What Are DAOs and How Do They Work?
Introduction
Welcome to the developer's guide to Decentralized Autonomous Organizations (DAOs), from conceptualization to implementation. This article is the first part of a two-part series. In this initial guide, we provide you with a comprehensive resource, offering in-depth insights into fundamental concepts and practical use cases. In the second part, we will explore the steps involved in developing and deploying DAOs.
Our goal is to provide you with a deep understanding of DAOs, bridging the gap between theory and practical implementation. By the time we wrap up, you'll be fully prepared to leverage the transformative potential of DAOs in your blockchain ventures. So, let's embark on this journey and explore the fascinating universe of DAOs together.
The Foundations of On-Chain DAOs
In this series, we’re focusing on on-chain DAOs, i.e. DAOs that operate entirely on blockchain networks. Let's delve deeper into the key aspects of these DAOs and why they are important.
Why Do DAOs Matter?
Suppose you're a blockchain enthusiast who believes in the potential of decentralized finance (DeFi) projects. However, the DeFi space is rife with scams and rug pulls, making it challenging to identify trustworthy investments. In this context, you decide to join a "DeFi Investors DAO." This DAO is a collective of like-minded individuals who research and vet various DeFi projects. Members pool their resources to fund promising projects and collectively decide which ones to support. Smart contracts within the DAO ensure that funds are only released to projects that meet specific criteria, eliminating the risk of scams.
Therefore, this mechanism effectively mitigates the risk of falling victim to fraudulent schemes or scams, illustrating the critical role of DAOs in establishing trust and safeguarding collective investments in decentralized finance.
How Do DAOs Work On-Chain?
Blockchain Infrastructure: At the core of on-chain DAOs lies the blockchain, a distributed and immutable ledger. The blockchain's transparency, security, and trustless nature are vital for the functioning of DAOs. You can imagine the blockchain as the bedrock upon which on-chain DAOs are built, a digital landscape where trust and transparency reign supreme. This decentralized ledger, shared across countless nodes, ensures that every transaction every decision, is unchangeable and accessible to all. It's like a digital archive, safeguarding the essence of a DAO's existence.
Smart Contracts: Smart contracts are the engines that power DAOs. These self-executing contracts are written in programming languages like Solidity. Smart contracts define the rules, processes, and interactions within a DAO, ensuring transparency and trust among participants.
Tokens as Ownership and Voting: Tokens are the gateway of DAOs, representing ownership and voting rights. We'll explore how these digital assets are created and distributed within DAOs. They are the digital embodiment of ownership and the very essence of democratic governance. These tokens, like prized keys, unlock the doors to influence and decision-making within the organization. Tokens give participants a stake in the organization and a say in decision-making processes. Understanding the role of tokens is pivotal to grasping how DAOs function in practice.
Governance and Decision-Making in On-Chain DAOs
Now that we’ve outlined the DAO tech stack, how do people interact with DAOs?
Proposals and Voting
At the heart of decentralized blockchain governance models are proposals and voting systems. Contrary to centralized frameworks, blockchain networks emphasize decentralization, where all participants have a say in the decision-making process. Here's how proposals and voting unfold
Proposal Creation: In DAOs, change is initiated through the proposal creation process. Protocols can propose a wide array of actions, including protocol upgrades, allocation of resources, or modifications to network parameters. This open-ended approach fosters adaptability and responsiveness to the evolving needs of the ecosystem.
Transparent Discussion: Upon proposal submission, it enters a phase of open discussion. This critical stage allows DAO members to engage in transparent discourse, sharing their insights and opinions. It is a collaborative effort to refine and optimize proposals, addressing concerns and considering community feedback.
Voting: Once the discussion phase concludes, the proposal is put to a vote, typically through a smart contract. DAO members exercise their voting rights, often employing native tokens or governance tokens as voting instruments. The voting process is designed to ensure inclusivity and fairness, with each member's influence proportional to their holdings.
Decision Outcome: The proposal outcome is determined based on voting results. Decisions may include acceptance, rejection, or modifications, and they must adhere to predefined voting rules. DAOs may implement simple majority voting or more sophisticated mechanisms to ensure consensus.
DAO Voting Mechanisms
Decentralized democracy within a DAO is actualized through a multitude of voting systems and mechanisms.
Delegation
In a DAO, delegation empowers token holders to entrust their voting power to a selected representative. This process closely resembles real-world representative democracy, where citizens elect officials to make decisions on their behalf. This system guarantees that decisions are entrusted to individuals with the most expertise on the matter, thus safeguarding against external influence and fostering the community's sustained prosperity.
A typical scenario is a DAO, where token holders collectively decide how to allocate funds for various projects. Now, consider a token holder named Alice, who is particularly passionate about DeFi initiatives. She might choose to delegate her voting power to Bob, a well-versed DeFi expert within the protocol. This delegation means that Alice empowers Bob to vote on her behalf in decisions related to DeFi projects.
Quorum Voting
In this voting type, decisions or proposals are required to meet a specific quorum, or threshold, to be considered valid and implemented. When creating a proposal, the initiator sets a quorum, specifying the minimum level of participation required for the proposal to pass. During the voting period, members cast their votes, and for a proposal to be successful, it must receive enough votes to meet or exceed the established quorum. This ensures that important decisions within a DAO have substantial support from the community, prevents a small minority from making significant decisions, and encourages active participation.
An example could be a DeFi DAO, where token holders are engaged in a decision-making process concerning a crucial update to their yield farming strategy. David, a token holder, initiates the proposal, setting the threshold for participation at a minimum of 10 tokens. A seven-day voting period is established, during which token holders must lock a minimum of 10 tokens in the DAO's smart contract to become eligible voters. Ultimately, 60 token holders meet this quorum requirement, contributing 60 votes in total. To pass the proposal, a simple majority is needed, and in this case, with 40 votes in favour and 20 against, the proposal secures the majority vote. Consequently, the DAO proceeds with the implementation of David's proposed yield farming strategy, showcasing the effective utilization of token-based quorum voting in DeFi governance. A typical example can be found here.
Token-Weighted Voting
In this voting type, voting power is proportional to the number of tokens held by a participant. The more tokens an individual holds, the greater their influence in decision-making processes. Token-weighted voting ensures that stakeholders with a larger financial commitment have a more significant say in governance matters. This method is often employed in most DAOs, allowing token holders to vote on proposals or determine various protocol changes based on their token holdings. It reflects a practical approach, as those who have invested more in the ecosystem have a heightened stake in its success. However, it may also lead to centralization concerns, as those with substantial holdings can dominate governance decisions.
Multisig Voting
Multisig voting, short for multi-signature voting, is a governance mechanism frequently used in blockchain projects. This method involves requiring the approval of multiple private keys to authorize actions or decisions within a system. Specifically, multisig voting is used to safeguard assets and ensure that critical actions are only taken with the consensus of a predefined number of key holders. For instance, in a multisig wallet, the control of funds is shared among multiple parties, and a minimum threshold of signatures (usually involving a majority or supermajority) is necessary to execute transactions or enact changes. Multisig voting is seen as a security measure to prevent unauthorized access and protect against single points of failure. It is being employed in DAOs where several stakeholders or custodians are involved in decision-making processes and must collectively agree on actions to be taken. An example of this type of DAO can be found here.
Quadratic Voting
With quadratic voting, each participant is allocated a set number of voting tokens, and they can allocate these tokens to different proposals or issues. The key distinction is that the more tokens they allocate to a particular proposal, the more "voting power" they invest in it. However, the relationship between tokens and voting power is not linear but quadratic, hence the name. This means that allocating four tokens to a proposal doesn't provide four times the influence of allocating one token; it provides sixteen times the influence. This approach allows participants to express stronger preferences for issues they care deeply about while still having some influence on other topics.
Quadratic voting is especially valuable in DAOs because it ensures that major decisions reflect the collective will of the community. This mechanism combats issues like tyranny of the majority by allowing minority voices to have a meaningful impact and preventing any single interest group from dominating decision-making. By thoughtfully allocating their voting tokens, participants can influence outcomes and create a more balanced and representative governance structure within the organization.
On-Chain DAO Case Studies
The DAO
The DAO was one of the earliest and most renowned on-chain DAOs. It was launched on the Ethereum blockchain in 2016. The primary objective of The DAO was to enable decentralized crowdfunding for projects in the Ethereum ecosystem.
The DAO raised a significant amount of Ether (ETH) through token sales, but it faced a critical vulnerability that led to a contentious hard fork, resulting in a split between Ethereum and Ethereum Classic. Despite its challenges, The DAO served as a pioneering example of how on-chain DAOs could be used for crowdfunding and decentralized decision-making.
MakerDAO
MakerDAO is an on-chain DAO that plays a central role in governing the Maker Protocol, a key platform in the DeFi space. The Maker Protocol issues a stablecoin called Dai, which is backed by collateral assets.
MKR token holders participate in decision-making within the MakerDAO system. They can propose changes to the protocol and vote on various governance proposals. MakerDAO's governance has successfully managed to maintain the stability of the Dai stablecoin through various market conditions, demonstrating the efficacy of on-chain DAOs in the DeFi sector.
Developer DAO
Developer DAO is a community-driven organization that focuses on funding and supporting open-source software development within the blockchain and cryptocurrency space.
It provides a platform for developers to collaborate and receive funding for their projects through decentralized governance. Developer DAO serves as a testament to the growing importance of on-chain DAOs in nurturing innovation and collaboration within the blockchain developer community.
No-Code Tools for DAO creation
If you don’t have the technical expertise to create your own DAO smart contracts, there are many no-code tools out there now which make it possible. Let’s take a look at some.
Aragon
Aragon is a platform that provides a user-friendly interface for building and managing DAOs without requiring extensive coding skills.
Here’s how it works:
Create a New DAO: Users can initiate the process by creating a new DAO on the Aragon platform. This involves providing basic information about the organization, such as its name, purpose, and description.
Customize Governance Rules: Aragon offers a user-friendly interface to customize the governance rules of the DAO. Users can define decision-making processes, voting mechanisms, and more, all through simple configurations.
Token Management: Users can also create their own tokens or integrate existing tokens into the DAO to represent ownership and voting rights. Aragon provides tools for token issuance and management.
Proposal Creation: Members of the DAO can create proposals for various decisions, such as fund allocation, policy changes, or any other matters relevant to the organization.
Voting and Decision-Making: Aragon simplifies the voting process. Members can participate in voting through the platform, and the results are automatically tabulated based on the predefined rules.
Execution of Decisions: Once a proposal is approved, the Aragon platform can execute the decision automatically. This can include actions like fund transfers, contract interactions, or other transactions.
Decir
Decir is an open-source platform that enables users to create and manage DAOs without extensive technical expertise.
Here's how it works:
Create a New DAO: Users can initiate the process by setting up a new DAO on the Decir platform. They need to define the DAO's purpose, structure, and initial parameters.
Governance Processes: Decir offers an intuitive interface to customize the governance processes. Users can define decision-making mechanisms, such as voting rules, without writing code
Connect Token: Users can create their tokens or integrate existing tokens into the DAO to represent ownership and voting rights. Decir simplifies token management within the platform.
Create Proposal: Members of the DAO can propose decisions related to the organization's activities, funding allocation, or policy changes. The platform facilitates proposal creation and submission.
Voting and Decision-Making: Decir streamlines the voting process. Members can participate in voting directly through the platform, and the outcomes are determined according to the predefined rules.
The Future Trends for DAOs
As the world of DAOs continues to evolve, new key developments and trends are emerging, for example:
Hybrid DAO Models: Some DAOs may adopt hybrid models that combine on-chain and off-chain governance. Hybrid DAOs can leverage the advantages of blockchain-based decision-making while complying with real-world regulations and legal frameworks.
Layer 2 Integration: With scalability being a significant concern, DAOs are to integrate with Layer 2 solutions. These technologies, such as Optimistic Rollups and zk-Rollups, offer faster and more cost-effective transactions, making DAO participation more accessible.
What Challenges Do DAOs Face?
While DAOs are attractive for many reasons, they are not without challenges. Two of the major ongoing challenges that DAOs face include:
User Experience: Improving the user experience for participants in DAOs is essential. Many potential users are not blockchain experts, and user-friendly interfaces and tools are needed to encourage broader adoption.
Governance Participation: Encouraging active participation in DAO governance remains a challenge. Creating incentives and removing barriers for members to vote and engage in decision-making is an ongoing concern.
Conclusion
We’ve covered a lot about DAOs in this guide, diving deep into their structures, governance mechanisms, and real-world applications. DAOs are ever-evolving, with no universal formula for success. They’re all about innovation, constantly adapting and improving their governance models.
Looking ahead, we see DAOs integrating more hybrid models and advanced technologies, like Layer 2 integrations, to improve functionality and user experience. With the insights from this guide, you’re well-prepared to navigate the DAO landscape, understanding its challenges and opportunities. Stay tuned for Part 2 of this guide, where we dive into the technical implementation of on-chain DAOs.