What are DAOs and how they work

The aim of DAOs is to find practical solutions to have decentralized governance, which is why many DeFi projects have already started to implement them in their own protocol, while others have indicated it as one of the next goals in their roadmap.

One of the most significant challenges that DeFi has to face in order to reach its maximum potential, so to speak, is related to the topic of fully decentralized governance. This is an area that is being discussed a lot as it is currently not possible to address and solve all the problems that arise from full decentralization.

The path towards full decentralization adopted by the different DeFi platforms is not yet clear and with regards to the management of the protocol, which is one of the biggest challenges to date, there are few examples of companies that are running a governance based on on-chain systems. 

What are DAOs? 

A DAO, or Decentralized Autonomous Organization, is a comprehensive concept in support of an organization that operates exclusively according to rules imposed by the code that constitutes the smart contract under which it is programmed, which is publicly verifiable by everyone. 

The DAO is autonomous because it operates following the set of rules written in its contract, without the intervention of anyone, except at the time of its creation. The organization is totally independent of its creators and cannot be influenced in any way from the outside. 

Its degree of decentralization derives from the fact that all decisions and actions taken are dealt with by the whole community according to proposals in favour of a possible update of the protocol, which can be approved through a voting system, without the presence of a central authority controlling the outcome. 

When a proposal is approved by the community, the entire amount raised by the community is allocated directly to financing its development. It is in the members’ interest to vote for a better change, as it could increase demand and use of the platform, thereby increasing the value of the token they hold. 

The rules to be followed by the members of a DAO are strict because they are represented by the set of pre-programmed rules defined in the DAO’s smart contract that describe what can and cannot happen within the system. However, for this to work in a sustainable way over time, it must also have certain flexibility. 

It is thanks to this important factor that it is possible to eliminate the need for a central authority in charge of maintaining and developing the protocol, for the simple reason that all management rules are written in those lines of code that cannot be altered.

At this point, the choice of an intermediary to supervise the proper functioning of the organization would be a waste of time, effort and money, since it is already able to do everything on its own. 

A user’s right to vote is represented by the possession of the so-called governance token and thanks to this the members of the organization can cast their votes on the decisions concerning the development of the protocol. The total supply of governance tokens issued in circulation can be understood as a fragmentation of the shares in the “corporate world” in which no matter how much an individual holds, the mere fact of owning them gives everyone fair rights. 

However, in a DAO there is no hierarchical structure, and this ideal can be compromised by an inappropriate allocation of governance tokens to a majority of a few influential individuals. 

The mission of a DAO is in total alignment with its values such as transparency of financial transactions within the public ledger, founded according to a concept of democracy, non-exclusion of the individual, privacy and anonymity, voluntary participation and non-aggression.