Crypto protocols are meant to be governed by decentralized communities of stakeholders. Not because it’s more efficient or important for ideological reasons, but because it’s necessary to unlock their core value proposition: that the underlying protocols will continue to run as designed and will remain open to anyone who wants to use or build on them, without having the rules shift under their feet.
These are not our words; they are Andreessen Horowitz's Jeff Amico's.
As an early VC investor in crypto startups, A16Z is knee-deep in decentralized governance. They are constantly exposed to it as token holders in some of the leading decentralized protocols in the space. Their experience tells them that decentralization of governance is another key feature in crypto's identity. It is a matter of trust to them: decentralization guarantees that projects will be transparent and remain faithful to their foundations.
The ultimate goal is to replace intermediaries like global banks and tech platforms with software built on top of networks that direct the value they generate back to the users who own and run them.
Again, not our words: this comes from The Economist.
Today we will be talking about yet another acronym in the crypto space. One that is likely to become as important as DeFi and NFTs and join the club of the most important applications of blockchain to date. We're talking about DAOs.
The acronym DAO stands for Decentralized Autonomous Organization, and the concept refers to organizations who cooperate digitally through online platforms that are transparent, somehow democratic, binding, and self-executing. Blockchain technology built a bridge between digital decision-making and the movement of funds that opened the door to a new remote, global, digital way of working together. Blockchains can host programs where the conditions for cooperating are written in stone and open for anyone to read. As a result, DAOs are a new way of cooperating.
Let’s imagine a homeowner's association deciding whether to fix a fence or not while behaving like a DAO. This very modern group of neighbors frequently communicate via an app where decisions are discussed and voted. And the fence around their building is broken.
Their app shows them three different proposals to fix the fence. They have been voluntarily submitted in detail by one of the neighbors.
a) Simple fix: solve the problem with the hole and get on with life. The fix would cost $500; Contractor X would repair it in a matter of three days. The contractor would charge 50% in advance and the other 50% once the community votes to agree the job is satisfactorily finished.
b) Full fix. For those who think the hole is just a symptom of general deterioration, spending $5000 on changing the whole fence is the second option. Contractor Y would do the job in two weeks once an initial 20% payment is made. The community would unlock the rest of the payment by voting 15 days after the job kicks off.
c) Just pass. Holes give fences their unique flavor.
A fully decentralized and autonomous organization would require all the details to be written in stone. Or, in better terms, written in code. For example, what are the payment details for the association, Contractor X and Contractor Y; when would payments be made, when would the final consultation about the results be launched, and how long would it be open for voting. What are the voting thresholds to consider a vote approved or rejected, how is communication managed with the chosen contractor, and what happens if the job is not appropriately finished... Every detail would need to be laid out because the app doesn’t take decisions or ask questions; it executes the tasks.
In a DAO, once the neighbors voted on their favorite opinion, the decision would be automatically executed, for example, sending the initial payment and starting a counter before the final consultation is launched in the community's app.
According to Linda Xie´s definition:
A decentralized autonomous organization (DAO) is a group organized around a mission that coordinates through a shared set of rules enforced on a blockchain.
Or in other, more informal, words from Cooper Turley, they are “internet communities with a shared cap table and a bank account.”
DAOs are a new way of making decisions that could disrupt organizations as we know them. They prioritize transparency, debate, and collaboration. They make execution a technical challenge, devoid of human intervention, where every detail is pre-defined and binding. It is not hard to scale the example of the homeowners to larger communities and imagine how this would work for some areas in corporate and political decision-making.
Decentralized Autonomous Organizations are the iteration of online communities spun from crypto. They share features with previous manifestations of digital associating, such as good old mailing lists, forums, or Facebook groups. They add the component of decision-making and financial allocation.
Financial incentives are not just another ingredient. They are the fairy dust that makes communities fly. Web 2.0 brought unparalleled borderless cooperation between peers thanks to digital platforms. Now the communities formed by those people have a budget. This makes motivation and drive different.
There are many use cases for DAOs. Turley mentions some possible categories, and one single DAO can belong to one or more of them. Some of them are:
- Grant DAOs, where participants pick projects to fund among a list of requests. Grant DAOs are frequent in the DeFi space, where the community of token holders is constantly seeking to make the community grow.
- Venture DAOs, similar to grant DAOs, but whose purpose is to become investors in promising crypto projects. Flamingo, The LAO, or Metacartel are examples of these.
- Protocol DAOs, frequent in DeFi: users can decide how the protocol should work and vote for changes in the code. For example, when a liquidity pool wants to add a new liquidity pair. Uniswap, Aave, Compound,… all main blue-chip decentralized exchanges have protocols governed by the community.
- Collector DAOs, where participants with a common interest meet, debate, and decide. They are frequent in the NFT space, where a DAO can be made of the owners of a certain collection and decide on measures beneficial for the project, like purchasing more items or even burning some to make the rest more valuable (#truestory). Cryptopunks and Squiggles are some famous NFTs with their own communities.
DAOs obviously have many downsides. They are still an immature way of decision-making, often prone to inequality and unfairness. Sometimes they are plain unnecessary and just a shallow mannerism in the hands of over-enthusiastic players. But governance is becoming increasingly important, especially since decentralization is becoming the shield that defends projects from regulators.
If the value is to be retained within the confines of crypto, instead of shared with big institutions and corporations, governance, in general, will have to play a critical role in coordinating a huge variety of wills.