Decentralized Autonomous Organizations

decentralized network and organizations

What are decentralized autonomous organizations?

A decentralized autonomous organization (DAO) is an organization that operates on blockchain networks that are completely independent and only follow rules encrypted in smart contracts—there is no human intervention. The advantage to DAOs is that instructions are executed when triggered by predetermined rules, which enables transparency, cost savings, and decentralized decision-making in an encrypted environment. Because DAOs are decentralized they can be distributed across multiple countries and jurisdictions, which can create legal issues. Additionally, because the members and investors tend to have a general partnership in a DAO, there can be legalities around liabilities.

How does a decentralized autonomous organization work?

Decentralized autonomous organizations are based on blockchains and were initially created for a venture capital fund as an organization that does not adhere structurally to traditional business organizations. Traditionally, businesses operate within a hierarchical management structure with decision-makers at the top or as a board of directors. DAOs were created for individuals to have direct control of the organization. There is no hierarchy within a DAO and the stakeholders involved equally share operations within an open-source code protocol.

This means equal parts ownership, and decision-making power is created by a preset of rules in a completely transparent environment on open-source code (also known as smart contracts). By having these preset rules, stakeholders within the DAO do not make decisions, rather the smart contract triggers a decision or action to be made and thus eliminates human error or manipulation. Additionally, DAOs are decentralized meaning they are unaffiliated with any country or geographic jurisdiction.

Back to the initial DAO having been created as a venture capital fund. With equal investors; decision-making within an open-source, automated system; and no direct regulation by a particular country—the initial DAO for a venture capital fund could theoretically exist as a flat organization without human manipulation and with the ability to move money anonymously to any part of the world.

Since the inception of the DAO as a venture capital fund, DAOs have been created for multiple other uses such as data distribution, governance, digital currency, social media, gambling, insurance, other types of funding, as well as a number of other use cases.

How do you create a decentralized autonomous organization?

Anyone can create a DAO with the right community and funding. Below are common steps taken to create a DAO.

Security

Securities are financial instruments used to raise funds for public and private businesses. Securities can come in the form of equity, debt (e.g., loans), and hybrids (equity and debt).

Exchange-Traded Fund (ETF)

An exchange-traded fund (ETF) is a combination of securities that track on an exchange and can be purchased or sold on the stock exchange the same as any other stock. An ETF can contain stocks, bonds, mutual funds, commodities, and other combinations of investments.

Crypto ETF

Crypto ETFs are similar to any other ETF. While an ETF tracks a combination of securities on a traditional exchange, a crypto ETF tracks one or more digital tokens, is traded like a stock, and subject to price changes as investors buy and sell through the day.

Volatility

Volatility measures the variance between returns from securities or market index. When considering investment, it is best to think of if an asset has high volatility, then it has high risk.

Funding

With your game plan and programmed smart contract, you’ll need to seek funding from your community. Funding is usually in the form of investing in tokens that are spent within the organization. Community members who invest will now have voting rights on the organizational operations.

Deployment

Once the funding phase has ended, you are ready to deploy your DAO. Upon deployment the DAO is completely autonomous and independent of the initial creator. The DAO now lives on the blockchain and your smart contract takes automated actions based on your preset rules. At this point the DAO is open-source and all financial transactions are recorded on the blockchain for anyone to see.

Moving Forward

Once the DAO is fully functional, any decisions that need to be made about distributions of funds and proposals for the future are voted on my investors or members of the DAO. The majority vote will rule on changes to the DAO moving forward.

What are the advantages of decentralized autonomous organizations?

team holding hands with a plant in cennter symbolizing governance

Decentralized autonomous organizations have their advantages in funding and business operations. Here are some:

Governance

When a DAO is established, there are is a type of governance or preset rules encoded into the blockchain protocol. Any proposed changes to the code are voted on by the DAO shareholders. Depending on the size of a user’s investment will indicate voting power. Larger investors will receive more voting power than smaller investors. This type of governance ensures all shareholders are aware of the rules up front and have a vote in operations.

Structure

DAOs are flat organizations in which each individual investor in the network are equal contributors and have a vote. This encourages community participation to achieve any specific goal of the DAO and have influence on shaping the DAO.

Transparency

Financial transactions taken place in a DAO are recorded on the blockchain and available for anyone to view. Investors in the DAO can visibly see how funds are spent, which helps in how to spend and vote on fund allocations in the future.

What are the challenges of a decentralized autonomous organization?

While DAO’s appear to be the new wave of the future for business, there are disadvantages to DAOs. Here are those:

Hacks

The first venture fund DAO was the “largest crowdfunding project in human history” raising $100 million in cryptocurrency in two days on the Ethereum blockchain in 2016. However, a hack resulted in a $55 million theft of that cryptocurrency. Although DAOs are based on encrypted blockchain technology that is usually impenetrable there is always a chance for vulnerabilities and hackers could have negative impacts on the DAO and investors of the DAO.

Decentralization

Having a decentralized system has its advantages as it does not necessarily have to abide by regional jurisdictions, however, if there is a legal issue then a DAO being a decentralized system may encounter challenges. DAOs function in the transfer of funds across multiple counties and should a legal matter occur then legal action would have to be addressed in multiple countries and jurisdictions as well as deal with cross-border contractual issues.

Legal Uncertainty

Decentralized autonomous organizations are in their infancy and evolving constantly. With this ever-changing digital landscape there are a number of legal gray areas such as regional jurisdictions, intellectual property, and personal liabilities.

Decentralized Autonomous Organization Use Cases

As DAOs gain in popularity there are a number of new and interesting ways DAO blockchain platforms are being adopted. As of now, we are seeing DAOs used in corporate governance, funding, venture capital, social media, data distribution, gambling, insurance, and other business activities and continues to grow.

Examples of Decentralized Autonomous Organizations

Decentralized autonomous organizations vary in function. Below is a list of popular DAOs.

  • Augur – A peer to peer, decentralized gambling exchange powered by Ethereum
  • Dash – Allows the transfer of digital money globally
  • DXdao – Develops, governs, and grows DeFi protocols and products
  • MakerDAO – Decentralized, collateral-backed cryptocurrency
  • MetaCartel – Awards grant funding to support dApps in finding customers and pilot opportunities
  • MolochDAO – Speedily and efficiently awards grant funding to projects across the Ethereum ecosystem
  • Steem – A social blockchain that generates revenue streams to users sharing content
  • Synthetix – Supports derivative trading in DeFi
  • The DAO – The initial crowd-funding campaign dealing in Ethereum
  • Uniswap – A decentralized automated liquidity protocol built on Ethereum

Why do I need legal guidance about decentralized autonomous organizations?

an attorney working gon a document about decentralized organizations

There can be a number of legal gray areas when it comes to DAOs spanning from regional jurisdictions on the execution of smart contracts to partnerships and liabilities. Depending on the nature of the DAO and what jurisdictions it crosses over, it’s important to secure legal counsel like Blockchain Investment Council to give guidance on how regional laws and cross-border contracts could impact DAOs.

Legal jurisdictions aside, there is the other matter of who could become liable for debts or legal action taken against a DAO. While the nature of a DAO is to run without human intervention, there are humans behind the creation of a DAO and those humans can be members or investors of a DAO. Whether you’re a member of a DAO or an investor in a DAO, the default assumption is that each person is part of a general partnerships, meaning every stakeholder (member or investor) is responsible for liabilities like money or services owed to another party.

Should a DAO go south, anyone in the general partnership of a DAO could be in danger of losing their personal assets. To avoid such risk, at the beginning of the formation of a DAO it is essential to have legal contracts in place to protect all DAO stakeholders and other potentially liable individuals or businesses involved. At Block Chain Investment Council, our team can advise on the appropriate contracts required when forming a DAO in order to avoid potential damaging financial and legal risks in the future.

Glossary of Important Terms

Here are some important terms to learn when it comes to decentralized autonomous organizations:

Smart Contract

A smart contract is an encrypted piece of code that lives on a blockchain as an agreement between a seller and a buyer.

General Partnership

A general partnership is a business arrangement in which multiple people agree to shares of all assets, profits, and financial and legal liabilities. Since each partner owns an equal share, any partner can be sued for business debts.

Liability

By law, a liability is something a person or company is responsible for owing (e.g., loans, debts, services, mortgages, taxes).

DeFi

DeFi, also known as decentralized finance, performs financial transactions over a blockchain cutting out the middleman by bypassing traditional banks and financial institutions.

To find out how the Blockchain Investment Council can help you with your cryptocurrency and SEC compliance filing, please contact us here.

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