What is Dao?

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26 Jan 2024

The world of #DeFi is actively developing. More and more people are interested in decentralized finance. In this regard, it is enough just to look at the number of new initiatives, ecosystems and conferences. Countries are even starting to implement cryptocurrencies as legal tender. The need for an open, transparent and secure financial system is the main driving force behind the decentralized versus traditional finance debate. It is therefore not surprising that decentralized finance is slowly emerging as an alternative to today's financial system.

The world of DeFi is actively developing. More and more people are interested in decentralized finance. In this regard, it is enough just to look at the number of new initiatives, ecosystems and conferences. Countries are even starting to implement cryptocurrencies as legal tender. The need for an open, transparent and secure financial system is the main driving force behind the decentralized versus traditional finance debate. It is therefore not surprising that decentralized finance is slowly emerging as an alternative to today's financial system. Using DeFi is currently too complex for inexperienced users due to the small number of refined users and the relative complexity of the industry. Users can learn how multiple blockchains work, which tokens are on which chains, where and how their returns are generated, etc. They need to understand. However, we can say that these problems are being resolved as time goes by. Bridges have become popular for moving assets between different chains, and in the future users will not know or care which blockchain they are using.

Imagine a vending machine that not only takes money from you and gives you food, but also uses this money to order products. This machine also purchases cleaning services and pays its own rent. In fact, as you put money into the machine, you and other users have a say in matters such as what the machine will order and how often it will be cleaned. It has no administrator, all these operations are written into its code.

This is more or less how a Decentralized Autonomous Organization called DAO works. The idea of such a governance model has been floating around the cryptocurrency community ever since Bitcoin removed the middleman from financial transactions. Similarly, the main idea of DAO is to establish a company or organization that can function without hierarchical management. It is important to distinguish between the DAO, which is a type of organization, and “The DAO,” which is the name of such an organization. The project was one of the first attempts to create a DAO and failed before it even started due to a bug in its code.

How DAOs work

Initially, Bitcoin was considered the first fully functioning DAO; because it has a set of pre-programmed rules, functions autonomously and is guided by shared consensus. Since then, the use of smart contracts began to be introduced on the Ethereum platform and the creation of DAOs became more widespread, acquiring their current appearance.

So what does a DAO need to be fully functional? First of all, some rules to follow. These rules are encoded in smart contracts, which are a type of computer program, and while they exist autonomously on the internet, they also need humans to perform tasks that they cannot do on their own.

Once the rules are established, the DAO enters the funding process. This is very important for two reasons. First, the DAO must have an internal property; Tokens that can be spent by the organization or given as rewards for certain activities. Second, by investing in the DAO, the user gains voting rights, as well as the ability to influence how it operates.

Once the funding process is over and the DAO is ready, it becomes completely autonomous from its creators and everyone else. They are open source, meaning their code is publicly viewable. More importantly, all rules and financial transactions are recorded on the blockchain. This makes DAOs completely transparent, immutable and honest.

When the DAO becomes active, it is decided unanimously where and how the funds will be used. Anyone who buys shares from the DAO can make offers regarding their future. To prevent the network from being flooded with offers, a monetary deposit may be required.

Thus, shareholders vote on the proposal. To take any action, the majority must agree. The percentage required to reach majority may vary between DAOs, as written in code.

DAOs allow global peer-to-peer financial transactions, like investments, donations, and loans, without intermediaries. However, a flaw in the voting system poses a risk of exploitation before it can be fixed.

The Story of The DAO

'The DAO' is the name of a particular DAO; A German startup that shares the same team with slock.it, specializing in 'smart locks' where people share properties with a decentralized version of Airbnb . The DAO launched tokenization in May 2016. Somehow, the project managed to raise more than $150 million, becoming the most successful crowdfunding in history.

The DAO's code wasn't perfect, and as it was open source and publicly viewable, someone found a bug to exploit. On June 17, unidentified hacker or hackers began transferring money from The DAO to a 'child DAO' that copied The DAO's structure. By the time the transfer was stopped, the hacker had already stolen more than $50 million worth of Ether.

Although the reason for the theft of funds was the error in The DAO's code, the incident greatly damaged both Ethereum's reputation as a platform and the reliability of the DAO concept. In fact, it caused the Ethereum network to split in two. But the point is, all this could have been prevented by testing the code. Perhaps, this event has a very important place in the development of DAOs; Possible vulnerabilities have been laid bare, and future DAOs will certainly consider these vulnerabilities.

Usage Areas

#DeFi (Decentralized Finance): DAOs are frequently used to provide governance of DeFi protocols. DeFi refers to decentralized financial applications and performs financial transactions such as lending, lending, and providing liquidity. DAOs contribute to the management of these protocols, make management decisions and participate in the development of the protocols.
Community Management: DAOs are used to manage a project or community in a decentralized manner. This includes developing the project, making decisions, distributing resources, and managing the involvement of community members. DAOs can strengthen community governance by ensuring a democratic decision process among project contributors.
Arts and Culture: In the arts and culture field, DAOs are used to manage the collection of works of art, ensure the support of artists, and evaluate the contributions of community members. DAOs can provide a more transparent and participatory structure in the traditional art world determined by central authorities.
Investment Funds: Some DAOs are used to manage investment funds in cryptocurrencies or other digital assets. DAO members can vote on specific investment strategies and make decisions based on the fund's performance.
Social Platforms: DAOs can be used to manage social media or content platforms in a decentralized manner. This allows creators and users to have influence over the future of the platform.

Advantages of DAO

The most obvious advantage of a DAO is that it removes centralization from organizations. While most organizations in the world are managed and controlled by centralized parties, DAOs put the management of the organization in the hands of those who are truly invested in it. In theory and in practice, every investor should have the opportunity to help manage the DAO.
Another advantage of DAO is that the rules are predefined, transparent, verifiable and distributed. Since the rules are always publicly verifiable, no one will be able to claim that they did not understand the DAO's rules before joining. However, proposals and decisions often require a certain amount of time and should be carefully considered before publication.
Moreover, a DAO's rules and transactions are always recorded on the blockchain, ensuring full transparency and accountability of every financial decision and action. While centralized organizations may keep opaque records, DAOs' records are always public.

Disadvantages of DAO

The problem with the decentralized nature of the DAO and voting mechanisms is that a post-launch security vulnerability cannot be fixed until a majority of stakeholders approve its fix. This leaves the door open to potential hackers and malicious actors who want to exploit all of the DAO's funds.
At the same time, DAOs cannot improve themselves. A contractor must be hired to develop on the core foundation of a DAO, which requires decentralized voting. Some might say that this has the potential to slow down the development of the DAO, but many would also argue that the advantages of the decentralized governance model outweigh its disadvantages.
An additional concern shared by those who are not natural fans of blockchain technology and cryptocurrencies is that communities cannot make the best management decisions for an organization. However, this largely goes no further than personal belief.
Finally, the main concern about DAOs is the lack of a clear regulatory structure. Most states in the world have not clearly defined their legal views on DAOs. This situation may hinder the rapid development of organizations.

DAO examples

Basically, any autonomous organization with a decentralized management and budget system can be a DAO. This makes almost every decentralized cryptocurrency network a DAO, especially considering the crowdfunding done before the official launch. Below you can find a short list of the most well-known and successful DAOs.

Dash — An open-source, peer-to-peer cryptocurrency that offers instant payments and private transactions.

Digix Global — The gold standard of peer-to-peer digital value. Each Digix Gold token represents 1 gram of LMBA standard gold and is secured in Safehouse vaults.

BitShares — A decentralized cryptocurrency exchange; It markets itself as a fast and mobile trading platform and offers the stability of the dollar along with the freedom of cryptocurrency.

Finally, it should be noted that DAO does not have the ability to produce a product, write code, or develop hardware. Instead, an entrepreneur can be hired for the required work. This assignment is done through the same voting process, and the smart contract provides a quick payout if the task is done correctly.