Understanding DAOs: Their Importance, Benefits, Challenges, and Future
What are DAOs and Why Do They Matter? photo
By: Natali

What are DAOs and Why Do They Matter?

Table of Contents

When you turn on any blockchain-related conference, you always hear about DAOs and their importance. But why does everyone talk about them? Why do they generate that much of a fuss? Where and how can they be used? How can they govern without a central authority? Can they build a transparent and autonomous economy? In this article, I will explain it to you in detail.

You’ll get to know the benefits and challenges of decentralized autonomous organizations. You will finally understand their differences from traditional organizations. I will also provide you with a few examples of proven DAOs that you can safely test today.

What are DAOs?

A decentralized autonomous organization (DAO) is a group of people who form a digital organization whose rules are managed by code, not by any central authority. All DAO’s regulations and procedures are encoded in a self-executing smart contract.

DAO’s rules are transparent and immutable. No one can change them without community consent. The core DAO’s principles are:

  • Decentralization: DAOs don’t have a single authority point. They are governed by a member community with equal voting rights.
  • Autonomy: DAOs are self-managing. Their rules are pre-described in a smart contract. It executes automatically when two parties meet the requirements.
  • Transparency: DAO rules and procedures are transparent and publicly available. Anyone can check that this organization operates fairly.

We can track the first DAOs up to 2016. The first platform has a straightforward name: DAO. It was a crowdfunding platform that allowed people to invest in Ethereum projects. Unfortunately, it was hacked, so users lost $50 million worth of Ether.

This event led to a lot of criticism of DAOs. On the other hand, it shows smart contract vulnerabilities that we, as a blockchain community, should overcome to become better and safer.

And we did it! Today, DAOs are a relatively safe place where people can communicate and earn money. There are many DAO types. Here are the most common:

  • Investment: These DAOs pool together funds from members to invest in prospective blockchain projects.
  • Community: They were created to support a specific community.
  • Service: These communities provide a specific service, like governance, marketing, or education.
  • Gaming: These organizations manage and play decentralized games.

DAOs are still a new and evolving technology. However, they have the potential to revolutionize the business, building more democratic and transparent organizations.

The Technology Behind DAOs

DAO is pre-described in its smart contract: each transaction type, limits, regulations, etc. Once parties meet the contract’s requirements, the contract executes automatically.

Everyone with access to that network can see the DAO rules procedures, and transaction history. This high transparency level lowers the possibility of fraudulence or corruption in DAO.

Those contracts are crucial for DAO since they define all the rules of the organization. The terms are written into code and cannot be modified without the consent of all involved parties. These contracts are used to automate tasks involved in running a DAO:

  • Voting: They automate voting in DAOs to save time and ensure that voting is fair and transparent.
  • Treasury management: Contracts can manage DAO’s treasury, including funds tracking, withdrawal approval, and investment.
  • Asset ownership: Smart contracts can track asset ownership.
  • Governance: They automate governance tasks, including setting up voting, approving proposals, and adjusting DAO rules.

Overall, smart contracts are a powerful tool that can be used to improve the efficiency, transparency, and security of DAOs. They are essential for the successful operation of any DAO.

DAOs vs. Traditional Organizations

Decentralized organizations have many advantages over traditional options. To ease the comparison, I gather key differences in the big list:

  • Decentralization. DAOs are decentralized. They are not controlled by any single entity and don’t have censorship. Traditional organizations are typically controlled by a central authority. They can single-handedly change rules and censor other members.
  • Autonomy. DAOs run on self-executed smart contracts. They can operate without human intervention or with a minimal level. Traditional organizations need constant human intervention to make decisions.
  • Transparency. DAO rules are transparent and publicly available to each member. Traditional organizations often have an opaque decision-making process.
  • Efficiency. Due to DAO automation, they can be more efficient than traditional organizations. Traditional companies are often bureaucratic.

DAOs are resilient to corruption because they don’t have a single authority point. They are more efficient because smart contracts automate most of the tasks. DAO rules and procedures are transparent and publicly available, which makes them more accountable to the community.

They can solve or at least mitigate centralization struggles, when a small group of people control the whole organization, keeping in secret crucial details. Traditional organizations often are resistant to change and innovation, stifling their growth and competitiveness. DAOs can solve these challenges by providing a more decentralized, transparent, efficient, and innovative way of organizing and doing business.

Real-World Examples of DAOs in Action

Modern DAOs are more secure than their predecessors, so you can safely use the following options. They are great platforms that are tested by millions of users.

Uniswap is one of the most common decentralized exchanges (DEX) allowing users to trade crypto without central authority. Uniswap is one of the most popular DEXes, with over 30 million active users and $5+ billion in daily trading volume.

Aave is a lending service where users can borrow and lend without traditional financial institutions. Aave is one of the most popular lending platforms, with over $17 billion in assets under management.

Lido Finance is a promising liquid staking solution for PoS networks. As of today, it’s one of the most popular DeFi protocols with $13+ Billion TVL (Total Value Locked).

Decentralized autonomous organizations are crucial for the modern crypto industry. Here people can get needed services and don’t rely on traditional institutions. DAOs can be well-governed without main authority.

But at the same time, they can be too complex for general users. They also are still vulnerable to smart contract cyberattacks. So I recommend choosing DAOs to participate carefully.

Benefits of Adopting DAO Structures

Decentralized autonomous organizations reduce bureaucracy. There is no need to fill a ton of papers and wait until the administration approves it. All transactions are managed by smart contracts.

No one can bribe it. The only way to approve the transaction is by meeting pre-described requirements. Also, no one can change the smart contract details single-handedly. All DAO members have the chance to participate in the decision-making process.

All DAOs are transparent: their rules and procedures are stored in the public ledger. Anyone can check the fairness of the system. Those organizations are also more cost-efficient since they don’t require the same level of bureaucracy.

DAOs potentially can be scaled to accommodate any number of members and transactions. They are not limited to a single authority point. With modern consensus mechanisms, and with side chains, layer 2, and sharding solutions they can meet almost infinite scalability.

Challenges and Concerns with DAOs

Those organizations still face many challenges. And scalability is still one of them. As I said, potentially DAOs are far more scalable than traditional organizations. But as for now, some of them may face scalability issues.

They can be difficult to scale, as it can be challenging to coordinate the actions of a large number of people. There are multiple ways to mitigate this issue.

The first one is to partially centralize DAOs with a hierarchical structure, where a few leaders make decisions for the rest of the community.

Another way to boost scalability is by using a liquid democracy system, where members can vote on decisions and delegate their votes to other members. It will make decision-making more efficient and democratic. But at the same time, it can lead to confusion and potential gridlocks.

There is no one-size-fits-all solution to the scalability issues for DAOs. Users should pick the solutions depending on the specific DAO and its goals.

Other DAOs’ challenges are tied to the decision-making process. As DAOs grow, it becomes more difficult for members to communicate and coordinate their actions. It may lead to delays, inefficiencies, or even conflicts.

The third major concern here is security levels. As DAOs grow in size, they become more vulnerable to cyberattacks. They will get a larger attack surface, so they are more likely to attract the attention of hackers.

Thus, DAO developers should build systems on modern, safe, and fast consensus mechanisms with advanced smart contracts. It will boost the scalability and security of organizations. A liquid democracy system where users can temporarily delegate their votes to other members to mitigate decision-making problems.

Expert Opinions and Forecasts

Most experts agree that DAOs will disrupt the world in the future. As of today, those organizations are still in their early stages, looking for ways to build strong, secure, and decentralized organizations.

Stanford scientists say blockchain governance structures offer a fundamentally new way of organizing businesses. Even more, the use of DAOs is largely consistent with American business law’s emphasis. Building legal DAO-related laws should be easier than with other blockchain tools.

World Economic Forum experts think that DAOs are big experiments to show how humanity can connect, collaborate, and create new organizations. If DAOs turn out to be a working concept it will prove that people are capable of true democracy, where everyone’s opinion matters. But if it fails, it will show the need for at least partial centralization.

Today DAOs are confronted by a fragmented and uncertain regulatory landscape, and developers, policy-makers, and other parties should unite to overcome those challenges.

Researchers from Singapore Management University find DAO's potential autonomy and organization fascinating. At the same time, they point out decision-making and dispute challenges that future developers need to overcome.

DAOs in the Future

DAOs are still in their infant stages so we will see many changes there. We will see an increased role of those organizations in decentralized finance (DeFi) systems. DeFi allows people to lend, borrow, and invest money without a centralized intermediary. DAOs can manage funds and make decisions in a decentralized approach.

Decentralized organizations will also become an integral part of Web3, the more user-centric and decentralized version of the Internet. We will also see the usage of AI services in DAOs. AI can automate tasks and decision processes, improving the organization's efficiency.

Blockchain scalability is a major challenge we need to overcome to see the true power of DAO. Sharding, sidechains, and layer 2 solutions can partially solve this problem.

As DAOs become more popular, there is a growing need for regulation. It may take a few years to get a tremendous regulatory base for those organizations. We all should be prepared for this uncertainty period.

Overall, DAO has a bright future, when this technology can be used to create new governance forms, financial systems, and international teams.

Wrapping Up

DAOs meaning is pretty simple: they are services that run on smart contracts and connect people for different purposes. DAOs are an integral part of blockchain. Their history started back in 2016 when people believed in the potential of decentralized organizations. The first few DAOs had severe smart contract vulnerabilities, so developers shut them down.

As of today, those organizations are far more secure. They are transparent, efficient, and mostly autonomous. DAOs are organizations that are run by smart contracts (code) and not by people. They can’t become corrupted. All members have the opportunity to participate in decision-making.

However, there are still plenty of challenges to overcome. The main challenge is scalability. DAOs need to accommodate a large number of members and transactions, so developers need to use layer 2 and sharding solutions to ensure that people can use DAOs without interruptions.

Other vital challenges are security and issues with decision-making processes. Despite all these problems, DAOs have a great chance to redefine the blockchain future. As DAOs continue to evolve, we will see them more and more.