In this article, we will talk about DAO — a type of protocol governance on the blockchain. We will explain how DAO works and give examples of such organizations.
What is DAO
DAO stands for Decentralized Autonomous Organization. It’s the technology that drives apps on the blockchain. With DAO, projects can be run autonomously and managed by the community. The creators only set the initial rules of work and release the app. After launch, they can no longer influence it. The DAO issues special tokens to users. The owners of these tokens can propose changes to the app or vote on other users’ proposals. For example, users can vote for a new interface, for a fee change, or for a bug fix.
DAOs can independently manage their capital, therefore they are actively used in the decentralized finance ecosystem. This form of governance increases the transparency of work and the level of trust in the project. The DAO code is open source and you can find it on GitHub. Users with programming knowledge can review a DAO code on their own. Therefore, anyone who sends a large amount of money under the DAO’s control can learn how the protocol will manage it.
In 2020 DAOs are not legally binding in countries where there is legislation regarding cryptocurrencies. Only the companies that develop such projects have legal force, but not the projects themselves. However, there are attempts to create a DAO that will govern the actions of other DAOs. So far, this regulation is carried out through decentralized courts. For example, Aragon has created its decentralized Aragon Network Jurisdiction. If a project enters into this jurisdiction, it agrees to abide by certain rules. Aragon enforces these rules through smart contracts. In the event of a dispute, it will be resolved in the decentralized Aragon Court. The system will randomly select 5 judges among the volunteers and they will make a decision.
How DAO works
DAO is a complex smart contract that can manage simple smart contracts. Since it works on the blockchain, its work always involves cryptocurrency transactions. These transactions are automated by smart contracts. And to automate the smart contracts themselves, protocols use DAO.
DAO’s special feature is its governance system. The creators have no influence over the project after the launch. Any changes can only be made by voting, which requires special governance tokens. These tokens can be obtained by using the basic app functions. For example, users can obtain them in exchange for the liquidity providing, taking out or providing loans. In other words, the app can be influenced by those who use it. But governance tokens have their own value, so they can also be bought or sold on cryptocurrency exchanges.
Let’s draw an analogy with a joint-stock company. Such companies are managed by a board of directors. Shareholders can vote on decisions. Shares can be bought or received for working in the company. In the case of DAO, a governance token is used instead of a share. And instead of the board of directors — the owners of these tokens. An important difference is that shares give not only the right to vote, but also the right to a share of the profits. And governance tokens are intended solely for voting, although they have a value.
The DAO is the first decentralized autonomous organization that emerged in 2016. It is an analogue of an investment fund. Users could send money to The DAO smart contract and receive governance tokens in return. With these tokens, they voted on how The DAO would invest their money. In the same 2016, hackers found an error in the project’s code and used it to withdraw funds to their wallets.
MakerDAO is an analogue of a bank. In this DAO you can take out a loan in DAI stablecoins. This loan is secured by cryptocurrency. Users can vote with the governance tokens on the terms on which loans will be issued. For example, they can choose the size of the interest rate and the amount of the liquidation fee.
DAO is a decentralized autonomous organization. It’s a form of governance that is used in decentralized finance protocols.
The peculiarity of this form of governance is in autonomous work. The developers create the protocol and after launch it works independently. The creators don’t have the technical ability to influence the project after the launch.
Changing the DAO’s rules or fixing errors in the DAO’s code is possible only by voting. Only owners of the governance tokens can vote. These tokens can be obtained either for using the main functions of the app, or bought on cryptocurrency platforms.