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What is DAO?

When you encounter news articles about blockchain and cryptocurrencies, you might have recognized the term “DAO” several times. However, it can be very difficult to understand what DAO exactly means, what possibilities it has, and what its limitations are. In this article, we will deep dive into the DAO in order to understand the meaning of DAO, its strengths, and weaknesses.

Let’s define the DAO!

DAO stands for Decentralized Autonomous Organization. Let’s find more out by dividing DAO into 3 words.

| “Decentralized”

  • Decentralization is one of the key features of the Blockchain Trilemma, which refers to the distribution of the decision-making powers and compensation rights of participants in a blockchain network. If we think of DAO as an organization built on blockchain technology, it should be very important that the rights and obligations of each participant in the DAO are properly distributed. In addition, the free entry & exit of each participant will also play an important role in maintaining the philosophy of decentralization. If you would like to study the meaning of decentralization in detail, feel free to check out the following article:

| “Autonomous”

  • Just as the “Autonomous Vehicle”, the “Autonomous” in DAO also means the nature of the organization’s policy and decision-making, and the execution of the process being carried out “automatically”. It means that many things operate with automated mechanisms, such as how to vote and implement agendas that someone has put, and how much compensation will be earmarked for decision-making participants. DAO implements this through “Smart Contract”. This enables the power to “automate” and “enforce” the way in which voting powers are distributed, the overall decision-making process, and the level of rewards given to each participant all through Smart Contracts (or Programming Codes).

| “Organization”

  • DAO is an organization with a specific common purpose or mission. Many different kinds of DAOs with various purposes, such as DeFi, fundraising, academic research, NFT marketplaces, social communities, asset management, and blockchain oracle, have been showcased and the number continues to grow.
In conclusion, DAO can be defined as an organization with a specific common purpose, in which many decisions and processes are automatically executed through Smart Contracts, in a form that anyone can participate.

DAO vs Other Types of Organizations

In order to understand DAO more deeply, it can be a great start to compare it with other existing types of organizations. Let’s briefly compare the corporations and Congress with DAO!
DAO
🕸
Corporation
🏢
The Congress
🏦
Decision Makers
Governance Token Holders
Stockholders
Senators & Congressmen
Conditions to Participate
Holding Governance Tokens
Holding Stocks More Than a Specific Threshold
Elected to the senator or the congressman
Rewards for Participation
Governance Tokens
Dividends (Cash or Stock)
Salary
Decision-making Process
Automated with Smart Contracts
In accordance with the Domestic Commercial Law
In accordance with the Constitution and the Law of the Congress
Decision-making Speed
High
Medium
Low
Publicity & Transparency
Fully Open to the Public
Partially Open to the Public
Partially Open to the Public
Purpose of Organizations
A Variety of Purposes
Profit Maximization (Private Purpose)
Legislation (Public Purpose)
Democratic Features
Direct Democracy
None
Indirect Democracy (Representative Systems)

Decision Makers

  • The decision-makers of the DAO are the governance token holders. It’s similar to the corporations, but it’s different from Congress in that senators and congressmen must be elected to participate.

Conditions to Participate

  • In order to participate as a decision maker within the DAO, you must have governance tokens. This is also similar to the corporation cases, but it differs from Congress, which is founded on public interest purposes.

Rewards for Participation

  • In DAO, the governance tokens are distributed to each participant as rewards for contributions to decision-making. Or, in some cases, the surplus profits generated through the growth of the DAO can also be distributed to the participants. It’s similar to the corporation cases, and theoretically, as the size of the DAO increases or grows, the market value of the governance tokens increases, resulting in an increase in compensation as well.

Decision-making Process & Speed

  • What sets the DAO apart most is that the decision-making process is automated with Smart Contracts. This allows the decision-making and enforcing process of governance to take place very quickly. In particular, DAO can systematically prevent the organizations from being ruined, such as the tyranny of a major shareholder of a corporation, or the major parties of Congress.

Publicity & Transparency

  • The DAO records all of its decision-making processes in a form that anyone can view on the public blockchain. While some decision-making processes in corporations and Congress are closed to the public, DAO has a more complete openness.

Purpose of Organizations

  • While corporations are self-interested and the Congress is a public interest-seeking organization technically, DAO can be established for various types of purposes. From non-profit activities such as relief organizations to for-profit activities such as DeFi and NFT markets, all the cases can be implemented in the form of DAO.
  • However, it’s important to note that the purposes of the organization and each of the participants are clearly distinguished. Although the DAO can have a non-profit purpose in terms of the organization itself, each participant still can be a self-interested individual. DAO, basically, bridges the gap between the organization and the individual through reward systems, influenced by the Game Theory.

Democratic Features

  • DAO and Congress are similar in that they are basically built with democratic features. The Senators and Congressmen participate in the legislative processes, representing the will of all the people, elected under the Indirect Democracy (or the Representation Systems). DAO, on the other hand, involves each participant in the governance decision-making processes under Direct Democracy.
  • However, it may be difficult to say that the DAO has the “pure” Direct Democracy. In some cases, DAO may apply the “One-person, one-vote” rule, but most of the participants are given the decision-making power differentially depending on how many shares of the governance tokens each holds. This is a hybrid form that combines Democracy and Capitalism, which can be a mixture of the decision-making processes of corporations and Congress.

The Merits of DAO

"A fast decision-making environment can be established within the DAO."

  • Because the decision-making process of DAO is through Smart Contracts, it is much faster than the traditional organizations by minimizing unnecessary human intervention and errors. When an “Agile” environment is highly required, building a DAO can be helpful for this case.

"Anyone can freely participate in the decision-making within the DAO."

  • In the case of traditional organizations, participation is greatly restricted because they must meet various regulatory conditions such as nationality, the status of residence, and even licenses to participate in the decision-making process. In the case of DAO, however, holding the governance tokens in his/her wallet allows anyone to participate regardless of regulatory conditions, letting much more participants join to operate the DAO together.

The Shortcomings of DAO

"There is a possibility that certain major holders could take control of the decision-making process within the DAO."

  • Similar to the corporation cases, each participant is given the decision-making power differentially based on the amount of their governance token holdings in DAO. Because of this, there is a disadvantage that a particular participant can make exclusive decisions regardless of the opinions of many smallholders if the participant has more than 50% of all the distributed governance tokens.
  • Of course, even if Smart Contracts deploy a mechanism that prevents monopolistic cases through setting hard caps, it can be technically impossible to detect a single participant if the participant creates multiple wallets and participates in duplicates.

"The larger the size of the DAO, the lower the participation."

  • This is similar to the shortcomings of Direct Democracy. As written below, as the number of participants in the DAO increases, the influence of each individual reflected in the organizational decision-making is bound to gradually decrease and converge to zero.
Case
Power Distribution
There are 10 participants holding the same stake.
each has 10% of all the decision-making power.
There are 20 participants holding the same stake.
each has 5% of all the decision-making power.
There are 100 participants holding the same stake.
each has 1% of all the decision-making power.
There are 1,000 participants holding the same stake.
each has 0.1% of all the decision-making power.
  • Therefore, as the size of the DAO increases, the problem of “Political Apathy” in Democratic Societies is also found in the DAO, and various measures should be taken to solve the problem.

"There is also the possibility of DAO moving into the form of “Mob rule”(or Ochlocracy)."

  • Plato, an ancient Greek philosopher, once discussed Mob rule as a disadvantage of Democracy. In other words, he pointed out that if some policies in areas where professional or academic insights are required are determined by the public and not by expert groups, the whole society can move in the wrong direction.
  • This can also happen with DAOs. If policies that require financial engineering understanding, such as Tokenomics design, are entrusted to all participants, there is a possibility that the continuity of the DAO will be severely compromised. In addition, if the decision to confiscate the governance tokens of specific participants depends on the votes of all participants, it may result in violating the property rights of the existing constitution or victimizing certain individuals unfairly. When this occurs, it is difficult to ask for responsibility for such a decision.

The Right Direction DAO Should Take

As written above, despite the clear advantages of DAO, there are still challenges to overcome. We need to study mechanisms in order to prevent monopolistic decision-making structures, and hybrid systems that combine Democracy and expert-based decision-making structures to overcome Political Apathy and Mob rule.
DAO is a great organizational form with blockchain technology to overcome many of the shortcomings that traditional organizations have experienced so far. If DAO is improved to a more complete form, it will have great potential to be applied to many more fields than it is today.