What Are Decentralized Autonomous Organizations (DAO) and How They Work

What Is a DAO?

A decentralized autonomous organization (DAO) is a type of organization with no central authority, and decisions are made collectively by members involved in its governance process. After a decision has been made, DAOs typically utilize smart contracts to automatically execute actions based on predetermined conditions.

How Do DAOs Work?

The primary goal of DAOs is to dissolve centralized control and establish a community-driven approach to decision-making. Members of a DAO can propose and vote on decisions, such as funds allocation and smart contract parameter modification. The outcome is then implemented once a consensus is reached. 

DAOs often run token-based governance where tokenholders automatically become DAO members. Notably, voting power often correlates with the number of tokens held, meaning members with greater stakes have more influence during voting. 

Additionally, most DAOs have a treasury or fund jointly controlled by the organization. As already mentioned, the distribution of these funds is determined by proposals and votes by their token holders, and transactions are automatically executed through smart contracts based on the voting results.

Pros and Cons of a DAO

While DAOs offer a plethora of advantages with a decentralized approach to governance, there are still some drawbacks attached to this innovation. Here we look at the pros and cons of decentralized autonomous organizations

Pros

Decentralization

DAOs distribute decision-making power amongst members, lowering the risk of monopoly and corruption. This structure reduces the reliance on a single entity to make decisions for the organization, while encouraging broader viewpoints and participation, which is consistent with the decentralization ethos of blockchain technology.

Transparency 

Proposals that are being evaluated by a DAO are often posted on public forums for members to deliberate, and oftentimes anyone is free to share their views. In addition, every decision, vote, and transaction within a DAO is stored on a public blockchain. This degree of transparency promotes confidence among members and enables constant audits, ensuring that all operations are verifiable.

Community Engagement 

DAOs enable members of the organization from all over the world to participate in decision-making, regardless of their location. This active participation can promote a strong sense of community and collaboration, enriching the project's strategies and outcomes.

Cons

Security Risks 

Despite its promise, DAOs are not immune to security vulnerabilities. Exploits in smart contracts, the code that frames DAOs, can result in substantial financial losses. Hence, implementing solid security measures is critical to the success of a decentralized organization.

Coordination Complexity

Managing and coordinating large groups of participants from various time zones and cultural backgrounds can be difficult. This complexity may result in communication breakdowns, misunderstandings, and delays in reaching a consensus.

Slow Decision Making 

The decentralized nature of DAOs can lead to slower decision-making processes and slow development. Unlike traditional organizations where decisions can be made swiftly by a CEO or board, DAOs often require extensive voting periods, especially with a large and diverse member base.

Plutocracy

DAO voting powers are often distributed on a “per token” basis, meaning a user has more voting power the more tokens they hold, which favors the wealthy, or insiders. More recent experiments with DAO governance have looked to reduce the effects of plutocracy.

Governance Attacks

Due to the process of token-based voting, a malicious actor can submit a proposal that disproportionately benefits himself, and buy or borrow the requisite governance tokens to vote for their own proposal, thereby giving the proposal a high chance of success during the voting period.