How Does a Crypto DAO Work (The Basics)?

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Welcome to the exciting world of crypto DAOs! If you’re new to the concept, fear not – I’ll break it down for you in a way that’s easy to understand, even if you’re starting in the world of cryptocurrencies and blockchain technology. 

A short summary

What is a DAO in simple terms? – DAO is like a futuristic organization that runs on a blockchain, with decision-making powered by the people through a consensus mechanism.

How does a DAO work (a brief explanation)?

  • A DAO is typically created as a smart contract with predefined rules and conditions programmed.
  • Members of DAO hold tokens representing their ownership or stake in the organization.
  • Tokens grant voting rights and the ability to participate in decision-making.
  • The voting process is transparent and verifiable on the blockchain.
  • A smart contract automatically executes the outcome of the proposal. 

For example, if the proposal allocates funds to a particular project, the smart contract would release them accordingly. This automated process makes a DAO “autonomous” as it operates based on predefined rules without the need for intermediaries or central authorities.

It’s important to note that DAOs are still relatively new, and their legal status and regulatory framework are still evolving.

So, let’s dive deeper and explore the fascinating realm of DAOs!

What are DAOs?

DAO stands for Decentralized Autonomous Organization. At its core, a DAO is an organization that operates on the blockchain, governed by code and consensus rather than a centralized authority. 

This means that decisions within a DAO are made collectively by its participants without the need for intermediaries or traditional hierarchical structures.

» Learn more: A complete history of DAOs

How do DAOs differ from traditional organizations?

DAOs operate decentralized, which sets them apart from traditional organizations in several key ways:

  1. Governance by code and consensus: DAOs are governed by smart contracts, self-executing contracts encoded on the blockchain. These contracts automatically execute pre-programmed rules and decisions based on consensus among the participants.
  2. Direct control and decision-making power: In DAOs, participants have direct control and decision-making power over the organization’s operations. Participants typically hold tokens representing their stake in the DAO, giving them voting rights and influence over decisions.
  3. Lack of centralized authority: Unlike traditional organizations, DAOs do not have a centralized authority that makes decisions on behalf of the organization. Instead, the participants make decisions collectively through voting or other consensus mechanisms.
  4. Transparency and openness: DAOs are typically transparent and open, with their operations and decisions recorded on the blockchain, a public ledger. This allows for increased transparency and accountability, as all participants can verify and audit the actions of the DAO.
Traditional vs Decentralized organizations structure

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Here’s a comparison table that highlights all the critical differences between DAOs and traditional organizations:

DAOsTraditional organizations
GovernanceGoverned by code and consensusGoverned by a centralized authority
Decision-makingCollective decision-making by participantsDecision-making by a top-down hierarchy
TransparencyTransparent operations recorded on the blockchainOperations may not be fully transparent
ControlDirect control and decision-making power for participantsControl in the hands of centralized authority
StructureDecentralized, without a central authorityCentralized, with a hierarchical structure
FlexibilityFlexible and adaptable to changing needsMay be less flexible and slower to adapt
InclusivityInclusive, allowing participation from anyoneParticipation may be limited to certain individuals or groups
AccountabilityTransparent and auditable actionsAccountability may be less transparent
IntermediariesNo need for intermediariesMay require intermediaries for decision-making
TrustTrust in code and consensusTrust in centralized authority

Note: The table above provides a general comparison, but it’s important to do further research and analysis when considering the appropriate organizational structure for a specific project or initiative.

Understanding the basics of DAOs

Now, let’s examine the core components of DAOs and what they are made of. 

Core components of DAOs

DAOs are built on the foundation of blockchain technology, smart contracts, and utility tokens.  

Here are the critical components of a DAO:

  1. Blockchain: DAOs run on blockchain networks, decentralized and transparent ledgers that record all transactions and actions taken within the organization. This ensures transparency and immutability of operations.
  2. Smart contracts: Smart contracts are self-executing agreements coded with rules and conditions. They are stored on the blockchain and automatically execute actions based on the consensus of the participants.
  3. Tokens: Tokens play a crucial role in DAOs. They can represent ownership, voting rights, or other forms of value within the organization. 

There could be two types of tokens in DAOs:

  • Governance tokens: These are used for voting on proposals and influencing decision-making within the DAO.
  • Utility tokens: These are used to access the DAO’s products or services and may have additional functionality, such as stablecoin, staking, or earning rewards.

For example, the MakerDAO ecosystem consists of two coins: MKR (Governance token of the MakerDAO and Maker Protocol) and DAI (Utility token, designed to function as a stablecoin with soft-pegged to the U.S. dollar). Projects could have just one coin that combines both functions, governance, and utility, like in Ethereum (ETH) cryptocurrency.   

How does a typical DAO work 

Let’s look at the details of how DAOs function, from creating to the execution of proposals. Keep in mind that different DAOs might operate uniquely. 

  1. Creation: A DAO is created as a smart contract on a blockchain platform like Ethereum, with predefined rules and conditions encoded in code.
  2. Membership: People can become DAO members by acquiring tokens representing their ownership stake in the organization.
  3. Proposals: Members can submit proposals for decision-making within the DAO, such as funding requests or rule changes.
  4. Voting: Members can vote on proposals using their tokens. Each member’s vote is weighted based on the number of tokens they hold, determining their influence in decision-making.
  5. Approval: If a proposal reaches a predefined quorum or majority vote, it is considered approved by the DAO.
  6. Execution: If a proposal is approved, the smart contract automatically executes the outcome, such as transferring funds or updating rules.

DAOs statistics show it’s still an emerging concept, and their legal status and regulatory framework are evolving, shaping the future of decentralized governance in web3.

Exploring the inner workings of DAOs

Let’s dive deeper into the inner workings of DAOs and explore how they operate!

Decentralized governance

Every DAO’s governance structure is at its heart, determining decisions and actions. In a DAO, governance is typically achieved through consensus among its members, who participate in decision-making. Here’s how it works:

  1. Proposals and voting: DAO members can submit proposals for various actions, such as making changes to the DAO’s operations, allocating resources, or updating smart contracts. Members typically discuss and vote on proposals, with voting power often proportional to the members’ stake or token ownership.
  2. Consensus mechanisms: DAOs use various consensus mechanisms to reach an agreement among members, such as simple majority, supermajority, or quadratic voting. These mechanisms ensure that decisions are made collectively and represent the majority’s will.
  3. Smart contracts: DAOs often utilize smart contracts, self-executing code running on blockchain networks. Smart contracts contain the rules and conditions for decision-making, including how proposals are submitted, voted upon, and implemented.
  4. Transparency: DAOs operate transparently, with all proposals, votes, and actions recorded on the blockchain for public visibility. This fosters trust and accountability among members, as all decisions are open to scrutiny.

Tokenomics and incentives

DAOs often use tokens for participation, governance, and ownership. Tokens represent a stake or share in the DAO and can have various functionalities. Let’s look at:

  1. Token distribution: DAOs typically distribute tokens to participants through initial coin offerings (ICOs), airdrops, or token sales. Tokens can also be earned through contributions to the DAO or by providing liquidity to the DAO’s ecosystem.
  2. Voting power and influence: Tokens often represent voting power in DAOs, with more tokens translating to a more significant influence in decision-making. This aligns token holders’ interests with the DAO’s success, as they have a stake in the outcomes.
  3. Incentives for participation: DAOs use tokens as incentives to encourage participation and contribution from members. Tokens can be rewarded for various activities, such as submitting proposals, voting, or providing value to the DAO’s ecosystem.
  4. Governance through token voting: Token holders can vote on proposals using their tokens, giving them a direct say in the DAO’s operations. This allows for decentralized governance, where decisions are made collectively by token holders.

Challenges and considerations

While DAOs offer exciting opportunities, they also come with challenges and considerations that organizations need to be aware of:

  1. Participation and engagement: Maintaining high levels of participation and engagement from members can be challenging, as not all members may be actively involved in the DAO’s operations.
  2. Decision-making efficiency: Achieving efficient decision-making in large DAOs with diverse stakeholders can be challenging, as finding consensus may take time and effort.
  3. Legal and regulatory compliance: DAOs must navigate the legal and regulatory landscape carefully, as the regulatory environment surrounding DAOs is still evolving in many jurisdictions.
  4. Security risks: DAOs are vulnerable to potential security risks, including smart contract vulnerabilities, hacking attacks, and scams. Robust security measures and audits are crucial to mitigate these risks.
  5. Scalability: As DAOs grow in size and complexity, scalability can become challenging, as blockchain networks may have transaction speed and capacity limitations.

Example of a DAO workflow structure 

Crypto DAOs offer exciting opportunities but challenges regarding framework, governance, security, scalability, and technical knowledge. 

Below is an example of the DAO structure of the ShapeShift project. 

ShapeShift DAO structure example

DAO examples and use cases 

Examples of DAOs

DAOs are gaining popularity across various industries, and there are numerous examples of successful DAOs in the crypto space. Some noteworthy examples include:

  • MakerDAO – A decentralized lending platform that uses smart contracts to manage collateralized loans.
  • Uniswap – A decentralized exchange (DEX) that allows users to trade cryptocurrencies without intermediaries.
  • Gitcoin – A decentralized platform for financing open-source projects using a quadratic funding mechanism.

Use cases of DAOs

DAOs have a wide range of use cases in the crypto space, including:

  • Decentralized finance (DeFi): DAOs manage lending and borrowing protocols, decentralized exchanges, and yield farming platforms.
  • Gaming and virtual worlds: DAOs manage virtual economies, NFT projects, create decentralized gaming platforms, and distribute rewards to players.
  • Social impact and charity: DAOs can pool resources and donate to charitable causes or support social impact initiatives, such as environmental conservation, poverty alleviation, or education.

Overall, DAOs are gaining traction in the crypto world due to their decentralized and transparent nature, which empowers communities and individuals to participate in decision-making processes and have more control over the organizations they are part of. 

» Learn more: 20+ notable DAO use cases

Benefits and drawbacks of crypto DAOs

As with any technology or innovation, DAOs have their fair share of advantages and disadvantages. Let’s explore them in more detail.

Benefits of crypto DAOs

  1. Decentralized governance: DAOs empower individuals to participate in decision-making without a centralized authority. This promotes inclusivity, transparency, and democratic decision-making, where every member has a say in the organization’s direction.
  2. Increased participation: DAOs provide a platform for individuals from diverse backgrounds and locations to collaborate and contribute. This fosters innovation, creativity, and a sense of community, as participants can join forces and work towards a common goal.
  3. Enhanced trust and transparency: DAOs operate on blockchain networks, which are immutable and transparent. All proposals, votes, and actions are recorded on the blockchain, ensuring transparency and accountability among members and reducing the need for intermediaries.
  4. Flexibility and customization: DAOs are highly customizable, with their rules and operations defined through smart contracts. This allows for flexibility in adapting to changing circumstances and evolving needs, making them adaptable to various industries and use cases.
  5. Ownership and incentives: DAOs often issue tokens to members, providing them with ownership and financial incentives. This aligns members’ interests with the DAO’s success, fostering active participation and engagement.

» Learn more: All the DAOs benefits

Drawbacks of crypto DAOs

  1. Lack of legal framework: The regulatory landscape surrounding DAOs is still evolving, with varying legal frameworks in different jurisdictions. This can create uncertainty and potential legal risks, as DAOs may have different legal protections than traditional organizations.
  2. Governance challenges: Decentralized governance can sometimes be challenging, as decision-making can be slow or contentious. Achieving consensus among members with different perspectives and interests can be difficult, and resolving disputes may require additional mechanisms or interventions.
  3. Security risks: DAOs operate on blockchain networks, which are not immune to security risks. Smart contract vulnerabilities, hacking attacks, and scams can pose risks to DAOs and their members, emphasizing the need for robust security measures and diligent code development.
  4. Scalability issues: Blockchain networks may have transaction speed and capacity limitations, which can impact the scalability of DAOs. Addressing scalability challenges may become a hurdle as DAOs grow in size and complexity.
  5. Technical knowledge requirement: Participating in a DAO may require technical knowledge, as members must understand blockchain technology, smart contracts, and other technical aspects. This can be a barrier to entry for some potential participants.

Here’s a table summarizing the pros and cons of DAOs:

Pros of DAOsCons of DAOs
DecentralizationRisks of hacking or fraud
TransparencyLack of regulation
EfficiencyGovernance challenges
InnovationLack of centralized authority
Financial incentivesComplexity
FlexibilityPotential for token manipulation

Note: It’s important to remember that the pros and cons of DAOs may vary depending on each DAO’s specific implementation, structure, and governance mechanisms.


And there you have it, fellow DAO adventurer! As we wrap up, let’s recap the key takeaways:

  1. DAOs are decentralized autonomous organizations that leverage blockchain technology to enable collective decision-making and governance without central authorities.
  2. DAOs are powered by tokens representing ownership, voting rights, and financial incentives and are used to participate in the governance and decision-making process.
  3. DAOs offer numerous benefits, including increased transparency, decentralization, inclusivity, and potential for innovation in finance, collaboration, and governance.
  4. However, DAOs also come with challenges and limitations, such as potential risks, security concerns, and scalability issues that must be addressed.
  5. The future implications of crypto DAOs are vast and exciting, from disrupting traditional hierarchies, democratizing finance, fostering social impact, and driving governance innovation to reshaping economic paradigms.

As you navigate the world of crypto DAOs, remember to stay curious, keep learning, and embrace the possibilities of this exciting and rapidly evolving space. 

Article by
Artem Minaev