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Chapter 6:  dApps & Defi

The Notion of a Decentralized Autonomous Ogranization (DAO)

Interesting Fact:
Did you know that the term "decentralized autonomous organization" was initially used to characterize multi-agent systems in an Internet-of-things (IoT) context in the 1990s?
9 minutes

In this section, I will tell you what is a DAO in crypto!

If you’re an avid coffee lover just like I am, chances are that, at some point in your life, you’re going to purchase a modern coffee machine. A single press of a button, and you’ve got your coffee made! While the machine does all of the work for you, though, you still need to clean it, refill it with water, add coffee beans, and perform general maintenance.

In essence, this example is the perfect illustration of how DAOs work. In this section, I’ll explain the concept of a DAO in simple-to-understand terms, and we’ll also discuss why DAOs are important in the world of cryptocurrencies, in general!

So, let’s get to it!

What is a DAO in Crypto? (Animated Explanation)

Video Explainer

Video Explainer: The Notion of a Decentralized Autonomous Ogranization (DAO)

Reading is not your thing? Watch the "The Notion of a Decentralized Autonomous Ogranization (DAO)" video explainer

What is a DAO in Crypto? (Animated Explanation)

What is a DAO in Crypto? (Animated Explanation) What is a DAO in Crypto? (Animated Explanation)

What is a DAO?

First things first - what is a DAO, in the first place?

DAO abbreviates as a “Decentralized Autonomous Organization”. Three very big words, but when you break them down, the concept itself is rather simple.

What is a DAO in crypto: Decentralized Autonomous Organization.

Decentralization” is something I’ve covered quite a few times already - if you’re interested in studying the concept in-depth, you should check out the previous sections. To put it shortly, though, decentralization refers to something lacking a single, central authority - imagine a company without a CEO where all of the employees are equally responsible for making decisions!

Autonomous is a fancy way of saying “self-sufficient”. This refers to a system being able to complete certain processes without someone else intervening, and having to manually complete the process. Here, you can simply think about the earlier-mentioned coffee machine example - once you press the button, you don’t need to push and pull any more levers, or grind the coffee beans by hand - the machine does all of the work for you in an automatic manner.

Lastly, in this context, “organization” references the fact that there is a group of people making the decisions. So, when you add all of that together, DAO simply stands for a group of individuals who are concerned with some sort of an active project and are responsible for making decisions, changes, and upgrades to that said project.

In all honesty, the example of the coffee machine is the perfect visualization here. The machine works by itself - just as I’ve stated earlier, you do not need to do anything after pushing the “Start” button! Simply sit back, and wait until the machine does its job.

What is a DAO in crypto: An example with a coffee machine.

In the cryptocurrency world, the equivalent of this would be a smart contract. Smart contracts are special programmed agreements that allow for certain processes to happen automatically, without the need for a human to intervene.

In the same way how you turn on your coffee machine, and the rest of the processes happen automatically, smart contracts allow users to participate in multiple different processes - cryptocurrency trading, lending and borrowing money, trustless gambling, and so much more. If you’d like to learn more about smart contracts, make sure to check out the section "What are Smart Contracts?".

Going back to the coffee machine example, even though all of its processes are automatic, every once in a while, you are going to need to clean the machine & its filters, fill its water tank, and perform general maintenance, too. Well, the same can be said about smart contracts, as well!

In order to perform certain updates and programmable changes to the contract, and to take care of the project behind it, in general, you have DAOs - groups of people who all vote on proposed changes to their respective network, and implement them, if a mutual decision is made.

How Do DAOs Work?

Now that you have a bit of a better idea of what is a DAO, you might naturally wonder - how do they work?

Well, the underlying idea behind DAOs is actually pretty simple. However, we’re going to touch on a bit of tokenomics - if this term isn’t familiar to you, or you don’t understand how blockchains work, fundamentally, I would strongly advise you to check out the section "What is the Blockchain?", before reading further. That will give you a better understanding of what to expect when it comes to DAOs.

Now, think about the last time you and your friends got together at someone’s place, for a casual hangout. At some point in time, someone asked the big question - should you order pizza or Chinese food?

Well, there’s only one way to settle this question, in a civil fashion - you and your friends decided to vote! In this situation, there was no central entity who would come and make the decision for the entire group - instead, each member of the friends’ group votes, and gets to be a part of the decision-making process.

This is essentially how a DAO functions. Well, it’s a bit more complex than that, but the general idea is the same.

What is a DAO in crypto: How do DAOs work?

For starters, in order for a DAO to form around a specific crypto project, there needs to be a token associated with that project. By the way, there is a section about tokens, and how they differ from crypto coins, too - you can check it out if you want to understand tokens a bit better!

But in regards to DAOs, tokens are like voting ballots. The more tokens each individual in the DAO has, the stronger will their vote become.

Think of the same pizza VS Chinese food example discussed earlier. Let’s say, some of your friends simply have a huge craving for pizza - I know I would be one of those friends. Well, in this case, you might feel bad for them, if you do end up ordering Chinese - those friends simply “sway” the rest of the group’s decision!

While there’s no “feeling bad” or “swaying” with DAOs, individuals with a larger collection of tokens are going to have more influential votes, nonetheless. In the vast majority of cases, the tokens can be acquired by purchasing or trading them on a cryptocurrency exchange.

Why are DAOs Important?

Now that you have a better understanding of what is a DAO in crypto, and can comprehend how these DAOs work, in the first place, the big question that remains is simple - why do DAOs exist, and why are they even important?

What is a DAO in crypto: Why are DAOs important?

With time, the communities behind crypto projects have understood that the concept of a DAO is actually essential for any long-term decentralized ecosystem to prosper, and retain its decentralized features.

The core feature of a DAO is decision-making. Namely, DAOs are responsible for all of the core decisions that might involve the crypto project - this is true with some sort of changes, upgrades and updates, new features, token logic tweaks, and so on, and so forth.

What is a DAO in crypto: Decision-making.

The biggest benefit of a DAO, in this regard, is the fact that all of these decisions are going to be completely trustless. In other words, they won’t be made by a single person who might have some selfish intentions in mind, but rather, by the actual community behind the project.

Imagine that you have your favorite coffee shop - one that you’ve been visiting for a few years now. The shop would serve some amazing coffee, and have great music playing in the background. One day, the shop owner makes a deal with a new coffee bean provider - while this provider isn’t known for the best quality coffee beans on the market, they sell them very cheap.

The coffee shop owner wants to maximize his profits - thus, he makes the deal to sell coffee that’s made exclusively from the beans supplied by said provider.

And, well… The new coffee sucks!

Well, if the shop was owned by a DAO, this decision would have been put to a vote. If the community behind the coffee shop decided that a tiny increase in profits in the short term isn’t worth losing out on loyal customers, long-term, the decision would be made to reject the offer made by the bean provider.

All of that is to say - with a DAO making the decisions on certain questions regarding the crypto project, there’s a much higher chance that the “right” decision will be made, instead of one that would maximize the profits, short-term, but lead to horrible customer experiences and “selling out”.

Another benefit - and also a shortcoming, in a way - is the fact that DAOs operate in an open-source manner. What this means is that their processes can be viewed at any point in time, and the integrity of their decisions (and, following that - code) can be inspected by anybody. The shortcoming here is that DAOs then become vulnerable to external attacks - since everything is out there, in the open, malicious third parties might spot a loophole, and take advantage of it.

Lastly, it’s also worth mentioning that the token voting system is sometimes brought in question, as well. As I’ve told you earlier, DAO members vote on changes and upgrades of a project with their tokens. Meaning that the more tokens you have, the more votes you will be able to cast, as well.

What is a DAO in crypto: More tokens – more votes.

What this might lead to is a big player coming in, buying up an exponential amount of tokens, and thus, creating a sort of centralized environment - their votes would then be the ones that would sway decisions the most. Naturally, many DAOs tend to have safety measures against something like this happening, but the concern is still out there.