The corporate governance structure as we know it today stems from advancements made by medieval European businessmen looking to expand cross-border trade. For instance, the British East India Company was the first global joint-stock company. It would offer shares to investors who could finance international trade commissions.
Over the last few centuries, the evolving economic, legal, and social dynamics have optimized this model for efficiency and shareholder wealth maximization. However, a new concept called Decentralized Autonomous Organization (DAO) is challenging the legacy of modern corporations.
This piece will explore how DAOs have evolved with the changing dynamic of Web3.
What Is a DAO?
DAOs aim to use a novel governance design that is decentralized, leaderless, community-led, and favors cooperation instead of the hierarchical approach of traditional corporations. In theory, typical characteristics of a DAO should be:
- Decentralization and autonomy: A DAO is a decentralized community whose governing principles, operations, and decision-making are autonomously enforced using smart contracts on the blockchain.
- Transparent and equitable governance: All members can participate in governance and exert equitable influence in the DAO’s decision-making.
- Economic interest: Every DAO member has an economic interest in the protocol’s success and has social trust (a shared purpose among community members in steering the direction of the DAO) that other members are similarly motivated. Example: MakerDAO votes to increase DAI savings rate
- Open source: The DAO code is publicly accessible. Anyone can review it and propose upgrades.
The abstract hierarchy of DAOs allows every member to add value, in contrast to the concrete hierarchy of corporations that reserve decision-making privileges for the executive level.
History has favored corporate governance due to its effectiveness in exerting control over a community and its ability to make assumptions on their behalf (agency theory of corporate governance), something decentralized governance could not achieve until now.
How to Choose a Suitable Governance Model
With the advent of blockchain technology, decentralized governance had the means to scale that it lacked previously. Modern organizations are often in a spectrum between corporate and DAO governance styles. They may evaluate factors like these to choose the optimal governance ideology:
- Decisions: In its nascent stages, an organization is still formulating its foundational principles; decisions may require expertise, so the ‘wisdom of the crowd’ may not be trustworthy here. The organization might gradually decentralize over time.
- Legal: Regulatory laws made for cooperatives cannot be superimposed over DAOs, as they function without representatives in the legal sense. DAOs that require legal recognition to function may look to areas with a forward approach, such as Wyoming in the USA, which recognizes them as LLCs. (Can DAOs go to court?)
- The DAO Dilemma: It states that with diminishing voting power of members and weak community interactions in growing DAOs, they tend to become increasingly disorganized as they become more decentralized.
- Anonymity: DAO members can use their blockchain identities to maintain anonymity.
- Censorship resistance: DAOs have the ability to operate independently and without interference from external entities (like governments).
DAO projects often start as centralized initiatives and lay the groundwork over which they achieve decentralization and autonomy over time.
How to Start Your Own DAO
DAOs, if done right, can be an effective social cohesion tool. A strong DAO is one with a clear mission, a motivated community, a right to expression, a voting system, and a decentralized treasury. Here’s how you can go about creating a DAO:
1. Groundwork – vision, mission, and DAO type
Every successful DAO has a clear vision and mission complementing each member’s economic interest. Use this to determine your DAO type and what the DAO expects from the members (example: Maker mission).
2. Establish the right to expression
The DAO needs a system to measure each member’s vested interest in the DAO and the value of their opinion, which it usually achieves with governance tokens or NFTs, which also need allocation, inflation, supply, and use cases (explore MKR tokenomics).
3. Go live on-chain
Once you formulate the DAO principles, it’s time to program it on the blockchain. Several toolkits help you do this without significant first-hand programming experience. Some well-known tools are Aragon, Colony, and DAOstack.
4. Set up off-chain governance
5. Set up a treasury
A decentralized DAO treasury is essential for managing funds and financing development initiatives and crowdfunding operations. Here are some treasury management tools to consider:
- Gnosis Safe – A multi-signature wallet provider, an industry standard among DAOs.
- Juicebox – A fundraising protocol for DAOs.
- Utopia – DAO treasury management toolkit
6. Grow your community
A DAO community is built with social trust and gets more decentralized as it grows. Tools like Discord, Deep DAO, Twitter, and Colony are used for communication, sharing proposals, voting, and analytics.
Key Criticisms Against DAOs
DAOs, even though they use blockchain technology, are often centralized in practice. Early adopters, institutions, and VCs often hold a large share of governance tokens, enabling them to affect the outcome of proposals (LidoDAO drama). Some communities are limiting the influence of whales with quadratic voting and vote-escrowed governance tokens (veCRV); both increase the stakes of accumulating voting power.
Token-based governance does not capture the true spirit and contribution of members.
Many argue that token ownership is not an accurate measurement of a member’s devotion and contribution to a DAO. However, some novel concepts like Proof-of-Humanity, Proof-of-Participation, and Soulbound tokens that quantify such parameters are being developed (Bright DAO).
Vote buying is a prevalent practice. DAOs have several members that have too few governance tokens to influence decisions. Their votes are often bought by offering external incentives for supporting a particular governance proposal. Such practices are tackled by making DAOs fork-friendly (Uniswap users can opt out of version upgrades) or by limiting governance parameters (Governance minimization in RAI)
DAOs are the first successful attempt to establish a global community with decentralized governance in history. They are in no regard perfect, and we may even discover new flaws as DAOs grow, but the good news is that recent innovations and breakthroughs show promise. Another catalyst to look out for is the potential for DAOs when they become legally recognized entities of the global economy.