How Does a DAO Work?
Note: Data in this section last updated July 3rd, 2022
In many ways, DAOs operate the same as a traditional organization.
“For-profit” DAOs must define their mission, raise capital, create a strategy, build a product or service and then sell it for a profit. Investment DAOs need to find LPs, identify promising projects and invest in them.
As such, many DAOs are beginning to organize similarly to traditional corporations, and divide themselves into working groups corresponding to the primary functions of the business (e.g. strategy, sales & marketing, operations and finance).
Larger DAOs are Often Organized into Functional Divisions
The most apparent difference between a DAO and a traditional organization is its decentralized nature. Unlike traditional organizations, DAOs are fully-remote entities – they have no headquarters, office or physical location and members often live all over the world.
In addition, they rarely have CEOs, Boards or managers. Instead, they are owned and operated by members who make decisions democratically.
While this may seem progressive, it’s not exactly novel, as this system has existed for quite some time in the form of a cooperative. In fact, many prominent organizations today – including Nationwide, Land-o-Lakes and the Green Bay Packers – are organized as coops.
What truly makes a DAO disruptive then, is its autonomous nature. While many people disagree on the meaning of this term – some believe it describes an entity almost fully administered by machines or AI – a more modest take is that it simply means that the organization has automated away unnecessary internal and external bureaucracy by replacing traditional contracts with smart ones.
Indeed, from a technical standpoint, a DAO is essentially little more than a collection of smart contracts built on the blockchain of a decentralized platform such as Ethereum (click the following link to understand more about how smart contract platforms work).
These contracts can be programmed to replace several processes in an organization and are used to:
Define Rules: DAOs don’t need to register as a corporation, domicile in a particular jurisdiction or create an operating agreement. Instead, ownership percentages, member rights and responsibilities, voting rules and allocation protocols are coded directly into a smart contract
Raise Funds: Unlike traditional corporations, who generally raise capital through private placements or IPOs, DAOs don’t use investment banks or the financial markets to raise funds and distribute ownership. Instead, they typically raise funds by creating and selling their own cryptocurrency token or NFT
Store Funds: DAOs don’t use banks to hold their funds. Instead, they custody and manage their own assets on a blockchain, and the community democratically makes decisions on how to employ this “treasury”
Govern: As mentioned, most DAOs don’t use a Board, CEO or Executive team to define strategy or make decisions. Instead, they power their non-hierarchical, democratic governance structure with a smart contract designed to tally voting results, record them onto the blockchain and sometimes even execute the decision
Attract Workers: Unlike traditional corporations, many DAOs don’t have employment agreements and instead rely on smart contracts to compensate workers in cryptocurrency tokens or stablecoins. In theory, this allows anyone to join a DAO, come and go as they please, work as little or as much as they want and even choose to remain anonymous
Pay Workers: Many DAOs are using smart contracts to develop innovate new compensation structures such as bounties (payment per task), peer-based compensation (where team members collectively vote on the allocation of the DAO’s budget) and “streamed” salaries (automated payments made in real-time)
Distribute Funds: DAOs can use smart contracts to transfer cryptocurrencies and stablecoins for virtually any purpose they deem necessary. This includes making distributions to owners, providing grants to developers, incentivizing customers, paying suppliers and partners, etc…. Because these payments bypass the traditional banking system, they theoretically aren’t subject to local regulations or restrictions on international currency transfers
Execute Operations: Some DAOs – notably “protocol DAOs” such as the decentralized exchange Uniswap – run a significant portion of their business using smart contracts. In these cases, the DAOs could program one smart contract to interact with the others (for instance, a successful vote to increase the take rate made through the voting protocol would automatically update the smart contract responsible for administering fees)
In practice, not every DAO satisfies all of the above conditions – many today are not fully decentralized nor autonomous.
But proponents are quick to remind us that we are still very early, and thousands of entrepreneurs are experimenting to find the perfect form that blends: 1) the strengths of a traditional organization, 2) the democracy of decentralized ownership and 3) the efficiency of autonomous execution through smart contracts.
In fact, the marriage of these three features is where DAOs get their name – Decentralized Autonomous Organizations.
For more detail on how DAOs are used in practice, let’s head to the next section… 👉
Last updated
