What’s a DAO?

Decentralized Autonomous Organization (DAO for short) is an organization with code-embedded rules managed by users and not controlled by any central government nor assisted by intermediaries. All financial records and transactions are maintained in a blockchain.

Daniel Latimer, the creator of the DPoS algorithm and the Founder of BitShares, Steemit and EOS (Block.one), proposed the concept of DAO in 2015. The concept was reintroduced by the Co-Founder of Ethereum Vitalik Buterin in 2016.

After its launch in 2015, the system was supposed to run without human management being supported by a smart contract and Turing complete platform, as per an Ethereum blog entry. Another important characteristic is that the network participants or users are not necessarily obliged by law or a legal contract but incentivized by the common goal to get a reward in the form of assigned assets or tokens. Therefore, the legal status of the network remains unclear.  

How it works?

DAO executes itself according to the embedded rules and acts based on users’ behavior. Once a specific condition occurs, the system automatically executes a predefined action. Due to network specifications like automatic timestamps, record unchangeability and all-party consensus, every program rule and subsequent action are recorded and transparent on a blockchain ledger.

Protocol or smart contract agreement defines the rules of the users’ behavior and acts accordingly by executing automated consensus. This significantly decreases the time spent on required actions lowering managing costs.

For example, let’s say a business approved funding for a new project. As per DAO protocols, the system will distribute the granted assets to the project assignees immediately without multi-level bureaucracy administration and paperwork.  In case the DAO system requires funds to keep running, it will automatically issue the governance tokens to the network investors that also have a role similar to shareholder and have a voting right that allows them to make any changes.

Is DAO secure?

Changing rules running on DAO is pretty complicated and can be done exclusively by writing a new code and consensus approval of all participants. Such a critical inability to react quickly when it comes to bugs makes the network vulnerable for hackers that could use it against the system and drain the funds.

The biggest consequence of such vulnerability took place in 2016 — about 3.6 ETH were stolen from the crowdfunding project “The DAO” because of security flaws in the code. The bug allowed investors to withdraw the funds at will, even despite the system started the process of shareholders voting to stop it. It ended with dividing the blockchain into Ethereum and Ethereum Classic to bail out the network.

Connection to DeFi

The popularity of DAO has raised significantly in 2020 with the spike in DeFi. All this led to the creation of new decentralized exchange platforms like Compound (COMP), yearn.finance (YFI), Uniswap (UNI) and yielding farming platforms dependent on it.