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

Beginner’s Guide / 02.02.2020

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

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

Blockchain, a mechanism to distribute and decentralize trust, can also be used to 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 a particular organization formed on a blockchain are handled by a large number of individuals from all over the world. It is a direct opposition to the idea of a small subset of individuals running a company from Silicon Valley.

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

The principal-agent dilemma is a trust-based problem. In a centralized hierarchy where a minority is responsible to control a majority without any oversight, there is always room for exploitation. Examples of such foul play could be seen among managers that act against the interests of shareholders or politicians that act against the interests of citizens.

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 to its participants a new paradigm for organizational design wherein one can imagine working for a global, boundary-less community, whose routine tasks are powered by a software protocol instead of being 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 a protocol that was open, user-friendly, scalable and most importantly valued privacy over everything else. Originally forking from Bitcoin’s source code, it didn’t take Dash long to produce an autonomy and identity of its own.

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 for 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. All decisions and changes to the stable coin protocol is made by the community 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, with which they can 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 vary wildly due to fluctuations in the price or MKR (MakerDAO’s token) and its 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 with respect to a DAO was the Ethereum DAO hack of 2016. Usually referred to as “THE DAO”, the project was created by the slock.it as 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 were 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 lead 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 members within the organization is uniquely innovative. Traditionally, one could not imagine such an organization to function in real life as the problem lied in trusting a large number of unknown people. A hierarchy-based model was the best fit as it reduced the number of people one should trust.

But, 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 concept of the DAO has picked up the largest traction, mostly because people started to realize the advantages that a trust-less, 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.