Have you heard of Decentraland or UniSwap? These are some of the major DAOs that have rapidly become the burning topic of conversation throughout the cryptoverse. However, for a layman, DAOs and the basic understanding around them are still uncommon. This is probably why not every common man is building their own DAO! On that note, we are going to explain some of the basic things that every blockchain admirer must know about DAOs. 

What is a DAO in Cryptocurrency?

DAO stands for decentralized autonomous organization. As the name suggests, DAO is a community-led organization with no centralized authority governing the course of its future or the decisions in the organization. The entire system of working of a DAO is autonomous and transparent. Also, no one in the community can manipulate the decisions as each and every decision is executed by smart contracts, if and when the predefined conditions are fulfilled. 

How does a DAO Work?

The typical working of a DAO can be summed up in three major steps. Let’s see how it works.

Working of a DAO

1. Establishment of Rules via Smart Contracts

The first step is to lay the foundational rules of the DAO. This is done by the core community of members who, after careful consideration and decision, feed the rules into the smart contracts. These contracts are visible to all, verifiable, and auditable, which means that any community member or prospective community member can look at the smart contracts and understand the working, terms, and conditions of the working of a DAO. 

When the smart contracts are formally fed onto the blockchain and live for the members to view, the next step in the working of the DAO is to raise funding. 

2. Fundraising

To raise the funds and fill the treasury, what the protocol does is sell the tokens in exchange for fiat money. As a result, the token holders obtain some rights over the working of the DAO. For example, the token holders attain voting rights that are generally proportional to their share in the DAO treasury. Once the treasury is full, the DAO becomes all set for its launch.

3. Deployment of the DAO

When the DAO gets finally deployed and the code is out, no one can edit or change the rules that will govern the working of the DAO. The only way to make any unavoidable changes is to build a proposal and achieve the required consensus for its execution.

What is the Purpose of a DAO?

DAOs are extremely valuable in serving the purpose of eliminating principle-agent dilemmas and problems. In the traditional system of transactions and contracts where two parties need a lot of trust in each other in order to execute a contract. However, in the case of DAOs, only the code needs to be trusted and it will alone do all the work. 

In addition to this, DAOs are extremely beneficial in eliminating the need for third parties for executing the transactions. This doesn’t only save time but also helps the parties in avoiding fraud. 

What is the Principle-Agent Dilemma?

Principle-agent dilemmas are basically conflicts or problems between people or groups and the authority which are designated the role of representing those people. The people or groups, in this case, are called principles whereas the representing groups are known as agents. Such conflicts may arise when the decisions of the agents are not in line with the interests of the principle. 

Take an example of a busy investor who has assigned the task of building their investment portfolio to a freelancer. If the freelancer with the investor’s money doesn’t follow the directions of the investor, it will be referred to as a principle-agent dilemma.

Advantages of DAO

DAOs have several advantages over traditional organizations. Some of these advantages are explained in detail below.

Pros of DAOS

1. Accountable

One of the most striking features of a DAO is its accountability. Since all the new ideas and proposals and the people voting for and against them are also visible in the bigger picture of blockchain and smart contracts, it helps in refining the proposals in order to serve the best interests of the DAO. 

2. Neutral

In traditional organizations where one authority holds more power than the other, the manipulation of rules and politics becomes quite evident. However, the neutrality of the DAO is one of the most significant advantages over centralized organizations. It is because the implementation of the rules is taken care of by smart contracts. 

3. Equality of Stake

In a DAO structure, the voting rights are proportional to the stake of the token holders in the system. This ensures the equality of stake within the DAO structure. This presents an opportunity for the token holders to choose the course of the future of DAO and design the framework for its working. 

Also, it creates transparency within the community as all the proposals are visible to all the community members, irrespective of their stake or position in the DAO community. Each member can vote, express their opinions, and present new ideas. 

4. Autonomous Structure

Since DAOs don’t follow the top-to-bottom hierarchy, it ensures that each member in the community feels free and is independent to vote on the proposals for the future of the DAOs. This gives a sense of liberty to the members.

Possible Disadvantages of DAO

No matter how much diligence is put into the development and introduction of a new concept, there will always be some pitfalls that none of us can deny. Similarly, DAOs also have certain limitations that are mentioned below.

Disadvantages of DAOs

1. Security Concerns

Fact that smart contracts are the sole authority governing the transactions and approvals in the DAO, there are high chances of the smart contract code being vulnerable. While it is true that no one changes or edits the smart contracts once they are in production, we must not forget that all the contracts are vulnerable to attacks and bugs. 

2. Regulatory issues

As the working of DAO is led by community members, this can pose serious management and taxation challenges. Due to a lack of rules and regulations to control these aspects, DAOs can very easily turn into disasters.  

3. Considerable transaction time

The voting mechanism of the DAO may contribute to certain downsides. For example, if the DAO requires immediate action to protect the system or resolve security issues in the contracts, the actions can only be taken if a considerable number of community members vote for it. Also, the voting may not occur on an immediate basis, which may cause a delay in taking the action. 

4. The concentration of the voting rights

Since the voting rights are solely determined by the number of tokens held by a member, there can be instances where a single member or a group of members can hold a large number of tokens and concentrate the voting powers. If they begin voting on meaningless proposals, it can easily shift the direction of DAO’s future towards a wrong turn. 

Conclusion

While it is important to give equal weightage to the various pros and cons of the DAOs, it should be noted here that the disadvantages of DAOs are more or less concerned with their advantages such as decentralization and transparency. Also, the disadvantages can be overcome by doing due diligence and recruiting a team of people who are genuinely interested in the project.