Knowing the Risks and Benefits of DAOs is essential for the growth of the protocol. Decentralized autonomous organizations (DAOs) are the newest trend in crypto. They are becoming so trendy that billionaire influencer Mark Cuban, gave them “the ultimate combination of capitalism and progressivism “label.

A DAO is an internet-native self-governing organization that operates via smart contracts. Essentially, a DAO can bring together a group of people who do not know each other and help them, for instance, raise collective capital.

DAO members choose their decentralized autonomous organization design and do not require intermediaries in their activities. The most significant feature of the DAO is that all its operations are transparent. Each decision undergoes community-based pitching, discussion, voting, and documentation process.

DAOs might sound new, but they are anything but. The oldest blockchain sector DAOs include the Ethereum DAO, aka the DAO. The DAO pooled Ethereum user investment capital to create a sustainable and rewarding investment vehicle.

Unfortunately, the DAO failed when a hacker drained 3.6 million ether from its coffers. The hack led to a dramatic hard fork event, creating the Ethereum Classic and the Ethereum network. So, as you can see, DAOs have their risks and benefits. But before taking a look at them, below are popular forms of decentralized autonomous organizations.

Types of DAOs

DAOs can support a wide range of governance operations. Some of the most common DAO applications include protocol, investor, and community DAOs.

Protocol DAOs serve communities that govern platforms or protocols. These flat organizations manage decentralized protocols such as borrow/lending applications, decentralized exchanges, and other decentralized applications (dApps) via token governance systems.

A protocol DAO’s smart contracts weigh its votes per a participant’s volume of governance tokens. Examples of protocol DAOs include Uniswap, MarkerDAO, Yearn Finance, and Compound.

Investor DAOs function like a crowdfunding app. Each of its contributors will purchase the specific DAO’s governance token or native asset to gain voting rights. Popular Investor DAOs include Flamingo and PleasrDAO.

PleasrDAO, for instance, came to the limelight in October 2021, when it merged that it had purchased the only existing copy of the Wu-Tang Clan’s “Once Upon a Time in Shaolin .”The internet community that operates a shared bank account purchased the copy for a massive $4 million.

PleasrDAO has also made investments in rare collectibles such as the “Doge” meme NFT that had a $4 million price tag. In addition, this investment DAO has a large portfolio of multimillion-dollar crypto assets.

So how do PleasrDAO members share their wealth? In the Wu-Tang Clan album instance, each member co-owns an NFT deed representing their album share.

Community DAOs like Friends with Benefits (FWB) start with no definite purpose but grow due to a social element that connects all their members. However, the community eventually adopts a DAO to democratize the governance process over time.

FWB describes itself as a global group of cultural thinkers, creators, and builders that gather digitally to shape the future of the Web3 ecosystem collectively.

Other examples of DAOs

Other popular DAOs include HerStory DAO, Komorebi Collective DAO, and MetaCartel Venture DAO. The HerStory DAO collects and funds projects by Black women and non-binary artists, while the Komorebi Collective DAO funds women and non-binary crypto founders. Finally, the MetaCartel Venture DAO is a for-profit business that invests in early-stage decentralized applications.

Risks and Benefits of DAOs

Decentralization

Most DAOs are not fully decentralized but allow their community members to vote on what they think is right and fair. Therefore, they have a stronger say in how a business operates, unlike centrally governed companies.

Innovation

Decentralization can govern aspects such as better working conditions, fair wages, and salaries. Additionally, DAOs can help eliminate consumer exploitation and ensure that problems are solved faster or better than in hierarchical organizations.

DAOs can also spur innovation since they build open-source projects on which other users can build businesses. As an illustration, while no one refers to the Bitcoin network as DAO, it scaled as one through community agreements. The Bitcoin node network has to come to a consensus on any protocol change. Moreso, any project can fork the Bitcoin codebase and create new blockchain products.

Builds a skin in the game governance system

With the DAO in place, everyone has skin in the game. To join DAO governance, members have to obtain governance tokens through purchasing, staking, or burning specific crypto assets. In addition, on-chain voting is public, meaning that every user who votes puts their reputation on the line.

For instance, other DAO members can view the number of addresses that voted for a wage increase and those that did not. The transparency of the process encourages democracy and lowers fraud. A DAO weighs its votes as per capital contributions, ownership balances, and holdings of the native token.

Community-driven entities

Unlike centralized organizations, a DAO has a flat management structure. As a result, DAO power is proportional to the number of tokens held by a participant. In addition, governance token holdings do not grant DAO community members any future privileges unless they are open for sale on crypto exchanges.

Consequently, a DAO’s unique structure creates a focus on community development rather than profit-taking. DAOs could therefore offer a more socially conscious system that builds equity in wealth sharing amongst its participants in the place of enriching a few large shareholders.

They could positively affect the organization and help address critical issues such as wealth and knowledge sharing or discrimination in society.

On top of that, DAOs lead innovation and introduce their members to new projects, such as the Ethereum Name Service (ENS) DAO or the play-to-earn ecosystem in the upcoming  Axie Infinity DAO.

Enhancing efficiency

Since DAOs are internet-based, they can pull capital from every corner of the globe. In addition, their communities can contribute money in the form of digital currencies through mobile phones or browser-based blockchain wallets.

These transactions are faster, their fees lower, and frictionless. In addition, a DAO’s internal controls will protect the user’s assets, and there are no extra costs required to detect fraud or malicious activity since blockchain transactions are transparent, secure, and auditable. Such efficiency allows DAO participants to access endless and innovative investment opportunities.

Slow decision-making

DAO governance flourishes when a large percentage of the community participates in discussions and vote casting. Therefore, large DAOs are slow in decision-making, affecting urgent decisions making.

Also, should most DAO members adopt a passive outlook, the DAO moderator will have difficulty moving DAO initiatives forward. Lack of sufficient feedback may force the moderator to adjust the governance protocol by lowering the number of votes.

As a result, many DAO slightly resembles a centralized organization where a few people (investors, founding team, executives) make decisions.

In their endeavor to tap the ‘wisdom of the crowd,’ DAO could risk a Sybil attack. Sybil attacks may occur if a few wallet addresses that hold 51% of the voting power make crucial governance decisions.

DAOs can embrace quadratic (equal-sided) voting to level the voting playing field. As a result, wallet addresses with the least number of tokens will hold a proportionately higher voting power per token than those with a large percentage of tokens.

Security risks

The smart contracts that govern DAO protocols are secure because their data has blockchain-level security. That said, smart contracts are Turing complete programmable devices. Therefore, they are vulnerable to hacking and require expensive technical expertise in their implementation. In addition, pseudonymity may also introduce security risks by incorporating malicious entities into DAOs.

Early decentralization risks

Early decentralization may introduce a new set of challenges in fledgling projects. For example, a dApp team that first pursues community ownership by distributing tokens could engender a community of speculators rather than real users. As a result, such units will find it difficult to create a product/market fit and, as a result, will not enjoy meaningful community participation.

The industry participants must understand and appreciate the Risks and Benefits of DAOs. The DAO’s rough consensus governance system will have to rise above the raging regulatory debate but promises a bright future for entrepreneurs and developers. These internet-native organizations could be the future of the corporate governance system.