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Fintech Friday's: DAOs

What are DAOS?​ Envision a world where you are able to synergise with a group of strangers around the globe to reach a specified coordinated purpose, by setting up your own rules and regulations, as well as taking the primary role of decision-making autonomously through the blockchain. This is what DAO (pronounced “dow”) is. Decentralised autonomous organisations (DAO) refer to people who have organised themselves into a company without the traditional hierarchical or centralised leadership (term named as “flat hierarchies”) structure. The lack of hierarchy, a contrast to traditional multinational corporations, is what allows for its unique community collaboration aspect, as each member oversees protocol at some level, to some extent. This is able to exist due to the rules being embedded into the code, therefore no managers are necessary, thus removing any bureaucracy or hierarchy hurdles. This is a significant benefit as the lack of a hierarchy means any stakeholder can put forward an innovative idea that the entire group will consider and improve upon. As it runs online, most members exist from around the world and the blockchain interface and technology used allows for all transactions to be transparent and immutable. Each individual member makes critical decisions about the future of the designated project by agreeing on foundation rules and then coming up with proposals about the future operations, proposals that achieve some predefined level of consensus are then accepted and enforced by the rules within the smart contract. This is followed by a voting process in order to decide on a specific proposal. Once a DAO is formed, it is run by members, through the use of crypto tokens. To obtain voting power or membership in a DAO, the member must own/ buy governance tokens, which are cryptocurrencies that are tied to a certain project. By holding these tokens, members attain access to certain rights, such as the ability to manage a common treasury, equity in the DAO or to be able to vote on certain decisions. Examples of DAOs, How they work, and Why we need them? DAOs have a multipurpose feature and can be used for things such as investment, charity, fundraising, borrowing, or buying NFTs, all without intermediaries. However, It is cardinal to understand that DAO is a broad term that encompasses a huge number of different types of groups and businesses. Two collectives can be vastly different, serving different purposes and working on different proposals, but still, both be DAOs. Bitcoin is principally considered to be the first fully functional DAO, as it has programmed rules, functions autonomously, and is coordinated through a consensual protocol. Some other examples of DAOs are things like PleasrDAO (which collects various NFTs and invests in other assets), MetaCartel VentureDAO (a for-profit business that invests in early-stage decentralised applications), and many more as seen in the picture below. DAOs are coded in smart contracts and rely on blockchain technology, thus cannot be changed unless voted upon by the DAO’s members. A smart contract is a computer program or a transaction protocol which is intended to automatically execute, and control legally relevant events and actions according to the terms of a contract or an agreement. They execute only if and when certain conditions are met. These rules are generally decided by the DAO stakeholders. DAOs are needed and extremely beneficial in operation as they hold significant advantages. One prominent advantage of DAOs is the lack of trust needed between two parties, which is contradictory to what a traditional organisation requires, as that needs a lot of trust behind and between the people behind it, while a traditional organisation requires a lot of trust in the people behind it, especially on behalf of investors; however, with DAOs, the only thing that needs to be trusted in the computer code of things like the smart contracts. Trusting that code is appreciably easier to do as it’s publicly attainable and can be extensively tested before launch. In addition, every action a DAO takes after being launched has to be approved by the community and is completely transparent and verifiable. Another advantage of DAOs is that it is able to offer a solution to the principal-agent dilemma. This dilemma is a conflict in priorities between various stakeholders within a business, like a person or a group (the principal) and those making decisions and acting on their behalf (the agent). The principal-agent dilemma is a common issue every business experiences due to misaligned stakeholder interests. An example of this is if the agent (the CEO) works in a way that’s not in line with the priorities and goals determined by the principal (the stakeholders) and instead acts in their own self-interest. Another typical example is when the agent takes excessive risk because the principal bears the burden. DAOs solve the principal-agent dilemma through their community governance feature. This is as in a DAO, the stakeholders involved work coherently together as a group and have incentives that are aligned, they all all have one common objective, thus acting against it would be acting against their self-interests.

Implications and Impact of DAOs Despite the various possible advantages, DAOs may also pose noteworthy risks. Firstly, not all DAOs work out, especially over the long-term, as they are a very risky area. Moreover, their lack of regulatory framework poses severe legal challenges, security and structural issues. Security risks such as flaws in smart contracts can be hard to fix even after they are spotted. In addition, as DAOs can be distributed across multiple jurisdictions, due to its globalised feature, since there’s no legal framework, any legal issues that may arise may likely require numerous regional laws to be present in a complicated battle. MIT Technology Review has, for example, revealed it considers it a bad idea to trust the masses with important financial decisions.

The views expressed within this article are those of the authors and do not represent the views of the Finance Student's Association. All images and references in this article are for fair and educational purposes only. The content in this article is not intended as legal, financial or investment advice and should not be construed or relied on as such.

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