I’m by no means an expert on DAOs, but like a growing number of people I’ve started a long and seemingly endless dive down the web3 rabbit hole and despite all of the excitement around blockchains, crypto & bitcoin, NFT’s, and projects like ENS (Ethereum Name Service), I feel like DAO’s might be the most important innovation yet.
For most DAOs joining the landscape today, it’s important to understand that the definition of a DAO is fairly illusive if you take the name literally.
If you want a truly decentralized and automated organization, there’s a lot of boxes that need to be checked to meet that description.
To keep things simple let’s consider a DAO as an online community that shares a bank account. This shared bank account is a key and unique aspect to what keeps all people in the DAO aligned.
Because it’s a shared bank account, everyone is incentivized to act in the best interest of the DAO. In addition to sharing a bank account, the DAO will usually provide access to tokens for its community members. Not only do the tokens allow everyone in the community to participate in the upside as the DAO increases in value, it also allows the community to vote on how the DAO operates and what sort of things the DAO uses its shared bank account for.
So, what makes a DAO work? Below I’ve highlighted some of the key elements of a DAO.
The treasury acts as a shared bank account for all members of the DAO and usually coincides with the issuance of a DAO token to the community members.
A common misconception is that DAOs start off decentralized.
That’s not always the case. DAOs should, and usually do just start off as a Telegram or Discord group. It’s important to understand that DAOs do not need to begin with a shared treasury, but launching the treasury and issuing a token is one of the main milestones towards decentralization within the DAO.
With a shared treasury in place to align the community, DAOs can take advantage of issuing its own token.
Tokens play one of, if not the most important role in a DAO.
The DAOs token is what allows all contributors, creators and community members of a given organization the ability to participate in the upside value creation that come from the growth of the DAO.
This is one of the major contrasts to web2 where the value created is centralized to the platform. Currently in web2, contributors (staff, team members) and creators in terms of the individuals who provide and upload content to these platforms do not have an real way to participate in the value that they are creating for the organization.
Think Uber, not providing its drivers with ownership.
Conversely, by DAOs issuing tokens to all members of the community, there’s now another shared incentive to act in the best interest of the DAO.
A lot of people might wonder how a token gets its value. From an asset perspective, as a baseline the token should trade at minimum equal to the value of its treasury, with the goal of having it trade higher based on the premium added by the value of the community on top of it. The more successful the DAO from a brand, production, or innovation standpoint, the higher the premium.
The concept of a token is simple. Deciding how to distribute these tokens is another story. If you want to learn more about how tokens are allocated, check out this great post “Optimizing Your Token Distribution” by Lauren Stephanian.
With a community, a treasury, and a token to bring together alignment and shared value, you can start to see why more and more people are flocking towards DAOs. But with that being said, DAOs have their own challenges, primarily around governance.
To quickly make sure everyone is on the same page, governance refers to the systems, rules and practices that allows an organization to make decisions.
In web2, governance of an organization is centralized at the top with a small number of individuals making decisions for the whole organization and its shareholders (community). This centralized group of decision makers usually looks like the c-suite, upper level management, early investors, or the board of directors.
As we’ve seen over history, it’s difficult to trust that a centralized group can and will make the best possible decisions for the overall community or shareholders, rather than benefit the top rungs by extracting value.
So what does that have to do with a DAO?
Well, when we explore a world where everyone has a voice and everyone has the ability to vote or submit ideas, how do you manage that in a fair and equitable way, while maintaining forward momentum and productivity?
This is where DAO governance comes in. When the community is small, it’s easy to make decisions and move forward towards the DAO’s objectives, but as the community starts to scale into the hundreds or thousands, without proper governance things can devolve quickly.
An example of DAO governance would be proper onboarding. How do new community members navigate and interact within the community with the hope of becoming value added contributors?
Voting is another example of DAO governance. If everyone in the DAO gets a vote, how do you prevent people with more tokens from swinging all the votes? This has been one of the more controversial topics surrounding DAO governance and as a result, many different voting types have emerged and choosing the best one for your DAO can be a challenge. If you want a deeper dive on different ways a DAO can set up voting using best practices, you can check out this great article on different voting types.
One more important example of DAO governance is proposals. The greatest thing about DAOs is the ability to crowdsource ideas from the community. It has been proven that by having more diversity of thought, innovation can accelerate. But how do you properly vet and filter all of the ideas that a community might have, and ensure that everyone has an equal opportunity to present their ideas? These are all the questions being worked through in realtime.
Community proposals are at the core of DAO governance.
They allow for members of the community to present ideas related to projects or improvements that they believe can add value to the community. These proposals can then be voted on by participating members of the DAO.
Because DAOs centre around a shared treasury, often these proposals involve deployment of treasury funds. Examples range from value add or revenue generating projects, treasury diversification (raising funds for the treasury), suggestions on governance (payroll, onboarding, voting, etc), potential partnerships, and any other topics the community may want to vote on.
Formalizing the proposal process is key in making sure the governance of the DAO can scale, and luckily web3 services such as SnapShot provide a platform for DAO proposals and community voting. FWB (Friends With Benefits), a prominent social DAO looking to explore the intersection of culture and web3, does a great job of governance and here you can see examples of their active and closed FWB proposals.
A DAO is a focused community centered around a treasury, shared ownership, and a shared mission. All members of the DAO are able to participate in the value created by the DAO through a native token (the token issued to members by the DAO).
DAOs are evolving by the day and this is by no means an exhaustive list for every aspect of a DAO. But understanding these concepts at a high level can help you move past wondering how or why DAOs work, and into what new business models or problems DAOs can tackle.