DAO: Fundamentals, Working Mechanism & Limitations

DAO

The concept of decentralization has brought revolutionary changes to the world. By eliminating the need for centralized authorities, it has put the power back in the hands of the community. One of the important innovations based on decentralization includes DAOs. It came into existence for the first time in 2016 on the Ethereum blockchain network. It leveraged the virtue of decentralization to establish community-led organizations. Let’s understand the concept of DAOs in detail.

What is DAO? 

DAO stands for Decentralized Autonomous Organization. It is an entity similar to a corporation but doesn’t have a centralized governing authority. A DAO is an internet-native entity based on blockchain technology owned and governed by a set of people collectively working towards a shared goal. In DAO every individual is empowered to have their voice in the decision-making process as opposed to conventional organization/company, where either an individual (CEO) or a handful of people (board of directors) take all the decisions to set the targets, budgets and envisions the company’s path. A DAO works through democratizing conduct while replacing the top-down management system with a blockchain-based functionality encoded in smart contracts. 

How do DAOs operate?

As discussed earlier, DAOs are a kind of crypto co-operatives that allow a wider range of people to acquire a piece of the organization and participate in management decisions while sharing a common goal. 

Most DAOs raise some initial funding to commence the operations by putting governance tokens on sale. These tokens give holders voting rights over DAO activities and conduct. Furthermore, governance tokens can be bought using a cryptocurrency such as Ether or BTC from the open market or earned by contributing to the DAO. For example, helping in research, designing graphics such as logos, or writing some codes. 

The funds raised through the sale of governance tokens are stored in a public blockchain treasury. This treasury allows anyone to audit income and expenditure. The funds in the DAO are utilized through a proposal typically written by a DAO member. This proposal starts idea to get discussed and debated among the community members and then put to the vote in front of the token holders, which is either approved or declined by the DAO’s community, which is implemented through encoded smart contracts.

A few examples of DAOs are as follows:

  • ConstitutionDAO raised over 47 million dollars in seven days in an attempt to buy the original copy of the US Constitution. 
  • PleasrDAO collects art and virtual assets like NFTs. They even purchased the only copy of an unreleased Wu-Tang Clan album, making the community members of PleasrDAO the only people in the world who can legally listen to the album. 
  • UkraineDAO raised over six million dollars to donate towards the Ukrainian defense effort.

Limitations of DAO

Although the DAO has immense potential and innovative use cases, they also have a few shortcomings/ limitations. Following are some of the significant limitations of DAOs.

  • Speed: Unlike traditional companies where a CEO makes all the decisions, a DAO requires a much longer period of time to make decisions. As in DAO, every user gets the opportunity to vote on a proposal which consumes more time considering the location, time zones, and priorities outside the DAO.
  • Education: A DAO has the responsibility to educate its community member about the proposals in regard to pending entity activities. Since the token holders of DAO have ranging educational backgrounds, understanding of initiatives, and accessibility to resources, it becomes a big challenge for a DAO to address this issue while formulating strategies to grow and communicate as a single unit.
  • Inefficiency: A DAO requires more time in its administration as it needs to educate the voters, communicate initiatives, explain strategies and integrate the participation of new members. Hence, a DAO runs a risk of being inefficient due to its decentralized nature.
  • Security: A DAO is based on blockchain technology which requires significant technical expertise to encode the accurate prerequisites to implement the decisions. In case the code/ pre-requisites contain a loophole, the DAO can be exploited easily. As the trust among the community member may be broken and users can leave the entity due to the lack of reliance on the entity’s structure.  

Nevertheless, once the concept of DAO is widely accepted, it can upscale the economic opportunity and allow more people to share the upsides of ownership in the decentralized world. It can restructure the power dynamics and empower the community. 

We hope this article helps you to understand the concept of DAO and how it works. If you enjoyed reading this article and want more educational blogs on the crypto space join our Telegram community and follow our social media handles. 

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