In the world of blockchain technology, an innovation has been gaining traction and capturing the attention of experts and stakeholders: Decentralized Autonomous Organizations, or DAOs. Unlike traditional organizations, DAOs are not managed by hierarchical individuals or entities, but by a set of intelligent and transparent rules. This allows them to operate autonomously and decentralized, without the need for intermediaries or central authorities.
DAOs operate in a space that is not subject to specific regulation or law, thanks to their decentralized nature.
They are based on smart contracts that run on a blockchain, coordinating the organization autonomously. These smart contracts can vary in complexity, depending on how they were initially programmed. However, once they are published on the blockchain, they become transparent and immutable. This means that anyone can review its operation and the rules programmed inside, with the certainty that they will not be altered in the future.
As smart contracts are fragments of computer code, i.e. a purely digital language, they enable a new degree of cooperation. They can manage decision-making between humans, machines and other smart contracts, which in turn can be controlled by other humans, machines and smart contracts.
Therefore, DAOs represent a significant technological innovation that has the potential to transform the way different entities cooperate. This is because they facilitate the creation of organizations that are autonomous, self-managed, transparent and efficient.
Operation of DAOs
DAOs are systems based on blockchain technology that operate collaboratively to meet a common goal. These organizations work with a set of transparent rules and programmed in a smart contract, which is published and secured on a blockchain. This ensures its transparency and automation.
In a DAO, members, whether individuals or entities, can participate and make decisions autonomously and decentralized. Each member owns a number of tokens or votes that are used for this purpose. This makes DAOs very interesting, since they allow to guarantee transparency and equality in decision-making, facilitating that all members have a voice and vote in the determinations that affect the organization.
Mechanisms of DAOs
A DAO operates through several mechanisms based on blockchain technology, including:
Smart Contracts: These are instructions encoded and stored on the blockchain that are automatically activated when certain predefined criteria are met. In a DAO, smart contracts establish the rules and actions of the organization, providing transparency, immutability and security.
Consensus Protocol: This mechanism defines the rules of the organization and can only be modified by collective vote. This ensures that no one outside the group can alter the rules. Any action that does not adhere to the rules of the code will be rejected by the system.
Token Issuance: A token is a digital representation of an asset integrated into the blockchain. It serves as a medium of exchange and economic reward among DAO participants. In addition, tokens grant voting rights in the organization’s decisions, ensuring member participation and the economic sustainability of the DAO. This token, in the environment of the MiCA Regulation, would fall within the definition of “utility token”, a matter of utmost importance when establishing under which regulations a certain project based on blockchain technology is framed.
Blockchain: The blockchain is a distributed and secure database that records all transactions and actions that occur within the DAO. It works as a public ledger that transparently and verifiably stores all relevant information of the organization.
These mechanisms are interrelated and depend on each other for the functioning of a DAO.
Thus, smart contracts define the rules and actions, the consensus protocol ensures compliance with these rules, tokens facilitate participation and economic sustainability, and the blockchain records and secures all transactions.
Together, they enable the autonomous and decentralized operation of a DAO.
Advantages and Challenges of DAOs
The main advantages of DAOs would be the following:
Transparency: DAOs are characterized by their transparency. All decisions are recorded on a blockchain, making them public and verifiable. Any individual can track and understand the activities of the organization.
Autonomy from External Influences: DAOs work through computer algorithms, which means that they are not subject to the influence of external agents. Unlike conventional financial institutions, which rely on government entities and other intermediaries, DAOs operate autonomously, without the need for intermediaries to conduct their operations and exercise control.
Automation of its operation: DAOs are based on computer code that is automatically executed according to the rules of the established protocol. This eliminates the need to interpret the rules of a DAO, as they are automatically triggered when specified conditions are met.
Global Accessibility: Thanks to their decentralized nature, DAOs can provide services globally, without being limited by geographical borders. Instead, they remove these barriers and democratize access to services for a broad spectrum of individuals.
Despite their advantages, DAOs can also have certain drawbacks:
Complex Rules: Implementing a DAO can be a complex process due to the innovative nature of blockchain technology. Automating tasks and making autonomous decisions can be challenging. A scheduling error can have significant economic consequences, requiring careful and meticulous programming.
Regulatory Challenges: Regulation of DAOs can be problematic in certain jurisdictions, especially those where regulation of blockchain technology and cryptocurrencies is ambiguous. This may create additional difficulties when implementing a DAO in certain legal contexts and may require extra diligence on the part of participants.
In addition, its natural universal and cross-border vocation makes it practically impossible to establish a single national regulation, or even supranational such as the European or American space, which regulates each and every one of the aspects of this type of organization, especially in terms of responsibility of the DAO and / or its members, an argument that we will face in another post.
Security Challenges: After the hacking of several DAO projects, it became clear that security is a crucial aspect in these organizations. It is essential to take measures to strengthen security in DAOs, including a thorough review of the code and the implementation of adequate protection measures to prevent future risks.
Examples of Successful DAOs
One of the first, if not the first, DAO to be released is TheDAO, probably the most well-known DAO today. Its fame is due to a series of significant events: (i) it raised 150 million dollars (in Ethereum) in 15 days by offering its own token to the public; (ii) you were the victim of a hacker attack that stole about one-third of your funds; (iii) recovered the funds through a “fork” of the Ethereum network; and (iv) was the subject of an SEC report that affirmed the applicability of rules on the public offering of financial products to ICOs.
An interesting aspect is that TheDAO was not “incorporated” into a legal entity. It existed only online, interacting with the outside world through specific intermediaries. According to their plans, TheDAO was to remain a purely digital entity.
Like TheDAO, few DAOs have consciously chosen to assume a precise legal form. Of the almost 300 existing DAOs according to the site deepdao.io, as of the date of publication of this post, it seems that few have explicitly adopted an associative or corporate form. Among the most notable cases, most have formed associations or foundations, very few societies. Recently, it has been highlighted that one of the most famous DAOs, the one that manages the issuance of the DAI token (a cryptocurrency with a capitalization of 6 billion dollars), has closed its foundation to reach an even greater level of decentralization.
Among the examples of DAOs constituted using corporate forms, it is worth mentioning the case of dOrg, a DAO that has taken advantage of a recent legislative innovation in the US state of Vermont that allows the incorporation of Blockchain Limited Liability Company (limited liability companies that can explicitly use means based on DLT technology to express votes in the assembly or elect their administrators). Or the case of TheLAO, which was constituted as a Limited Liability Company, demonstrating that legislative intervention that introduces “new” corporate models to allow the incorporation of DAOs may not be necessary.
Other examples are MakerDAO, a decentralized lending protocol that uses the Dai stablecoin; Uniswap, a decentralized exchange protocol that allows users to trade cryptocurrencies quickly and efficiently; and Aave, an Ethereum-based DeFi (Decentralized Finance) lending platform that allows AAVE token holders or those participating in AAVE staking to have a voice in their DAO.
Regulatory fit: All Yet to be Done
There is no doubt that DAOs represent a radical shift in the way organizations can operate and conduct their activities, but as is always the case with the emergence and advancement of new technologies, regulations have yet to find, let alone recognize, a specific space where we can place them and thus be able to “play” with clear rules of coexistence with other associative forms already existing in law.
The decentralization and automation provided by blockchains are key to allowing DAOs to operate independently and universally. Although there are still challenges and areas for improvement to consider, DAOs are a very interesting tool that will surely continue to evolve in the future.