Will DAO be the next hot spot in the blockchain field?

It’s an emerging solution, a way to automate the middlemen and distribute value back to users while preventing harmful concentrations of power.

What do student athletes going unpaid, Facebook ignoring privacy concerns, and banks paying no interest on checking accounts have in common?

First, all of these situations are unfair. All of them involve a rent-seeking middleman — a university, a corporation, a bank — who keeps the customer and all the value created for himself. Facebook won’t make money if you don’t release anything. A university will be unknown if it doesn’t have a football program. If a bank can’t loan money out of your checking account, they can’t earn interest.

These institutions are worth billions of dollars, accumulating value from the work of their members. However, it is not distributed to the people, the ones who make them possible. Even if you complain about this fact, they have the power to ban you, then censor your content, and even confiscate your assets, even if you bring them platform value.

But it doesn’t have to be this way. If we cut out the middleman and return value to you, if student athletes get a cut of ticket and merchandise sales, if users get a cut of ad revenue generated by their Facebook posts, if your checking account earns interest. With the rise of Bitcoin, Ethereum, and the crypto ecosystem, there’s an emerging solution, a way to automate the middleman and distribute value back to the user while preventing the harm of concentrated power: the DAO.

So what is a DAO?

A DAO is an online community with decentralized rule enforcement. Take any online community, a forum, a massively multiplayer online role-playing game, or your group chat with friends. Make sure that no one can tamper with the rules without the community's consent, and you have a DAO. For a board, the enforcement of the rules is not decentralized, because a single mod can exercise all the power.

Users give the most value to websites. Yet users are excluded from ownership or say in the platforms they create. DAOs automate these powers through code in smart contracts. So imagine we replaced the power-hungry mod with a tamper-proof bot that automatically enforced these rules. The rules would be transparent to all because anyone could see how the code was written. The bot would use these rules to moderate the community. If people disagreed, there would be a way to work it out. If enough people agreed, the bot's rules would change and a user might not be banned, or an unfair law would be overturned.

So is a Twitch channel or forum a DAO? A Twitch channel is an online community organized around an interest, incentivized by likes instead of tokens, with its own rules, such as not spamming, voting through polls, and allowing anyone to participate in the chat. Twitch chats are not DAOs because they lack decentralized enforcement. In Twitch live broadcasts, the host dictates all the rules. Even if users disagree, they can't do anything.

However, if we wanted to convert this Twitch stream into a DAO, we would just automate and decentralize the rules. For example, users vote on acceptance and ban, and bots scan for rule-breaking comments, not moderators. Automated voting would immediately implement community proposals if enough votes were passed.

We have the beginnings of a DAO. Not only that, but it’s programmed in a way that no creator can change the rules without consensus. Only then will we turn this Twitch stream into a DAO.

Why are DAOs so popular now?

In fact, the concept of DAO has been proposed for a long time, even before the launch of Ethereum. Vitalik Buterin mentioned it in the original white paper on Ethereum in 2012, so the idea is not new.

But before blockchain technology, the technology to decentralize rule enforcement never existed. Think of a blockchain as a database that everyone agrees to modify. In a centralized database, anyone can add an entry to the database. But with a blockchain, everyone has a copy of the database. So if you want to change an entry, you have to convince everyone to change their copy of the database together.

Some blockchain platforms in particular, like Ethereum, support smart contracts, or programs you can run on the blockchain. These smart contracts are like automated rules that no one can change. This way, the DAO follows the rules specified by this program. Anyone can look at the code and verify that it does what it says it does. No one can tamper with these rules because everyone has a copy of it. Even the creator of the original rules can't change them. If you try to adopt this rule, you have to convince others to change it with you. If the members don't agree to change it with you, it's unlikely to happen.

It seems that while DAOs have been around for a while, the technology to make them a reality has only just emerged, and there is a renewed interest in them.

How to create a DAO?

Building a DAO involves two parts: an online community of people, and ensuring the rules of this group are decentralized. This way any existing online community can be converted to a DAO, and setting up a DAO is all about setting the rules of participation in an automated, tamper-proof mechanism. Tools for setting up DAOs There are some common automation challenges when forming a DAO. These include: communication, joining the DAO, rule change proposals, infrastructure for voting, treasury management.

Fortunately, tools have emerged to automate and decentralize these issues.

Below is an example of how to set up the tool, involving a DAO created to fund a social cause.

Building a Crowdfund DAO

Let’s say we want to build a crowdfunding DAO, where members pool their money for a common cause, and we can vote together on what to do with that money, and then program the rules so that once a simple majority vote is met, the funds are automatically transferred to the agreed-upon project.

member

We allow people who donate to the fund to join to manage enrollment. The way the DAO does this is by issuing tokens to represent dollars. You submit some crypto to the DAO's smart contract. The contract puts it into a public pool and issues you a token, where 1 dollar = 1 token. If you own a crowdfunded token, you are a member of the DAO.

You can do this in two ways: create tokens through a tool like TryRoll, or manually write a smart contract to manage this token swap.Essentially, you will send some Ethereum to the address of the smart contract and call one of its public APIs, which will transfer the money to its vault and issue tokens to your address.

comminicate

Most DAOs communicate through a combination of Telegram, Discord, and Twitter, and that part isn't that hard, i.e. create accounts on all 3 platforms and make all community announcements there. Let's also assume that we only want token holders to join these channels. We can use a tool like Collab and log into these channels. If we own the tokens, the bot will automatically let us in. The bot can also check every few hours to see if we still hold the tokens. If we don't, it will revoke access to former members.

Treasury Management

We also need a way to manage the funds, and one way to do that is to use Gnosis Security to spread control of the treasury to different people. If you have 10 people, you can ask 6 of them to agree to do anything with the money. If you have a full-time team managing the fund, you can use Superfluid to support employee salaries from the Treasury. Alternatively, you can also get dashboards and insights into the state of the treasury through Llama.

vote

Now we have to decide what to spend the treasury money on. We can submit a proposal for a project and allow voting. This vote counting can be done with tokens, where each token converts to one vote. Decentralized proposal and voting tools exist, with snapshots and automatons being the most popular.

Compare this to what happens without blockchain. If one entity controls the treasury, that person can steal all the money for themselves. If one person controls the votes, they can manipulate the vote counts. If one person wants to control all communications, they can censor people. DAOs eliminate these risks by decentralizing and automating all parts of the organization.

One final note: crowdfund DAOs are actually a thing, and follow this general structure for setting up. The Constitution DAO recently attempted to raise funds to win a bid for a copy of the Constitution at a Sotheby’s auction. It issued tokens in USD, managed communications via Twitter and Discord, and used Gnosis to control treasury funds. Ultimately they failed, but it proved that a DAO could quickly pool funds together for a common purpose.

How to make DAOs successful

The structure of the DAO is established through the above steps. However, simply establishing rules cannot fully utilize the maximum benefits brought by the DAO, but to align the incentives of its members. The main function of the DAO is that it can distribute its value to its members. However, in web2, the work of users such as making videos, writing comments, user participation and even their subscriptions only benefits centralized organizations. The main advantage of the DAO is to automate this central organization and distribute rewards to its members. You can get dividends from your comment revenue. Facebook does not make a profit by selling your data to advertisers, but advertisers pay you.

In this way, a DAO is like a virtual cooperative. You get the value of all your work, and as the cooperative grows, you directly benefit as a member of it. It has better economic incentive alignment than existing web2 structures. If web2 companies already have sticky user engagement, imagine the flywheel of a DAO if you rewarded members for their contributions with real money, and incentivized them to make better content by rewarding them.

The most important and difficult part of creating a DAO is thinking through the economics of these incentives. There are many examples of this, but an example of how a DAO aligns these incentives is as follows:

• Financial benefits: Some DAOs act like decentralized banks, part of a broader movement called decentralized finance. Members can pool their money and lend it out to others. The interest paid by the lenders is then paid to all liquidity providers. This is like the interest earned by a bank being paid to all members with checking accounts.

DAOs that do this include Compound DAO, Aave, and Anchor Protocol, some with up to 20% interest just to provide liquidity to the DAO.

• Game theory: Some DAOs use game theory to incentivize wealth-creating behavior among their members. Think of game theory as incentivizing good behavior through punishment and rewards. An upvote and downvote system is a simple example of game theory that can promote good content because others will support it through upvotes, and oppose bad content because downvotes will hide it.

For example, one type of DAO takes advantage of cartel economics. Cartel economics refers to how oil companies, diamond companies, and drug cartels make money. The goods they sell are not actually scarce. For example, diamonds are not rare, but miners collude to artificially limit supply and drive up prices. This benefits all member countries because they are all incentivized to jointly limit supply to maintain a high-priced monopoly.

Some DAOs use this style of game theory cartel economics to create wealth for their members. These protocols mint tokens for their members to distribute, but then limit their token supply to the public. As the DAO's token supply shrinks, the few tokens sold on the market will cause its price to soar. Olympus DAO, Time Wonderland, and Rome DAO are typical examples of game theory DAOs.

Not everything should be a DAO

DAOs exist to serve any purpose you can imagine. Combining a DAO with insert crowdfund or insert community does not mean you have a new DAO. When launching a DAO, always ask yourself two questions: What is the web2 equivalent of a DAO? Does the DAO have any centralized parts? These two questions can reveal weaknesses in a DAO or show that a DAO is not needed at all.

The DAO and its web2 equivalent

Before we start creating a DAO, first think about the web2 equivalent of a DAO. A few examples: For a crowdfunding DAO - what if we created a crowdfund using GoFundMe? For a business DAO, what if we just created a company using a typical CXX structure instead of a headless organization? For a social DAO, what if it was just a group chat?

For most use cases, this isn't that bad. The consideration is: Slow. How slow is it if everything in an organization requires a vote, which is what a DAO is like. This makes it hard to change, and hard to innovate quickly. If an organization has more centralized power, then that organization can grow faster.

Decentralization is not needed, most things work just fine in the web2 version. For crowdfunding, GoFundMe works just fine without a DAO. Or for a Twitch stream, the owner should have the ultimate power because they own and created it. In fact, without strong moderators, the community may have too many spammers, causing the quality of the community to deteriorate over time.

No recourse for problems, because the DAO is not responsible for a single function, so if something goes wrong, there is no one to turn to. For example, for a financial DAO, customer service is a big advantage of a centralized business, but a DAO cannot do that without a separate person in charge. In fact, responsibility is even more decentralized, because everyone can be anonymous, you may not even know who the other DAO members are, and the only thing that unifies you with others is the automated rules enforced by the DAO's smart contracts.

The Weakest Link in a DAO

Most DAOs are a combination of decentralized and centralized parts. A DAO is only as decentralized as its most centralized part. It is this centralized part that can be exploited by bad actors. Especially if it is a key part of a centralized DAO, then this is probably not a very good DAO.

For example, many DAOs use multi-group wallets that require several leaders to agree to move funds. Although it is decentralized because a few people have power, if these few decide to collude together, they can move assets from the community's treasury. In this case, power is concentrated in the signatories of the multi-group wallet, and this concentration poses risks to the entire DAO.

While it is natural for a DAO to start out in some centralized way, over time and as the collective group grows, the leader will delegate more power to the collective group, so the DAO tends to be decentralized. Sometimes it is a matter of trade-offs. Some parts of a decentralized DAO are more important than others. The handling of funds will always be critical to decentralization. Voting is essential to decentralization, if you vote but only a few people count the votes behind closed doors, what good is that? Communication is not so important to decentralization, as the DAO's smart contracts can still function without it. Therefore, things like communication can be outsourced to centralized web2 tools like Twitter or Discord.

Summarize

A DAO is an online community where the rules of execution are decentralized. To establish a DAO is to establish the rules of the community in a decentralized way. You will start to hear more about DAOs because the technology to implement DAOs has recently emerged with the rise of blockchain. Many tools exist for setting up DAOs, and general solutions for common DAO problems have begun to emerge - communication, voting, and financial management.

Setting the rules of a DAO is a mechanical act. The difficulty with DAOs is setting up incentives that reward participation. Not everything needs to be a DAO. Always compare it to its Web2 counterpart. A DAO is only as strong as its weakest link (i.e. the most centralized link).