number of people one should trust.

With the advent of blockchain and the trust-less economy, thousands of conceptual innovations have come up. Out of all the words thrown here and there, the DAO concept has picked up the largest traction, mostly because people started to realize the advantages that a trustless, borderless, and self-regulating organization could have.

In the coming months, one must be sure to be on the lookout for a new wave of DAOs, all with unique niches. It’s highly likely that if any DAO gains significant traction, we could see a surge of interest towards creating the next big DAO similar to what we saw with ICOs in 2017.

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Sudarshan M is a long time crypto-enthusiast. Pulled in by bitcoin early on, it did not take long for Sudarshan to divert all of his academic attention from business studies to blockchain by doing his Masters and eventually pursuing his PhD in the subject.