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What is DAO?

What is DAO?

A DAO, or Decentralized Autonomous Organization, refers to a revolutionary way of organizing and running organizations, making use of smart contracts and blockchain technology to provide transparency, immutability, autonomy and security to them.

DAO stands for Decentralized Autonomous Organization. This refers to a type of organization that is controlled entirely by computational algorithms. These algorithms are known as smart contracts and determine the rules of how the parties involved in the DAO should cooperate. DAOs are not bound to any particular regulation or law due to the decentralized nature of where the smart contract is executed and which coordinates the organization, the blockchain.

The idea of this management model has been circulating in the cryptocurrency community ever since Bitcoin managed to get rid of the middlemen in financial transactions. Similarly, the main idea behind DAOs is to establish a company or an organization that can fully function without hierarchical management.

It is essential to distinguish between a DAO as a type of organization and the DAO, which is simply the name of one such organization. The project was one of the first attempts to create a DAO and failed spectacularly inside due to an error in its initial code.

How DAOs work

Initially, Bitcoin was considered the first fully functional DAO, as it has a pre-programmed set of rules, operates autonomously, and is coordinated through a distributed consensus protocol. Since then, the use of smart contracts has been made possible by the Ethereum platform, which has brought the creation of DAOs closer to the general public and shaped what they look like today.

But what does a DAO need to be fully operational? First of all, a set of rules according to which it will operate. Those rules are encoded as a smart contract, which is essentially a computer program, which exists autonomously on the Internet, but at the same time needs people to perform tasks that it cannot do by itself.

Once the rules are established, the DAO enters a funding phase. The funding phase is an essential part for two reasons. Firstly, a DAO has to have some internal property; in this case, it would be tokens that can be spent by the organization or used to reward certain activities. Secondly, by investing in a DAO, users gain voting rights and, subsequently, the ability to influence its operation.

Once the funding period is over, and a DAO is deployed, it becomes fully autonomous and completely independent from its creators and anyone else. They are open-source, which means that anyone can view their code. In addition, all financial rules and transactions are recorded on the Blockchain. This makes DAOs completely transparent, immutable, and incorruptible.

Once a DAO is up and running, all decisions about where and how to spend its funds are made by consensus. Everyone who bought a stake in a DAO can make proposals about its future. A monetary deposit may be required to submit such a proposal to prevent the network from being spammed with suggestions.

Stakeholders then vote on the proposal. To take any action, a majority needs to agree to do so. The percentage required to reach that majority may vary depending on each DAO, as specified in its code.

Essentially, DAOs allow people to exchange their funds with anyone in the world. This can be done in the form of an investment, a charitable donation, money raisers, loans, and so on, all without an intermediary. The one potentially significant problem with the voting system is that even if a security hole was detected in an initial code, it could not be fixed until the majority vote on it. While the vote is taking place, such hackers can exploit a bug in the code.

How to become a shareholder in a DAO and for what purpose?

Investing in a DAO is relatively easy, especially if we know how to buy Ether or Bitcoin and already have a wallet to store the coins. All we really need to do is buy tokens of a particular DAO, which is roughly equivalent to buying shares of a company. Once the funding phase is over, we can make proposals, vote on them and even make a profit. The amount of tokens purchased will correlate to the amount of voting power we will gain within the DAO.

However, before investing, we should be sure about the project so we know exactly what we are getting into. DAOs are completely transparent and their underlying codes are always open source, which means that only we have the opportunity to review those codes to make sure there are no bugs in them.

What is a Dapp?

Dapps, or Decentralized Apps, are essentially unstoppable apps, running on different Blockchains and powered by smart contracts. The main difference from ordinary apps is that Dapps are fully autonomous, do not require an intermediary to function, and are immune to censorship. In other words, they establish a direct connection between a user and a service. Through this, users can completely control the information and data they share.

As described in the Ethereum whitepaper, they fall into the "other" category, including voting and governance systems. The other two types of Dapps are money management apps and apps where money is involved and require another piece (insurance, charity, property, etc.).

Advantages of DAOs

It is undeniable that the very concept of DAOs is fascinating, as it strives to solve everything that is wrong with the way modern organizations are run. A perfectly structured DAO allows every investor to shape the organization. There is no hierarchical structure, which means that every innovative idea can be presented by anyone and considered by the entire organization. With a set of pre-written rules that every investor knows before joining the organization and the voting system, there is no room for discussion.

Moreover, since both submitting a proposal and voting in favor of it require the investor to spend a certain amount of money, it pushes him to evaluate his decisions and not waste time on ineffective solutions. Finally, since all rules and every single financial transaction are recorded on the Blockchain, available for review by anyone, DAOs are entirely transparent. Everyone who participates decides how to spend the funds and keep track of how those funds are spent.

Disadvantages and criticisms

DAOs, like almost everything else connected to cryptocurrencies, are an extremely new and, to some extent, revolutionary technology. So naturally, projects like this will attract a lot of criticism. For example, MIT Technology Review considers the idea of entrusting the masses with making important financial decisions to a bad one and one that probably won't yield any benefits. Their article says that a lot in the world will have to change for DAO-related projects to succeed on any scale.

Apart from a rather conservative sentiment that the masses cannot be trusted with investments, there are other concerns surrounding DAOs. The most pressing problem, especially after the Ethereum DAO hack, is a security issue related to the principle of "unstoppable code." During the attack, observers and investors watched helplessly as funds were siphoned from the DAO, but they could do nothing, as the attacker was technically following the rules. Of course, such attacks can be prevented if the code is well-composed and error-free.

Finally, for startups operating as DAOs to conduct business outside of a Blockchain network and communicate with a physical world of financial instruments and intellectual property, there needs to be some legal framework to support the existence of DAOs. Unfortunately, legal uncertainty plagues the world of cryptocurrencies because their technology is so new and radically different. However, the solution seems to be only a matter of time.

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