DAOs: Bringing Web3’s “Decentralization” Concept to Life | by Dave Anderson | Coinmonks | Jan, 2025

Decentralization is the underlying philosophy of the entire Web3 movement. For too long, our web experiences have been dictated by tech moguls, corporate executives, and board members — all of whom are motivated by their own self-interests, not what is best for the end user. This resulted in our personal data being sold, our privacy being compromised, and our web experiences deteriorating over time.

But what does decentralization actually look like in practice? Is it really possible to take power away from those who have always held it and give it to the community at large?

Through Decentralized Autonomous Organizations (DAOs), this vision is becoming a reality. With the emergence of blockchain and smart contract technology, organizations are adopting an entirely new structure that empowers everyone involved to make decisions and manage resources.

A DAO is a Web3-native entity collectively owned and operated by its members. That means there is no executive team or traditional hierarchical management.

DAOs are designed to function autonomously through smart contracts — self-executing agreements coded on the blockchain. This groundbreaking technology has allowed the idea of DAOs to come to fruition since large-scale decision-making and rule enforcement can be completely automated.

The core of how a DAO works lies in its smart contracts, governance tokens, and treasury.

Let’s start with smart contracts. The end-to-end operations of a DAO are driven by these contracts. Their code is immutable, ensuring that the rules decided on by members are automatically implemented and enforced as intended. Smart contracts also define key procedures, such as how members vote, how the organization operates, and how proposals are submitted and processed. Once deployed, these rules can only be changed by a consensus vote.

So how does someone become a member of a DAO and start casting votes? Voting rights are given to those who hold governance tokens — specifically the DAO’s native cryptocurrency. Tokens can of course be bought, and sometimes acquired through contributing to the DAO. For most DAOs, a single governance token represents a single vote. So the more tokens someone owns, the more influence they have on the DAO. A token-based voting system ensures that the people who have invested their money or time in the project and community have a say in its direction.

And lastly, there is the treasury — the DAO’s cryptocurrency holdings. These funds are collectively controlled by the DAO members, and any spending must be approved through the voting process. The treasury is essentially the DAO’s organizational budget which can be allocated to fund growth and project developments or compensate contributors. Since control over the funds is dispersed among the membership-based, the risk of financial mismanagement is greatly reduced.

By decentralizing decision-making and automating processes with smart contract technology, DAOs foster a democratic organizational structure where every member’s voice is heard.

We humans tend to make decisions that benefit ourselves, even if they go against the greater good.

In the corporate world, this dilemma is known as the principal-agent problem. It’s a persistent issue that occurs when the interests of executives or managers (known as agents) do not align with those of the shareholders or other stakeholders (known as principals). This misalignment leads to decisions that benefit the agents at the expense of the principles. Given that the goal of most businesses is to profit, grow, and deliver value to investors, the principal-agent problem undermines the organization’s success.

DAOs offer a solution to this problem by decentralizing the decision-making process. In a DAO, there is no central authority or small group of individuals that hold all the power. Decisions are instead made collectively by all members of the organization.

• Smart contracts: Self-executing code that automates proposals, voting procedures, protocol operations/rules, and treasury transactions.
• Governance tokens: Grant voting power to members and represent ownership stake in the DAO.
• Token-based voting: A system for distributing voting power based on the number of tokens held by a member.
• Treasury: A pool of shared funds (usually cryptocurrency) managed by the DAO and used to fund initiatives approved through voting.

Case Study: MakerDAO

MakerDAO was one of the first DAOs to rise to prominence in the Web3 era. As a DeFi protocol, they use their own stablecoin (known as DAI) to facilitate borrowing.

MakerDAO’s governance token (known as MKR) empowers members to vote on important decisions that maintain the health of the protocol and the DAI stablecoin.

One notable moment in MakerDAO’s history occurred during the March 2020 market crash, known as “Black Thursday” or the “COVID Crash.” In response to a sharp decline in the Ethereum price, the MakerDAO community voted to increase the collateral ratio and adjust other risk parameters to prevent a destabilization of DAI (remember a stablecoin must always hold the same value as its real-world currency). While other stablecoins briefly depegged during this period of market turmoil, the swift action from the MakeDAO community helped maintain DAI’s peg to the US dollar.

To really grasp the nuances of a DAO, you have to understand how a community member’s idea goes from a proposal to a vote — and finally becomes a key component of the organization’s operations.

Proposal submission

As we’ve covered, any DAO member can submit a proposal addressing a wide variety of topics. Before a vote takes place, proposals are often open for community review, giving other members a chance to provide feedback or suggest modifications. In some DAOs, proposals require endorsements from a minimum number of token holders before advancing to the voting stage.

Voting process

Members’ voting power is typically proportional to the number of tokens they hold. However, some DAOs use quadratic voting to prevent large token holders from having too much influence on decisions.

In quadratic voting, casting multiple votes becomes increasingly expensive. For example, while one vote may require spending one token, casting two votes might cost four tokens, and three votes could cost nine. In some cases, these tokens are permanently burned (meaning the token holder actually has to spend them to vote), while other times tokens are only locked up temporarily. Quadratic voting prevents a few large token holders from dominating decisions and gives smaller holders a more significant influence in shaping the DAO’s future.

Additionally, many DAOs have a quorum threshold, meaning a certain percentage of the total tokens in circulation must be used in the voting process before the outcome can be validated. This threshold prevents a small group from making decisions that impact the entire community.

Approval or rejection

After voting concludes, smart contracts determine whether the proposal passed or failed based on predefined criteria, such as a majority vote or quorum threshold. Again, proposals with a majority vote that do not meet the quorum threshold are still rejected.

Implementation

If the proposal passes, smart contracts automatically implement the decision. This can include distributing treasury funds to community-approved initiatives or adjusting protocol parameters. Automated implementation ensures that decisions go into effect instantly and as intended without reliance on human intermediaries.

DAO members have the power to vote on really any topic related to how the organization functions. Because decision-making is decentralized, a member can propose a vote on a wide range of topics that can improve the organization’s present-day operations and long-term outlook.

1. Organizational structure: Members often vote on how the DAO itself operates, including changes to its smart contracts or governance framework. These votes might cover the introduction of new operational procedures, changes to the voting process, or how decision-making is distributed among members.

2. Treasury and budget allocations: A significant portion of DAO voting centers around the management of the organization’s treasury. Members vote on how to allocate spending for various initiatives, such as supporting development teams, investing in new features/projects, improving existing infrastructure, backing community-driven efforts, funding marketing, or forming new partnerships.

3. Project development and initiatives: DAOs often vote on which new features to pursue, especially if the organization is part of an innovative blockchain project. For example, a DeFi protocol DAO might vote on new features aimed at attracting more users and increasing liquidity.

4. Protocol upgrades: For DAOs that govern blockchain protocols, votes can be cast on upgrades and technical changes. Protocol enhancements could be anything from security improvements to optimizing transaction speeds or reducing gas fees, all of which require community approval before implementation.

5. Changes to tokenomics: DAOs often need to vote on the economic aspects of their native tokens, such as adjusting token supply, altering reward distribution, or implementing new token incentive models. Tokenomics decisions can significantly improve the value of the token, which is crucial to attracting and retaining users and DAO members.

6. Staking and yield opportunities: Many DAOs vote on yield-generating opportunities for members. Specific examples include voting on staking parameters, liquidity farming options, or other DeFi-centric opportunities that help token holders get more out of their investments.

7. Partnerships and collaborations: Deciding on strategic partnerships is also a common voting topic. DAOs may vote to allocate treasury funds or resources to support collaborations with other protocols or organizations.

8. Hiring and compensation: For DAOs that require active management or development teams, members may vote on who to hire and what their compensation package should be. This ensures that funds are spent on the right resources.

9. Community guidelines and policies: DAOs with strong community engagement often vote on policies and guidelines that define acceptable behavior. This might include voting on moderation policies, membership criteria, or even the DAO’s overarching community values.

10. Dispute resolution: DAOs sometimes need to resolve internal conflicts or disagreements among members. In such cases, the voting process can be used to settle disputes, enforce accountability, or decide on the consequences of misconduct.

Case Study: ConstitutionDAO

ConstitutionDAO organically emerged in November 2021 with an ambitious mission: to purchase the original US Constitution at a Sotheby’s auction. What started as a joke on social media quickly grew into a serious group that crowdfunded cryptocurrency in preparation for the DAO’s bid.

The DAO raised over $47 million from more than 17,000 contributors in just a few days. However, despite the overwhelming community support, ConstitutionDAO lost the bid to a private buyer. Moreover, several issues arose in the lead-up to the auction. For one, a last-minute decision had to be made about how high to bid, and with thousands of participants to coordinate, the group was slow to react. The auction also required the winning bid to account for taxes and fees, but many members hadn’t anticipated these added costs, leading to confusion and misalignment. These factors exposed how difficult it can be for a decentralized community to quickly and effectively make decisions in time-sensitive situations.

The group disbanded shortly after the auction but ConstitutionDAO’s rapid mobilization demonstrated the power of decentralized communities to unite around a common cause. It also raised important questions about the effectiveness of DAOs in high-stakes scenarios.

DAOs are tailor-made for Web3 as tokens and smart contracts allow for sound voting systems and governance structures. We’re also starting to see the concept applied to many traditional organizations that hope to disperse decision-making across large communities.

Decentralized Finance (DeFi)

DAOs are most common in the DeFi sector because these protocols do not have a central authority and need community-based governance to function effectively. Token holders collectively vote on topics related to upgrades, fee structures, and liquidity incentives, giving the user base direct influence over the protocol’s direction. A decentralized governance model allows protocols to adapt and evolve on the fly, as circumstances in the DeFi ecosystem change.

Cryptocurrency and NFT projects

The DAO structure is also common in cryptocurrency and NFT projects that aren’t necessarily DeFi-focused. For example, a cryptocurrency DAO allows members to use their tokens to vote on any initiative related to the growth and operations of the project. Similarly, in NFT projects, owners can decide how to bring greater attention to the collection and support the creator. The cryptocurrency and NFT space is all about decentralization so it makes perfect sense for projects to put decision-making in the hands of their supporters.

Venture capital

Venture capital firms are adopting DAO models to pool resources and make collective investment decisions. For example, DAOs like The LAO allow members to collectively vote on which startups to fund, leveraging the expertise of a diverse group rather than a handful of partners. Decentralized venture capital taps into a broader knowledge base, leading to more informed investments while enabling members to share in the returns.

Non-profit organizations (NPOs)

NPOs are also exploring DAO structures to increase transparency and involve donors in decision-making. An example of this is Giveth, which allows donors to vote on how charitable funds are distributed. This model ensures that resources are allocated based on collective preferences, not by a centralized board. Decentralized NPOs foster greater trust and engagement among donors and can potentially lead to increased funding and support for the organization’s mission.

Content creation and curation

DAOs can be applied to content platforms to ensure creators are fairly compensated and content aligns with community values. On platforms like Mirror, members vote on which content gets promoted or funded, rather than leaving these decisions up to an algorithm. Under this model, the most compelling content reaches the masses and those who create it are compensated for their work and creativity.

The concept of DAOs dates back to 1997 when German computer scientist Werner Dilger introduced the idea of autonomous decentralized systems. However, it wasn’t until the advent of blockchain technology that DAOs became viable. In fact, Ethereum founder Vitalik Buterin introduced the concept to the Web3 community in a 2016 blog post.

As DAOs start to become a reality, numerous challenges and considerations are emerging that will need to be addressed for the concept to have staying power.

Legal uncertainty

As with other Web3 concepts, we need clear regulations before DAOs can become more common. The legal status of these organizations is unclear in many jurisdictions, leading to questions about liability, regulatory compliance, and how disputes are resolved. Without clear legal frameworks, many organizations — particularly those in traditional industries — will be unable to adopt a decentralized governance model.

Security concerns

Hacks and other security lapses also pose significant risks to DAOs. The infamous “The DAO Hack” in 2016 — where $60 million worth of Ethereum was stolen — highlights the vulnerabilities that not only exist in smart contract technology but also when there isn’t a specific individual or team responsibility for security.

Governance challenges

As we covered in the ConsitutionDAO example, putting a fully-fledged governance model into practice is challenging. While decentralization decision-making sounds great in theory, the reality is that some DAOs fail to promptly arrive at decisions and experience disagreements and infighting among members. This is especially common in large DAOs where different members have competing priorities and ideas. Circumstances in the Web3 landscape change rapidly and a DAO must quickly reach a consensus on the issues that impact its operations.

Technical complexity

Becoming a DAO member requires some understanding of blockchain technology. To join, an individual must acquire tokens, transfer them to their wallet, and connect the wallet to the protocol. This is a relatively easy process for those who already participate in Web3 but it can be difficult for someone doing it for the first time.

And then there is the need to have at least a basic grasp of the role smart contracts play in the voting process and the implementation and enforcement of decisions. This technical complexity can be intimidating for newcomers, creating a barrier to entry for those unfamiliar with the technology.

Unlike other Web3 concepts, DAOs have not only been widely adopted. They’ve endured downturns in the cryptocurrency market, showing that the idea is here to stay. Nearly every DeFi protocol today operates as a DAO and cryptocurrency projects in other sectors have turned to the model to involve their community in decision making and embrace decentralization.

The question now is if we’ll see organizations in traditional industries follow suit. It’s a big ask, as the people who have always been in control will need to cede power to their customers and users. However, as we move into the next iteration of the web, decentralization could become the norm, with people expecting to have a say in how the organizations behind the products and services they use operate.