The blockchain revolution has led to the emergence of many new concepts and processes, from decentralized finance, liquidity pools, and smart contracts to play-to-earn games and NFTs.

A new type of company or organization is also on the rise, the decentralized autonomous organization, or DAO. You’ve probably heard this term before but don’t know precisely what it means, how it works or if you should put some of your cryptocurrency funds in one. That’s what we are going to learn in this article.

DAO - the decentralized version of a traditional organization

A decentralized autonomous organization is centered around groups of people that have no central leadership, abiding by rules encoded on a blockchain through smart contracts. In order to become members of a particular DAO, crypto investors must purchase the governance token created explicitly for that decentralized autonomous organization. These coins allow the members to vote on decisions pertaining to the company.

The first DAO launched in 2016 on the Ethereum blockchain, called The DAO, had some vulnerabilities that hackers took advantage of, gaining access to DAO tokens worth nearly $50 million in cryptocurrency at that time. That was quite a blow for the Ethereum community and investors. A hard fork was carried out on the network in the following weeks after the June incident, and the resources were brought back to the group’s treasury.

How do DAOs work?

Decentralized autonomous organizations function with the help of blockchain technology. They do not have a central leader. All participants take part in any decision-making within the DAOS. The DAO’s code contains all the rules that must be followed, written in a smart contract that only runs when predetermined conditions are met.

As an entry requirement to join, each community member must agree to follow the DAO’s rules since breaking them entails a complete lockdown of the crypto funds. Three stages must be completed to create and launch a DAO successfully:

  1. Smart contract creation: In the first stage, the developers decide the organization’s purpose and write the open-source code for the smart contracts that will dictate the rules of the group of members. The code is tested heavily in this stage, as any subsequent changes after launch need to be submitted to voting.
  2. Fundraiser phase: This type of company functions on a shared cache of virtual currency gathered from each member. Joining the DAO requires purchasing a certain amount of crypto tokens in exchange for a stake in the company. Developers raise money through a token sale in this stage and establish the rules.
  3. The launch: The final stage involves the deployment of the DAO code on the network. As of this moment, any change can only be made through a voting system where each stakeholder that raised money in the previous stage has voting rights proportional to the number of governance tokens held. The project creators no longer have full control over the company.

DAOs are fully decentralized, autonomous, and completely transparent. Since they exist on open-source blockchains, anybody has access to their code. All their financial transactions can be audited, as they are recorded directly on-chain.

Why are DAOs a good idea?

The way DAOs operate solves the main issue of traditional organizations, the principal-agent dilemma. This concept refers to the conflict of interest between a group of people (principal) and the central authority making decisions on behalf of them (agent). As it can often occur, the decision-makers within an organization may prioritize their self-interests before the priorities and goals established by the stakeholders. Community governance solves this problem when it comes to DAOs. The DAO members support the governing rules and work as a group with aligned incentives. Holding a stake in the organization ensures that each and every participant is keen on seeing the DAOs succeed.

These projects have been steadily gaining traction around the world, with many DAOs implemented on the Ethereum network, amongst others. More and more people recognize their potential to change the way corporate governance works, although there are still some lingering concerns regarding their security, after The DAO hack of June 2016. Both analysts and investors believe that DAO companies are the future, eventually replacing traditionally structured businesses.

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