What is DAO
Imagine a vending machine that not only takes money from you and gives you a snack in return but also uses that money to automatically re-order the goods. This machine also orders cleaning services and pays its rent all by itself. Moreover, as you put money into that machine, you and its other users have a say in what snacks it will order and how often should it be cleaned. It has no managers, all of those processes were pre-written into code.
This is, roughly, how a DAO or a Decentralized Autonomous Organization, works. The idea of such management model has been circulating in the cryptocurrency community ever since Bitcoin managed to get rid of middlemen in financial transactions. Similarly, the main idea behind DAO is establishing a company or an organization that can fully function without hierarchical management.
It is essential to draw a distinction between DAO as a type of organizations and The DAO, which is merely a name of one of such organizations. The project was one of the first attempts at creating a DAO and it failed spectacularly within due to a mistake in its initial code.
Initially, Bitcoin was considered to be the first ever fully-functional DAO, as it has a pre-programmed set of rules, functions autonomously and is coordinated through a distributed consensus protocol. Since then, the use of smart contracts was enabled on the Ethereum platform, which brought the creation of DAOs closer to the general public and shaped their current look.
But what does a DAO need to be fully operational? First of all, a set of rules according to which it will operate. Those rules are encoded as a smart contract, which is essentially a computer program, that autonomously exists on the Internet, but at the same time it needs people to perform task that it can’t do by itself.
Once the rules are established, a DAO enters a funding phase. This is a very important part for two reasons. Firstly, a DAO has to have some kind of an internal property, tokens that can be spent by the organization or used to reward certain activities within it. Secondly, by investing in a DAO, users get voting rights and subsequently the ability to influence the way it operates.
After the funding period is over and a DAO is deployed, it becomes fully autonomous and completely independent from its creators as well as anyone else for that matter. They’re open source, which means their code can be viewed by anyone. Moreover, all of the rules and financial transactions are recorded in the Blockchain. This makes DAOs fully transparent, immutable and incorruptible.
Once a DAO is operational, all the decisions on where and how to spend its funds are made via reaching a consensus. Everyone who bought a stake in a DAO can make proposals regarding its future. In order to prevent the network being spammed with proposals, a monetary deposit could be required to make one.
Subsequently, the stakeholders vote on the proposal. In order to perform any action, the majority needs to agree on doing so. The percentage required to reach that majority can vary depending on a DAO, as it can be specified in its code.
Essentially, DAOs enable people to exchange its funds with anyone in the world. This can be done in the form of an investment, a charitable donation, money raising, borrowing and so on, all without an intermediary. One potentially major problem with the voting system is that even if a security hole was spotted in an initial code, it can’t be corrected until the majority votes on it. While the voting takes place, said hackers can exploit a bug in the code.
Finally, it is important to note that a DAO isn’t capable of building a product, writing a code or developing a piece of hardware. Instead, a contractor can be hired to perform a required task. This appointment is done through the same voting process, while a smart contract will ensure a swift payment upon the correct completion of the task.