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Followers of the cryptocurrency space have probably already heard of decentralized autonomous organizations. They’re a popular recent trend in which crypto projects are led by their communities, as opposed to some kind of centralized authorities.
DAOs, as they’re known, are fully autonomous and transparent entities governed by smart contracts that set out their foundational rules, execute any agreed-upon decisions made by the community and more. Within a DAO, voting rights are generally based on how many “tokens” an individual holds. In most cases, any token holder is able to make a proposal regarding the DAO, its actions, the disbursement of its treasury, investment decisions and more. The rest of the community then gets to vote on those proposals, with the result being enforced by smart contract code.
Ultimately, DAOs are governed entirely by their members, who collectively make all of the most important decisions regarding the future of the project, including technical upgrades. In order for a proposal to be passed, it must achieve a predefined level of consensus to be accepted. In this way, DAOs are considered to be democratic organizations that can serve as an alternative to the familiar hierarchical structure seen within most traditional organizations. DAOs are all about community collaboration, with each individual member participating at some level.
One of the most elegant things about the DAO framework is the way incentives are aligned. By that, we mean it’s usually in each member’s best interest to be forthright about their voting decisions, approving only those proposals that best serve the interests of the project.
Assuming that the protocol in question is healthy and robust and working towards something beneficial, it should slowly gather more users and boost the value of its native tokens. In this way, members of the DAO always get to share in its success.
How Do DAOs Work?
With most DAOs, the rules of the protocol are established by its founders, which in most cases is just a core team of community members. They create the smart contracts that lay out the DAOs’ foundational framework, which establishes the purpose of the DAO, the rules about how it operates, what is necessary for a proposal to achieve consensus, and so on. These smart contracts must be transparent, verifiable and publicly auditable in order to win the trust of new members.
Once the rules of the DAO have been formally written to the blockchain, the next step is to fund the DAO and figure out how to bestow governance.
In most cases, initial funding is achieved through token issuance, wherein the protocol sells governance tokens that equate directly to voting power. Those who’re interested in participating in the DAO can acquire these tokens, with the funds generated from the sale going to the DAO’s treasury.
In return for their investment, members acquire voting rights that are generally proportional to the number of tokens they hold. Once the initial funding stage is complete, the DAO is ready to be deployed and start fulfilling its purpose.
Most DAOs also share some of the profits they generate with their community members, based on the number of tokens each individual holds. A certain amount of those profits is usually always directed to the DAO’s treasury too.
How Can DAO’s Generate Profits?
DAOs can make money in multiple ways, through charging for access, services or a commission, or through various kinds of investments.
For instance, a DAO can vote to issue additional governance tokens and raise money that way, effectively charging new users for the right to access the DAO. One popular DAO that does this is FriendsWithBenefits, which describes itself as a group of cultural creators, thinkers, and builders who convene digitally and in real life to collaboratively shape the future of Web3. Individuals must own at least one FWB token to be able to access its community. However, it’s important to note that there’s a disincentive for existing token holders to issue more tokens, as doing so can dilute the value of their own holdings.
Because of this, many DAOs look to make money in other ways, such as by charging users for a service it provides. BanklessDAO, for example, charges customers for the consulting services it renders.
Some of the more sophisticated DAOs in the crypto space rely on investments in decentralized finance as a way of making money. On a simple level, this involves investing in various DeFi protocols and “staking” different kinds of tokens to earn yield, or providing liquidity to decentralized exchange liquidity pools to earn a percentage of trading fees.
Other DAOs have become so heavily invested in the space that they’re now actively accumulating tokens belonging to other DAOs that govern some of the most popular DeFi protocols, so as to accrue greater voting rights and direct additional rewards to themselves.
For instance, the so-called “Balancer Wars” has seen a number of well-known DAOs, including Olympus, Lido, Gnosis and Badger, work to accumulate veBAL tokens in order to vote on Balancer proposals that benefit themselves. They’re increasingly taking advantage of a DeFi protocol known as Aura Finance that maximizes the incentives for veBAL holders by enabling them to earn additional rewards in the form of AURA tokens, which means more profit to accrue even more veBAL in the long run.
Aura’s auraBAL token acts as a liquid wrapper for veBAL. DAOs can simply swap their veBAL holdings for auraBAL and earn additional rewards through AURA’s performance fees, as well as AURA tokens. Further, they can also deposit their auraBAL tokens into the auraBAL/(80/20 BAL/ETH BPT) liquidity pool on Balancer. For this, they can recieve auraBAL/BPT tokens that can then be staked on Aura Finance to earn a separate pool of AURA rewards for providing liquidity to other users.
If this all sounds complex… That’s because it is. The thing to understand though is that these DAOs are all competing for influence within the Balancer DeFi protocol so as to direct more rewards to themselves and increase their bottom lines by filling their treasuries. It’s a method that clearly works too, with Aura Finance rising from nowhere to become the 20th biggest DeFi protocol, just months after it launched.
How To Get Involved In A DAO?
The real beauty of DAOs is that anyone can get involved in one, so long as they’re willing to invest in it. Users simply have to identify a project of interest and establish that it is working as it should, and ideally generating revenue.
One thing to consider is that not all DAOs operate with the same purpose. Therefore, users should first identify the core function of any DAO they’re interested in joining.
For DAOs that are focused on technical governance, it’s necessary to understand what voting rights are bestowed on token holders and the kinds of proposals at stake. With Uniswap, for example, token holders are entitled to vote on how the fees collected by its treasury are distributed among themselves. However, with Compound, token holders are only allowed to vote on how the fees it generates are spent on bug fixes and system upgrades - they cannot vote to increase their own rewards.
Both Uniswap and Compound also use a part of their treasuries to fund other projects through DAO grants. Developers are free to apply for grants and highlight how their own projects may benefit the DAO itself. Then, token holders can vote on whether or not to fund the project, and if so, how much should be allocated.
Some DAOs are less interested in governance of the technical aspects of the protocol, and instead more focused on treasury pooling and allocation. Take SharkDAO, which is a collective that aims to pool its members’ funds in order to acquire highly sought after NFTs that are too expensive for most individuals to acquire by themselves. SharkDAO has so far raised more than 1,000 ETH to acquire five “Nouns”, which are NFTs from a novel experiment in generative, code-driven art that typically sell for in excess of $250,000. It’s a unique approach that provides interesting opportunities for individuals who’re interested in leveraging the power of a collective.
Before getting involved in a DAO, it’s important to assess its transparency. The details of the DAO should be publicly available for anyone to read, with a continuous record of its voting. To ensure full transparency, the voting records of individual token holders must also be observable.
Participation is everything for DAOs, which rely on their communities to come up with interesting ideas that can help them to achieve their overall goals. Individuals with an entrepreneurial mindset should find this especially interesting, as they can freely submit proposals they feel can help take the DAO forward.
That said, the level of participation will vary from token holder to token holder. DAO members can take part as much, or as little as they want. They’re free to join the DAO’s Discord or Telegram chat room, for example, where they can participate in discussions and take part in ongoing projects, earning compensation for their contributions. Alternatively, someone can sit back and reap the rewards of being a token holder, without actively participating in the day-to-day running of the DAO. DAO members have the freedom to decide for themselves how involved they want to be.
Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.