How Do Decentralized Autonomous Organizations Work?

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If you’re new to the cryptocurrency landscape, you’re likely encountering a wide variety of terms that aren’t too familiar and are even sometimes confusing — especially when it comes to concepts like decentralized autonomous organization, or DAO. Although it sounds like a secret government agency, a DAO is actually something closely tied to the ways people leverage crypto coins in unique ways.

DAOs are a unique mechanism within the broader decentralized finance, crypto and blockchain space. Often, these organizations aim to improve the overall crypto world in some way, ensuring a decentralized future isn’t just possible but also able to thrive. But what exactly are DAOs, and how do these organizations work? If you’re asking questions like these, here’s what you need to know.

What Is a Decentralized Autonomous Organization?

A DAO is a group of people who come together for a common goal — one that involves cryptocurrency in some way. Everyone participating in the organization buys into the DAO and agrees to follow various rules written into its code through smart contracts.

The purposes of DAOs can vary. However, all have similar structures. For one, there isn’t a central authority overseeing or limiting their activities, which is why they’re called “decentralized.” The overall hierarchy is flat, giving everyone who has a stake in the DAO an equal voice.

DAOs are online entities that prioritize transparency. All of their dealings rely on blockchain technology. That distributed ledger approach ensures all the DAO’s records are easily reviewable and unalterable. A cryptocurrency component – which can include investing activities and DAO-specific tokens – is typically part of the mix as well.

Overall, there are around 4,000 DAOs today. By mid 2022, they’d amassed an impressive $8 billion in their treasuries, showing just how powerful these organizations have the potential to be within the crypto landscape.

What DAOs Do (and the Problems They Aim to Solve)

As we mentioned, a DAO could potentially have any kind of purpose. It might serve as the framework for a traditional company but incorporate the flat structure and smart contracts to manage decision-making and operations in a more equitable way. A DAO could also bring together a group of individuals interested in investing in cryptocurrency safely, giving them a way to pool resources and reduce risk. A DAO approach can even work for nonprofits by ensuring donations are distributed in accordance with certain rules.

However, one of the main goals of essentially all DAOs is to promote organizational transparency and fairness. The structure gives everyone who buys in a say in the DAO’s operational decisions. It ensures that no single individual can automatically override the rest simply due to their position within the organization — something that can occur in traditional corporate hierarchies.

Additionally, the blockchain ledger technology helps to make sure all DAO votes are counted honestly and that every decision is openly recorded. In many cases, vote tallying is even automatic. In some instances, the resulting action may execute immediately once everyone approves it.

Why People Create DAOs

DAOs are attractive for many reasons. The flat hierarchy promotes fairness to give everyone a voice when it’s time to make operational decisions. There’s also an inherent amount of security in a typical DAO structure. Changes aren’t possible without group approval, which reduces the impact of single actors with their own (potentially harmful) agendas.

Because DAOs rely on crypto tokens, they also allow for asset management without traditional banking mechanisms. Couple that with transparent recordkeeping, and a DAO becomes even more appealing to anyone who wants insights into the DAO’s operations and decisions at all times.

The Role of DAOs in the Crypto Ecosystem

In most cases, participating in a DAO means purchasing specific crypto tokens associated with the organization. That allows the DAO to secure funds for various activities, as outlined in the group’s rules, mission statements and similar documents.

Because most DAOs feature tradable tokens, they create new entries in the broader cryptocurrency market. However, these aren’t purely forms of currency. Instead, they represent decision-making capabilities – or, more specifically, voting rights – within an organization. Typically, DAO tokens aren’t available across all crypto platforms. However, there are plenty of other avenues for trades.

How DAOs Operate and How They’re Funded

As mentioned above, DAOs are decentralized organizations with flat hierarchical structures. However, there are several approaches to their formation, operation and funding processes, each with its own benefits and drawbacks.

Token-based strategies let those who purchase tokens take part in operational decisions. The token serves as the buy-in mechanism. The ability to buy in may be available to anyone willing to make the purchase, though that isn’t always the case.

With share-based approaches, those wanting to join must first submit a request. That’s usually accompanied by tokens, work or another form of tribute. That process ensures those entering the DAO have the proper understanding of the DAO’s goals and operations — with the ultimate goal of guaranteeing all the participants feel comfortable making knowledge-based decisions. If shares are granted to an applicant, that person gets voting rights and partial ownership.

Regardless of the entry requirements, DAOs rely heavily on smart contracts from an operational standpoint. These agreements outline any rules regarding the DAO’s purpose and function. Smart contracts also typically hold the treasury, ensuring all records of fund movements are completely accessible to group members at all times.

Once a smart contract is live, it’s unalterable unless the group approves a change via a vote. Any attempts to circumvent that requirement typically fail. That’s because the smart contract isn’t designed to permit actions that aren’t allowed in the roles or supported by a formal vote of members.

In some cases, it may even lock the funds, preventing anyone from using the DAO. In that way, the smart contract features serve as deterrents against undesirable actions.

The smart contract mechanism also serves as a way to track and protect any DAO funds. The money isn’t spendable unless the terms within the agreement are met, such as the passage of a vote. This supports collective decision making and often allows automatic execution if a vote passes.

DAOs and the Future of Crypto

Functionally, DAOs represent a newer form of organizational structure that allows groups to come together for specific purposes and ensure all members have a say in the organization’s direction. For those who share a DAO’s interest, that alone is appealing.

However, DAOs are also impacting the crypto space. They feature native tokens, enabling treasuries to secure needed funds. This lets the DAO support and pursue projects that matter most to its members.

Essentially, DAO tokens are investable assets that offer more than currency potential. Regardless of token ownership, every investor gets a say, which isn’t something you can say for stock. Because of this, they’re becoming increasingly popular both as funding mechanisms and investment opportunities.