Introduction to DAOs
Written: July 2022
Note that since this article was written, Ethereum successfully completed the transition to proof-of-stake consensus on September 15, 2022.
This article is Part 4 of a five-part series that aims to provide an overview of the Ethereum network from an investment perspective. The first part provides some background on the mechanics of Ethereum, and then outlines its general value proposition and competition positioning. The second, third and fourth parts each focus on a key aspect of the ecosystem of applications that may be built on Ethereum, and aim to provide insight with regard to use cases, growth metrics and considerations. The fifth part examines the future of Ethereum from a broader perspective, and includes a discussion of its development roadmap, as well as different types of risks that may be associated with an investment in ether.
A decentralized autonomous organization (DAO) is a blockchain-native organization that is owned and managed by its members. Membership of a DAO is based on the ownership of tokens associated with the DAO. DAOs are governed via proposals made and voted on by its members. The rules of the organization can be encoded in smart contracts, which are transparent and publicly auditable. DAO activities conducted on-chain, such as voting, are also transparent.
According to Messari, DAO treasuries held more than $11 billion in cryptocurrency as at the end of 2021, of which $7 billion was held by the 15 largest DAOs.1 There are all sorts of DAOs; a few examples are outlined below. In general, DAOs provide a way for people to form and coordinate borderless communities based on common interests, pursuits or causes.
|Protocol governance DAOs
DAOs that govern blockchain protocols such as DeFi protocols. Participants vote on proposals that determine the development and direction of a protocol.
Club for holders of NFT collections. NFT tokens authenticate membership instead of fungible tokens.
Exclusive clubs and social communities that require token ownership for access.
Friends With Benefits
DAOs that pool assets from people to pursue investment opportunities. Profits are split across participants.
DAOs that allow the owners of virtual land and in-world currencies of metaverse platforms to participate in platform governance.
Note: Illustrates potential use cases. Use cases above are not an exhaustive representation of DAO use cases. Blockchain is an emerging technology, and it remains to be seen the long-term use cases of DAOs.
Decentralizing protocol governance
Protocol governance DAOs can enable the decentralized governance of decentralized applications. For example, the decentralized exchange Uniswap is governed by a DAO. Anyone who holds Uniswap’s governance token, UNI, is a member of this DAO and can participate in governance by publicizing their opinions, submitting proposals and voting on proposals. Proposals can concern a variety of topics, such as the economics of the platform, how to spend the protocol’s treasury funds or voting procedures.
Compared with traditional governance models, DAOs can be more transparent and democratic, and directly involve the users of a protocol with the governance of that protocol.
Typical governance token lifecycle
It can be difficult for a project to achieve truly decentralized governance. For example, token ownership can be highly concentrated. In a recent report, Chainalysis found, by analyzing the distribution of ten major DAOs’ governance tokens, that across several major DAOs, less than 1% of all holders have 90% of the voting power.2 On the other hand, if token ownership does become decentralized, DAOs can suffer from a lack of leadership, as well as coordination issues. Also, participation rates can be very low, with the vast majority of token holders not participating in the governance process. In many cases, the original team typically remains the most active and influential group of contributors. In the future, governance frameworks and voting mechanisms will likely continue to evolve to better address these challenges. It should also be noted that the legal status of DAOs remains largely unclear in most jurisdictions.