DAO – companies without management

If you have spent at least some time in the crypto space, then you could not help but hear about DAO – Decentralized autonomous organizations. But have you ever wondered how many of them currently exist?

There is a Constitution DAO that wanted to purchase a rare copy of the US Constitution, another wants to revive the disappeared Blockbuster video store network, and third DAOs want to invest in non-interchangeable tokens (NFT), another “hot thing” in the world of cryptocurrencies.

From 2019 to 2021, the number of DAOs increased by 660 percent. Meanwhile, the DeepDAO website lists more than 4,831 organizations, with more than 1.7 million. investors. However, DAO is not just about speculation or infatuation, but its basic idea is that an organization without a leader can surpass the traditional management structure. This is because the DAO is based solely on certain, transparent rules, or, more precisely, “smart contracts”.

According to Coinmarketrate.com, with the Ethereum blockchain, anyone can become a shareholder of DAO. To do this, they must agree to a smart contract that sets out goals, rules of the DAO, and invest the minimum amount in the Ether cryptocurrency. Anyone who violates the smart contract is excluded and loses their investment. It’s very simple.

The founders create an initial smart contract, which they then have to use to convince investors. Only when this obstacle is overcome does the DAO continues existing as an autonomous system. Members are charged a fee, which, in turn, is used to pay for developer services. According to Handelsblatt, about 40 people earn a living in the well-known Maker DAO, with an annual income of up to 1.5 million US dollars. Investors earn by increasing the value of community tokens – quasi-certificates of shares in the DAO.

The advantage of this approach is that a misdemeanor, whether conscious or unconscious of an individual, cannot destroy the entire organization. An overbearing CEO can endanger a corporation, but this is not possible in the DAO due to its decentralized structure.

Another argument of the DAO supporters: while the typical top-down approach in classically managed companies easily ignores the impulses of employees or shareholders, every investor in the DAO can equally contribute and find a majority for his proposal. However, in order to prevent the abuse of this “grassroots democracy”, investing in the DAO is a prerequisite. It takes a lot of time, but the structure of the DAO allows you to save on management costs.

The DAO promises to be more democratic, cheaper and more reliable than previous forms of organization. Unfortunately, the track record of previous DAOs is not the strongest argument in favor of the DAO.

Difficulties

In practice , there have been four difficulties so far:

1. The rules are only as good as the programs are. Indeed, every potential investor has the opportunity to pre-check smart contracts. But in reality, not everyone has the know-how or even the time to thoroughly check the code and anticipate possible difficulties.

The first DAO, simply called “The DAO”, allowed multiple refunds before updating the balance. Programmers did not expect that someone would do this, and also incorrectly programmed the sequence of processes: first, the capital was paid out, then the balance of the internal loan was updated. Thus, one hacker robbed the DAO of 70 million US dollars.

2. Transparency is both a strength and a weakness. Since the rules of behavior of the DAO are open, competitors can use this knowledge for themselves. If, for example, the DAO participates in the bidding, then other bidders also know the DAO bid limit. Irrational behavior and spontaneous changes of plans are excluded and make the DAO predictable for third parties.
3. Attracting interested investors is not easy, and keeping them on board is even more difficult. A decentralized structure cannot do without voluntary commitments. But even those who are convinced of the meaning of the DAO can quickly leave the organization again, and then there is a shortage of participants who, for example, will make the necessary changes to the code. Experience shows that there will always be a relatively small number of such dedicated people, so their preservation is necessary for the functioning of the DAO. That is why many DAOs give out rewards, often in the form of shares. Others allow investments only if investors are also “depositors” who contribute to the further development of the DAO. But that alone is not enough.
4. Taking the initiative is welcome, but it can quickly lead to chaos. Even if it seems that there is no hierarchy in the DAO, there are often “leaders”, often those who were originally behind the idea of creating the DAO. But in fact, the further development of the DAO should not depend on a few “leaders”; ideally, many impulses come from the middle of the investor community. However, many investors do not know where to start, what changes make sense at all, and how to avoid, for example, the simultaneous development of a contradictory or even similar idea.

Since participants often work only in their free time and in different time zones, new collaboration tools are important, in which all participants follow the rules of the game of teamwork. This is the only way to implement work in effective teams (guilds). It is not easy to find the right combination of freedom (to motivate voluntary participants) and recommendations.

A model for the non-cryptocurrency world?

These difficulties, and the decentralized decision-making structure, which always requires new solutions from investors, hinder the development and success of the DAO. However, these obstacles do not seem insurmountable. And the large number of DAOs that have appeared, especially over the past two years, in completely different areas, speaks of the rapid training of the DAOs themselves.

There are many successful organizations, but they attract less media attention than spectacularly failed cases. Alexander Bechtel of Deutsche Bank sees quite reasonable applications of DAO:

“What can be gained if a decentralized insurance contract based on blockchain is centrally managed and stored under a corporate umbrella? The involvement of an intermediary is not always necessary or adds value.”

Accordingly, decentralized organizations will help save on costs. However, it draws narrow boundaries, especially outside the world of “DeFi” (decentralized finance):

“The vast majority of things are much easier and more efficient to organize and implement centrally. In the DAO, every decision must be made by a majority vote. In many cases, this is not only impractical and slow, but also quickly reaches its limits in terms of management and responsibility. Our current legal systems cannot simply be imposed on them.”

So far, little can be said about the implementation of such projects in the non-cryptocurrency world.

“Most things are much easier and more efficient to configure and implement centrally.”, — argues Alexander Bechtel, Head of Digital Assets and Currency Strategy at Deutsche Bank.

There are enthusiasts who can well imagine an organization based on rules for the classic areas of the company’s activities, such as recruitment, procurement and sales, warehousing, money management, etc. At the same time, the production or purchase of products that are in less demand can be automatically reduced.

Employees are hired only with certain qualifications. Or prices rise automatically depending on demand. An obvious advantage for investors: the problem of the principal-agent is eliminated, and the manager of “my” company cannot make questionable decisions. There will no longer be room for uncertainty as to whether the decision is in the interests of the owners or the manager’s own interests.

The corporate world is too complicated

In many corporate situations, this may well work. But most companies are much more complex than previous DAOs. Who wants to translate the complexity of human decisions into smart contracts? However, first of all, there is not enough flexibility to be able to respond quickly to unforeseen events, such as a pandemic, a supply chain disruption or a failure of a large customer. Corporate practice is rarely unambiguous: most decisions are always personal weighing of arguments. Some decisions in retrospect will be harmful to investors, while the manager will not be accused of any fault.

This does not detract from the advantages of the DAO in narrow niches, but the utopia of a decentralized, self-sufficient company can too easily turn into a dystopia. The DAO will retain its strong place in the world of DeFi, but in the “real” corporate world, the classical decision-making schemes will not change much.