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In recent years, Decentralized Autonomous Organizations (DAOs) have gained widespread attention as an innovative approach to creating communities of individuals that share a common interest.
The ConstitutionDAO was created to fundraise for the purchase of an original copy of the United States Constitution. The UkraineDAO was created to raise funds for the war in Ukraine.
Suffice to say, DAOs are a great way for communities to rally around a single cause.
However, DAOs are not a magic solution that can replace the current system of working. Some people who strongly believe in decentralization may even think that DAOs can replace corporate companies!
In fact, I would not consider DAOs as a good investment vehicle unless you really know what you are getting yourself into.
In this blog post, we explore what DAOs are, how they function, why they exist, and why they cannot replace the current way of working.
Table of Contents
What are DAOs?
DAOs are organizations that are managed and run by a group of individuals, with no central authority or leadership. They operate on a blockchain network, using smart contracts to govern their activities such as voting and submitting proposals.
Members of a DAO rally around a single cause or interest. This can range from investing in different Crypto projects to crowdfunding for a particular project or charitable cause.
In essence, DAOs are communities of individuals who share similar interests and goals. The community is bound together by a common set of rules decided upon by the community.
How do DAOs function?
DAOs function based on the principle of decentralized decision-making. The DAO is never controlled by one person or group.
To vote or submit proposals in a DAO, members need to hold the DAO tokens. The more tokens someone holds, the more voting power he has. This is based on the assumption that someone who has invested more money buying the tokens will be more vested in the DAO.
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DAO members consist of contributors and token holders that are distributed in different jurisdictions. Proposals usually include expense reimbursements for work done, changes to the protocol, or adjustments to the token allocation.
The results from voting are final and are executed through smart contracts.
Why do DAOs exist?
DAOs exist for various reasons. For some, DAOs facilitate a bottom-up approach to governance not seen in corporate companies. Instead of taking orders from management, everyone is of equal standing in a DAO.
Others are motivated by legal reasons, such as evading the jurisdiction of central authorities. If there is no one in charge of a project, who can the government hold accountable when something goes wrong?
Still, others create exclusive communities based on shared interests, such as funding a DAO to buy different artworks or crowdfunding money to invest in projects.
Why DAOs can never completely replace companies
Despite the hype around DAOs, they cannot completely replace the current way of working.
Why is that the case? Firstly, there are security risks. For example, the Ethereum DAO hack in 2016 resulted in the loss of millions of dollars. Despite improved protocol security and many auditing companies emerging, security exploits will still happen from time to time.
When an exploit happens, the community loses trust in the DAO and the project becomes a shell of its former self. This is a big problem that has to be addressed on the technological front.
Secondly, while DAOs are not controlled by a single entity, they are still run by humans.
This is where human nature comes into play.
Without a hierarchy, decisions are made slowly if at all. For example, if the DAO is evenly split on a proposal, who makes the final call? What if a proposal that is unpopular is actually the right decision for the DAO? Who is responsible to ensure that the unpopular but right proposal gets voted in?
If a project is not owned by anyone, no one will take responsibility when things go wrong.
DAOs are still communities run by humans. Where there are humans, egos and ideological differences will eventually result in conflict. Instead of moving forward despite the differences, the group will split up based on their ideology.
There have been multiple instances of significant conflicts within DAOs, most recently seen in the case of Arbitrum (core team & community) and UMAMI (CEO & core team)
Thirdly, many DAOs are still overly reliant on the core team to run the DAO. Many DAO members prefer to be passive investors in the project. They prefer to receive rewards without needing to contribute to the project actively.
This leads to centralization of the DAO, defeating its purpose in the first place! To be fair, many projects have shared that they will eventually give complete control of the DAO to the community.
However, the real issue lies with the community’s lack of willingness to take active ownership of the DAO. Unless the core team builds a strong bond with the community or offers strong incentives for members to be active, DAOs will always be significantly centralized.
How to invest in DAOs (if you still want to)
You have read the reasons not to invest in a DAO. If you are still interested in investing in a DAO, there are a few things to keep in mind.
Firstly, check if the community is active. Outside of the core team, do community members submit proposals and vote regularly? DAOs with an active community are more valuable, as members will buy tokens to vote. Having strong organic demand for the DAO token makes the token a lot more valuable.
Secondly, find out if token holders receive rewards from the DAO. Rewards can come from investments made by the DAO using user funds or fees earned by the DAO. Distributing rewards is a great way to incentivize users to hold the token, reducing the selling pressure.
Conversely, if token holders can only vote and access the community, there is limited token utility. Speculators will be a lot more willing to sell the token whenever the price goes up. Find out if the DAO token offers a utility that aligns with user goals.
Finally, consider if the DAO is truly decentralized. DAOs that have anonymous community members all around the world are more resilient to government crackdowns.
DAOs with more wallet addresses that actively vote and submit proposals are a lot more valuable than DAOs whose community is more passive.
Some DAO Projects that I am personally keeping on my watchlist. Note that I do not hold positions in any of these tokens and this is not to be taken as financial advice.
- A project that aggregates yields from yield-bearing Arbitrum projects
- One of, if not the biggest DAO in Crypto and creator of DAI, one of the biggest decentralized stablecoin. You can borrow and lend tokens on MakerDAO
- A project that focuses on building a decentralized tokenized ecosystem
DAOs are an innovative piece of technology and a way of working using a bottom-up methodology. While there are opportunities to invest in DAO tokens, expecting a return on your DAO investment is not realistic.
Factors such as human nature, over-reliance on the core team and security vulnerabilities currently prevent DAOs from becoming commonplace.
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