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What is a DAO?

2023.06.5 MEXC

DAO stands for Decentralized Autonomous Organization, which refers to an organization capable of executing projects without the need for administrators. In this article, we will explain DAO for beginners.

1. Characteristics of DAO #1: Decentralization

What does it mean for a DAO to be "decentralized?" Organizations, such as companies and governments, typically have administrators and follow a hierarchical structure. It is common for lower-level members to act according to the decision-making of higher-level authorities. In such organizations, decision-making authority is concentrated in the hands of executives, which can be described as a centralized structure.

In DAOs, however, there are generally no representatives or administrators, and decision-making is carried out by individuals who own "governance tokens." Anyone who holds these tokens can participate in voting regarding the organization's decision-making.

The term "decentralized" is used to indicate that decision-making authority is not limited to specific executives. While organizations can be partially decentralized, as with a corporation where shareholders can vote based on their shareholdings, the influence of executives and employees involved in the actual operation of the company often outweighs shareholder decisions. Consequently, even if decision-making through shares is decentralized in theory, it tends to be more centralized in practice.

DAOs, on the other hand, do not have presidents, officers, or employees typically found in traditional organizations. Therefore, DAOs are expected to achieve a level of decentralized decision-making that would be impossible in conventional organizations.

2. Characteristics of DAO #2: Autonomy

Another characteristic of DAOs is their autonomy. Autonomy generally refers to the ability to act independently without being controlled by others. In DAOs, decisions made through voting are automatically executed without the need for any individual's intervention. This is achieved through smart contracts recorded on blockchain.

Smart contracts are mechanisms that execute contracts or transactions when predetermined conditions are met. Once a smart contract is stored on the blockchain, it cannot be changed by anyone, and the contents of the smart contract are accessible to anyone. As a result, DAOs have transparency not only in decision-making but also in the execution of the decisions that have been made.

3. Advantages of DAOs

3.1 Democratic and transparent decision-making

In DAOs, token holders can directly participate in voting, enabling democratic decision-making. The decision-making votes are recorded on the blockchain and can be verified at any time, ensuring high transparency in the decision-making process.

3.2 Cost-cutting

One of the benefits of an organization operating without administrators is the ability to cut costs associated with management. Additionally, by leveraging smart contracts, unnecessary costs related to transactions and projects can be easily eliminated.

3.3 Easy fundraising

DAOs can raise funds by issuing governance tokens and selling them to investors. Investors can sell the tokens if their price increases, generating profits. They can also continue to hold the tokens and participate in DAO decision-making.

4. Disadvantages of DAOs

4.1 Time-consuming decision-making

As mentioned earlier, one of the advantages of DAO is that all participants can be involved in the decision-making process. However, this means that decisions cannot be made without everyone's vote. The inability to make top-down decisions like centralized organizations can result in time-consuming decision-making. This drawback becomes particularly significant when there are serious issues or problems that need to be addressed promptly.

4.2 Security risks

In DAOs, there is a possibility of hacking attacks targeting system vulnerabilities, which could result in the loss of funds. As an example, "The DAO," an investment fund based on DAO principals, was hacked in 2016.

The DAO allowed participants to vote on investment targets, utilizing the characteristics of DAOs. However, The DAO had a vulnerability: it allowed dissenting investors to separate their funds from the DAO and create a new DAO. Exploiting this system, hackers stole approximately 3.6 million ETH, equivalent to one-third of their investment capital. This incident is notorious given the outsized value of the theft.

Following community discussions, a hard fork was executed to revert the blockchain to the state before the theft. As a result, the Ethereum blockchain split into Ethereum (ETH) and Ethereum Classic (ETC), which maintained the original chain.
Such system vulnerabilities can be targeted, and there is also the possibility of malicious actors influencing the voting outcomes by holding a majority of tokens, leading to decisions that may not be favorable for the overall DAO.

DAO's legal status remains unclear in many countries. Unlike companies with clear legal status, DAOs' legality is ambiguous. It is uncertain how to handle disputes or legal matters in the event of problems. The treatment of intellectual property generated by DAOs is also poorly-defined.

However, in some jurisdictions, there are movements to provide legal recognition to DAOs. For example, the state of Wyoming in the United States recognizes DAOs as a form of Limited Liability Company (LLC). Similar efforts are underway in Tennessee and the Republic of the Marshall Islands.

*Note: This article is for informational purposes only. Please conduct your own research and make investment decisions responsibly.

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