What is a DAO?
Human beings are social animals that rely on and require cooperation to survive and thrive, from the time of the law of the jungle to the laws of Man. As a result, we have always organized ourselves into tribes, groups, teams, committees, companies and other forms of collective action to grow, learn, adapt, coordinate & execute our higher vision. In all such organizations, a unified vision & objective is prescient to transcend an individual’s achievement.
In traditional corporate and business organizations, all employees enter into employment contracts & internal policies that regulate their relationship with the corporation and amongst one another. In addition, their rights and obligations are regulated by legal agreements, which are enforced by the governing law of the country they reside in broadly as a social contract, i.e., law-is-code.
DAOs, on the other hand, exist in the virtual layer above IRL and are internet-native organizations; collectively managed and owned by its members according to preset rules, self-executing and enforcing “smart” contracts and guidelines specified in code and enforced on the blockchain, i.e., code-is-law. One of the main benefits of a DAO is that they are functionally more transparent in its operations than traditional organizations since most actions are conducted ‘on-chain’ and anyone can verify the nature of such ‘on-chain’ transactions undertaken by the DAO, albeit some actions may still remain ‘off-chain’.
The term DAO represents three elements, although many more such elements may describe its true nature:
a) Decentralized: DAOs are considered decentralized because they are deployed on a public blockchain, making it open, permissionless, borderless, and censorship-resistant.
b.) Autonomous: DAOs are considered autonomous because the primary infrastructure of a DAO is open-source software, and its operations will effectively follow the rules embedded in its code and the governance efforts effectuated by its community.
c) Organisation: DAOs are organizations that facilitate human cooperation & coordination via collective ownership centred around specific purposes.
How does a DAO work?
The ecosystem of DAOs is a unique combination of smart contracts and a well-functioned community. Unlike traditional organizations, DAOs are not governed by boards or managers, rather aim to be governed by its members who collectively govern decisions made within the DAO through token-based voting mechanisms, which are carried out according to predefined rules in smart contracts.
Governance
Governance is usually required for building legitimacy in the decisions taken by the DAO. These decisions should be made with the mission, vision and goals of the DAO in mind. Governance is complex and difficult to get right (a history of traditional corporate governance speaks to it). Although it is impossible to build a ‘perfect’ system to operate a DAO, it is certainly possible to build ‘playbooks’ for governance patterns and DAO structuring based on its nature of operations. DAO-based communities so far have been experimenting with various systems to govern the infrastructure, from informal to formal processes, from loosely coupled off-chain to tightly coupled on-chain systems. An ideal governance model is one that maximizes a DAO’s meaningful participation, fair use by its community and the realization of its mission.
Over the last few years, we’ve seen significant innovation in token-based governance models among leading DAOs. The governance function of the token, operates akin to shares (i.e. a bundle of rights) but operating on open-software systems that promote long-term value and growth to its holders. It gives token holders the power to change the rules of the system when necessary and allocate the resources of the ecosystem through a decision making process. This is valuable for users as they become “owners” of the protocol. This results in stronger network effects, because the more useful a protocol is, the more valuable it becomes to govern it.
Entity Structure
DAOs can share characteristics with partnerships, corporations, trusts and cooperatives, but the operational and organizational functionality derived from the technology itself presents issues in being classified within those existing entity structures (Wyoming DAO-LLC regulation). In our view, DAOs are meta-software that enables any underlying legal structure and the primary decision at the outset of building a DAO is to determine whether it has a for-profit or not-for-profit purpose.
The non-profit DAOs aggregate capital and fund projects to serve the community at large and pursue education, science, environment, charity, etc. based on the votes of the members. Here are a few interesting examples: ConstitutionDAO was created to purchase an original copy of the US Constitution; DiatomDAO is raising support to protect the oceans; KlimaDAO hopes to speed up solutions for climate change by increasing the price of carbon assets. LexDAO is a non-profit decentralized guild of web3 lawyers with an education platform.
The other types of DAOs are organized for profit. Here are a few interesting examples of for-profit DAOs: MetaCartel Ventures (Venture DAO) is a for-profit DAO created by the MetaCartel community to make investments into early-stage Decentralized Applications (DApps); StakerDAO is a platform for governing financial assets in a decentralized, secure, and compliant manner.
Earlier, If DAOs are organized for profit, they run into securities laws issues, limiting their application and ability to fund ecosystem development and deploy capital efficiently. Even if DAOs are organized for charitable or social purposes, they run into legal grey areas where members may be considered partners and thus each member is individually liable for the activity of the organization. Despite these technical and legal challenges, the lustre of DAOs has not dulled. Now there are various forms of legal structures available that the DAOs can use to spin up and enable limited liability constructs.
Legal Structure
There are largely four camps of thought around how to approach legal structures in respect of for-profit DAOs. The first is the US-based LLC camp which largely consists of three options:
- The first option is to register your DAO under the DAO specific Wyoming legislation. This legislation allows DAOs to legally incorporate a limited liability company that can hire employees, scale, and grow. The legislation aims to give DAOs the legitimacy they need to establish themselves better and grow in the worldwide marketplace.
- The second option is to create a “legal wrapper," under Delaware's freedom of contract statute, which is created by structuring the DAO as an LLC to hold the company responsible for contracts, taxes, and violations of law, but not the individuals acting on behalf of that company. DAOs can also use Ricardian LLC that acts as an NFT-Factory smart contract with embedded Delaware Series LLC Agreement functions and IPFS-hosted documents as a public good on Ethereum.
- And the last option is the most recent explored model is to register your DAO under other legislation including the Colorado cooperative statutes, specifically the Uniform Limited Cooperative Association Act (CULCAA) which uses a limited cooperative association (LCA) structure. The LCA is a hybrid between a limited liability company (LLC) and a corporation. It is an entity built on the law of unincorporated entities. The LCA model has the potential to keep DAOs true to their ideals yet on safe legal ground.
The second is the UNA camp which stands for “Unincorporated Non-Profit Associate”. This can be created when a group of individuals wants to form an association without formalising it through registration. The UNA structure was used in the construction of MUSE0, a digital museum, where collectors and artists donate NFTs and the community decides on whether it should enter the permanent collection and the association at LexDAO.
The third is the investment club camp which can be created in the form of Limited Liability Autonomous Organizations (LAOs) which are legally compliant entities, such as an LLC or C-Corp. The LAO can enter into legally enforceable contracts, hold assets outside the chain, and pay dividends. Investors in an LAO must be accredited, but service providers who are compensated in LAO shares can earn their shares of the LAO portfolio.
And the last is the Offshore Entity camp that registers their DAOs to foreign jurisdictions with favourable tax regimes (e.g., the Cayman Islands, Panama, Singapore, Ireland, BVI, Bermuda and Switzerland) and wrapping the DAO in a foundation-style entity or entity providing simplified limited liability protections, formed in such jurisdiction. There are no perfect legal structures for DAOs. Every option has to be made within the consideration of multiple factors, taking into account its downsides, and every option is mired in regulatory complexity. Ultimately, a decision is required to be made (ideally with legal counsel) taking into account the risks considering limited liability and tax structures. The market now offers multiple protocols enabling DAO deployment with preset governance frameworks (and some with underlying legal entities), providing the protections necessary to operate in the real world as discussed below.
DAO deployment frameworks
A DAO deployment framework is a set of smart contracts developed by platforms that allow the streamlined deployment of DAOs with preset governance patterns. These platforms work as a base layer to enable the creation and governance of DAOs over its agreements, funds, ownership, membership management, proposals and other activities requiring coordination. Different DAO framework platforms endow DAOs with different sets of capabilities. Deploying a DAO without a platform is possible, but it may demand specific technical and legal skills that most communities do not possess easily. Examples of platforms that are providing such frameworks are:
Moloch v2 is an upgraded version of MolochDAO that allows the DAO to acquire and spend multiple different tokens, “guildkicks” to remove unwanted members, “ragequit” for members who want to exit DAOs with their portion of proceeds, and “loot” to issue non-voting shares but entitled to financial distributions.
KaliDAO is a protocol for on-chain orgs inspired by the best components of Compound and Moloch DAO governance. The smart contract code is simple to make it easier to read, secure assets and customizable through its extensions. KaliDAO protocol enables setting up a LLC and UNA legal structures in tandem with the DAO, in a no-code format for founders to easily spin up DAOs with limited liability protection.
DAOhaus is a no-code platform for launching and running DAOs. It is owned and operated by its investors & the community. All DAOs on the platform utilize the glorious open-source code of Moloch.
Tribute by OpenLaw makes DAO development easier by balancing a more modular design and an optimistic rollup with the security guarantees of Moloch. Its tech stack includes solutions to cancel proposals, create non-voting shares, kick out members, use NFTs for membership, whitelist tokens, and much more.
DAO Stack is a modular stack that includes governance protocols and easy-to-use interfaces for creating and managing DAOs.
Colony v2 is focused on reputation-based task management, ownership, structure, authority, financial management, and dispute resolution
Aragon provides a suite of applications to create, manage, and govern DAOs at scale. This includes Aragon Court, Aragon Govern, Aragon Voice, and Aragon Client.
Orca is designed around “pods”, which is another name for a working group. Pod is regarded as a child DAO in a sense and has its own membership and governance. In essence, each pod functions as a mini-DAO within a larger DAO construct.
Attributes of DAOs
Each DAO varies in terms of decentralization and autonomy, but fundamentally, these are the core values that make an organization a DAO. Other than these core values, building a purpose-led DAO requires several prerequisites:
Contribution
In contrast to traditional companies, individuals can move fluidly between DAOs, often contributing to multiple DAOs simultaneously in a permissionless manner, i.e., DAOs are open-source communities. This flexibility appeals to many contributors and is one of the factors that has enabled DAOs to attract fresh talent just as in traditional open-source. Some contributors flourish when they can flow between projects and contribute wherever they feel most inspired; others may flourish when they can dig into a single project without distraction. And still, others want something in between. Where DAOs really shine relative to traditional organizations is that they can support many contributor engagement models at once, allowing contributors to choose the one that’s right for them.
Compensation
DAOs currently benefit from the flexibility they can offer their contributors. This flexibility is appealing to many contributors but it often leaves contributors to navigate multiple compensation structures. DAOs must ensure that compensation is commensurate with the value created, and their non-hierarchical nature presents a challenge for measuring that value, especially as contributors learn and grow. However, designing a compensation program that promotes contributor choice while remaining fair, transparent, and simple to administer is essential for DAOs. As per DAOhaus, there are set of principles to create adaptable contributor compensation programs:
- Contributors should have flexibility in how they engage with the DAO depending on their level of participation.
- Contributor engagement and compensation models should be interoperable with that of other DAOs.
- Contributor value should be assessed in a bottom-up and top-down fashion simultaneously.
- Contribution to DAOs should be a transparent activity, ideally with on-chain mechanics.
- Contribution to DAOs should ideally be recorded in its operating terms.
Some examples of compensation & contribution tools available in web3 for DAOs are:
Coordinape is a compensation tool based on reciprocity, based on the premise that the contributors of the working group know best who creates the most value.
SourceCred uses an algorithm to determine how much value a contribution or contributor added to a project overall.
Govrn has created a “mobile model” in which the community assign weights to different types of contributions according to their priorities.
Opolis is one of the first digital employment cooperatives for independent workers which provides human resources benefits in web3.
Sablier is a protocol for real-time finance that leverages smart contracts to offer a continuous, autonomous, trustless payment.
Superfluid is a protocol for handling subscriptions, salaries, rewards and any composable stream of value, with continuous settlement and per-second netting for extreme capital efficiency.
Roll provides custodial Ethereum wallets capable of sending and receiving social money from the Ethereum blockchain and within the Roll network.
Collective Ownership
The idea of collective ownership is at the core of DAOs. DAOs are not meant to be owned by a handful of founders and investors, rather the community which forms its essence. This notion of collective ownership works because everyone is a stakeholder (through tokens) and no single person is in the custody of funds and a decision-maker (except in case of the treasury multi-sig itself). Ownership determines incentives and motivates users to contribute to products in more profound ways, be it with ideas, development, design, legal or community building. For the last decade, we’ve lived in a period in which ownership has been concentrated among a few centralized organizations, which decided the end-user relationship. DAOs represent a new framework for organizational culture, where ownership is reclaimed and redistributed in the hands of the community that built it. Examples like PleasrDAO fractionalizing the Doge meme, ConstitutionDAO raising upwards of $40 million to buy a copy of the U.S. Constitution, or AssangeDAO raising money for the liberation of Julian Assange suggest templates for new models of ownership. Some more examples of how next-generation platforms are driving an ownership economy:
Gitcoin is a platform that enables developers to get paid for working on open source projects.
Seed Club is a social token incubator that’s focused on helping creators launch and grow social tokens
Friends with Benefits is a social DAO and community that is 100% owned and governed by the participants
SuperRare, an NFT marketplace that distributed tokens to its artists and collectors, who will govern curation, the DAO treasury, and future product direction.
ObscuraDAO provides photographers with commissions to produce their envisioned projects, a community, grant opportunities, and educational resources to help them explore NFT photography.
DeveloperDAO exists to accelerate the education and impact of a new wave of web3 builders.
Collaboration
We need a fully interactive and collaborative DAO ecosystem for DAOs to truly revolutionize how we work and coordinate. Many DAOs share common goals, but they currently act in isolation and lack the tools to collaborate. Building and improving the tools and platforms for DAO communities to work together will have immense impact and produce powerful interactions between DAOs. Many DAOs are emerging, which provide the tools for DAOs to communicate and coordinate like Prime DAO. But we are still in the very early stages of this revolution. There are many great examples available that showcase D2D collaborations:
Coordination
Coordination failure occurs when a group of humans could achieve a desirable outcome by working together but fail to do so because they don’t coordinate their decision making. But with the advent of blockchain technology, we can now program our values into our system with trustlessly using smart contracts, allowing us to coordinate with multiple actors and, therefore, solve coordination failures. DAOs are horizontal organizations with very few command and control structures. Members rely on smart contracts as the primary glue to facilitate economic transactions and social interaction. It is essential to have defined values embedded into smart contracts, especially regarding governance, treasury, onboarding newcomers, etc., to have good coordination between members. To ease the process of coordination, DAOs need better software tools that support governance, software collaboration, treasury management, access and many more.
Parting Thoughts
DAOs are a paradigm shift over traditional companies in many ways as they are global from the get-go, permissionless to join or contribute, and smooth in many processes such as community building, onboarding newcomers and real-time compensation. While there are plenty of kinks in this process today, there’s every reason to believe they will be ironed out over time. Ultimately, the success of the DAOs lies in the unique synergy and harmony between its smart contracts and the community. We still have a long way to go to see these DAOs be completely efficient and genuinely decentralized. As with all technological advances, DAOs will continue to grow bigger, stronger, and more diverse.