Everyone’s doing it - but how do DAOs work, and why use them?
NFTs received all the buzz in 2021, but another crypto-related trend quietly gathered steam. Groups from crypto investing platforms to fans of US history all embraced the power of Decentralised Autonomous Organisations to explore new methods of organisational governance.
With such a variety of use cases, how exactly do DAOs work? What’s their role in the crypto world, and how might they catch on beyond it?
Organising decentralised organisations
How do you organise a largely disconnected group of people who share a common interest?
That’s the challenge faced by a growing number of crypto and blockchain-based enterprises. And it’s not a new problem. To a large degree, it’s similar to the problem faced by large, traditional, publicly-traded companies. There’s a shared interest (the company itself) bringing together an otherwise disconnected group of people (the stockholders).
The goal is to get those people to act as a collective, using their group decision-making to benefit the company or achieve a common goal.
Traditional companies work as a unified group by centralising the decision-making process. The exact method varies from company to company, but you’ll typically find some combination of a governing board and then numerous laws and bylaws that allow stockholders to participate in company governance indirectly.
But what if there were a way to harness the power of the blockchain to serve a collective interest without centralised control? The answer to that question lies in a DAO - a Decentralised Autonomous Organisation.
Smart contracts: The power behind the DAO
A DAO works by using smart contracts as an enforcement mechanism. There’s no need for obscure election procedures to govern who makes it on the next board of trustees; no shadowy backroom politics; and no obscure bylaws to muddle up a planning meeting.
Instead, all of those laws and bylaws can be established and enforced through a series of smart contracts, which kick in when certain parameters are met. Need to release funds to particular parties at set times? Smart contracts will execute payments automatically, without involving a centralised treasurer.
In other words, by using a DAO, groups can hard-code their entire organisation on the blockchain. Once it’s set up, the only way to change those rules is through a vote, allowing a DAO to incentivise collective participation without relying on centralised governing bodies.
Smart contracts provide another key advantage to a DAO: transparency.
Everything is coded directly onto the blockchain, making the entire DAO structure, and the smart contracts that power it, publicly visible.
That extreme visibility can have some drawbacks; any weaknesses in the DAO’s structure or execution can be easily found by bad actors. But when set up correctly, transparency builds trust in the DAO’s organisation. At the same time, smart contracts enable it to operate smoothly without a central government.
Not every DAO is perfect, of course, and every organisation needs a bit of flexibility. Even DAOs need to be able to adjust their own rules and regulations as they go. DAOs function democratically - rule changes require a simple majority of votes. One good example is Phuture’s own DAO, which passes changes that receive 51% of the vote with a 30% quorum. This provides institutional flexibility while maintaining a decentralised, democratic approach.
Tokens - Permission to enter the DAO
If you’ve ever wondered why there are so many tokens out there, DAOs are a big reason why. While membership in a DAO can be as simple as signing up on a list, most DAOs reserve membership for token holders. Holding a DAO’s native token enables users to vote on proposed changes.
Exactly how a DAO manages its tokens can vary. A simple token-based membership allows any token holder to participate in DAO governance. Share-based memberships, like Phuture’s, require some kind of donation or tribute in order to participate. In Phuture’s case, users must hold 1,000 PHTR tokens, or 1000 ePHTR tokens, in order to participate in decision-making processes. The ePHTR token is Phuture’s governance variant token; both variants are acceptable to reach the minimum share.
DAOs in real life
The concept of a decentralised organisation powered by the blockchain isn’t new. The idea was first raised shortly after Satoshi Nakamoto’s famous Bitcoin whitepaper. And to a large degree, a DAO is just a broader application of early ideas on how to structure organisations that are separated and disjointed.
A few real-world examples can help to illustrate how the DAO idea has grown over the years into one with dramatic real-world potential.
Begun in 2016, The DAO was the first major attempt to establish a working DAO. Based on the Ethereum network, The DAO was an instant success that quickly turned into a cautionary tale.
The DAO was an investment vehicle, relying on the power of crowd-based decision making to direct their investment strategy. Token holders could vote on which projects to support. At its launch in April 2016, The DAO raised $150 million. A month later, The DAO controlled roughly 14% of the current ETH supply.
So far, so good - but in May, Ethereum developers began to point out potential flaws in The DAO’s code, flaws that a hacker could potentially exploit. By June, those fears were realised. Over the next few weeks, nearly ⅓ of The DAO’s ETH holdings were siphoned off.
The DAO’s coding errors and the hack that ensued resulted in one of the most famous, and controversial, blockchain decisions - the Ethereum/Ethereum Classic hard fork. Voters made the decision to reset the Ethereum blockchain, restoring the lost tokens. But a certain segment of Ethereum users resisted, pointing out that the hack wasn’t malicious, per se; the attacker had simply taken advantage of a loophole in The DAO’s code.
The DAO project failed in the aftermath of the controversial hard fork, and the DAO token was removed from major exchanges. Eventually, what was left of the project was folded up in the MakerDAO project, a far more successful DAO that continues today.
The DAO’s failure showed the path to success. In the intervening years, DAOs have become particularly popular with DeFi Dapps. Phuture is a good example - a DeFi investment tool that uses a DAO and a native token, PHTR, to make decisions as a collective.
Recently, proponents have begun to apply the DAO structure to projects outside the crypto world.
After all, financial management and business administration aren’t the only fields that require disparate groups of people to work together. Any shared interest could, in theory, benefit from a DAO.
The most dramatic recent example of this new trend is Constitution DAO. When one of only 13 known original copies of the US Constitution came up for auction at Sotheby’s in 2021, fans realised that this was a chance to apply the DAO structure to a real-world cause. Constitution DAO issued a $PEOPLE token and raised over $40 million to participate in the auction, with the plan to partner with an educational institution to publicly display the document.
When the gavel fell, the constitution copy sold for $43 million, outside Constitution DAO’s reach. Another DAO failure? Not exactly; Constitution DAO failed to win the auction, but succeeded in acting as a collective. That included winding down the project. The group’s website is still active, allowing participants to redeem their $PEOPLE tokens for $ETH. There was no dramatic controversy in the wake of the project, and no devastating loss of funds.
In fact, Constitution DAO demonstrated the versatility of the DAO structure, as useful for fans of American history and public education as it is for advanced DeFi investors. Constitution DAO lasted only a few months from start to finish, showing that DAOs don’t have to be long-running projects in order to be successful.
Dawn of the DAO
2021 was the year of the NFT. But looking back, it might be remembered as the Dawn of the DAO - the year the Decentralised Autonomous Organisation model went mainstream and changed how collectives operate.
For more information on how Phuture’s own DAO operates, and on how to participate in it, check out this link.