How to Create a DAO- Decentralized Autonomous Organization?

Organizations are hierarchical traditionally, and control flows from top to bottom. Traditional organizations require people to trust each other, or at least those at the top, and power is centralized in the hands of a few.

These concepts are against what modern internet-native organizations want- trustlessness, transparency and decentralization. Decentralized Autonomous Organizations (DAOs) fulfill that need.

What is a DAO?

A decentralized autonomous organization justifies its name. It’s a governance style for decentralized applications (DApps), projects and crypto-investment funds, whose roots lie in decentralization.

A DAO is a community-owned, decentralized, autonomous organization automated by code and open for participation. Its autonomous quality comes from smart contracts that run processes without human intervention, offering trustlessness.

A DAO is created and run by a community, which collectively partakes in decision-making, funds management and project undertakings. DAOs have been continually improving since 2016 when Ethereum’s capital fund, “The DAO”, suffered an attack due to a vulnerability in its code.

Today, DAOs are the top choice for the governance of Decentralized Finance (DeFi) projects.

Related: Everything You Need to Know About the Bitcoin Lightning Network

Advantages of Building a DAO

DAOs offer significant advantages for crypto projects.

• Trustlessness – The most important benefit of DAOs comes from their reliance on smart contracts that reside on the blockchain. This way, proposals for change can be voted for, automatically posted on the blockchain and trigger a proposed change. Results can’t be censored or rigged.

• Community organization – DAOs allow anonymous communities to work in tandem. Participants have no accountability to a real identity and need to trust people they don’t know. The underlying technology guarantees the integrity and allows a socially and culturally diverse community to collaborate.

• Cheap – DAOs are affordable for the functionalities they offer. They can be set up at no cost or for a small fee.

• Decentralized – A DAO holds its members accountable for its decisions. A single person or group doesn’t have any special powers in a DAO and thus lacks complete control.

• Innovative and growth-committed – Since a DAO has no hierarchical structure, any stakeholder can propose an innovative idea that other members consider and improve. Internal disputes are easily solved through voting, as per pre-written rules in the smart contract.

• Principal-agent dilemma – Decentralized autonomous organizations solve the principal-agent dilemma, which highlights a conflict in priorities of a person or group (the principal) and those making choices on their behalf (the agent). Community governance ensures principals or stakeholders don’t need to trust anyone but the code. DAOs also allow people to work as part of a group with aligned interests and incentives.

Related: Is the Crypto Industry Doomed After the FTX Collapse?

Requirements to Create a Decentralized Autonomous Organization

A successful DAO doesn’t happen by default. Here’s what it needs.

Structure

If you’re planning on creating a DAO from scratch, defining its core structure is key. There are many ways a decentralized structure could serve an organization or project. Find out how it might serve you. 

Here are a few questions to help you decide on a structure-

Type of DAO

The next decision to make is choosing the type of DAO you want. DAOs as a concept are still in their nascent stages, but there are quite a few exciting areas for their application, such as:

• Protocol DAOs that focus on governance via decentralized protocols. MakerDAO and Uniswap are examples of protocol DAOs.
• Investment DAOs bring together investors and crypto owners to support startups and innovative ideas. These enforce governance rights through smart contracts.
• Grant DAOs also support fresh initiatives but are reserved only for DeFi projects. The Uniswap Awards are one of the most popular DAO grants.
• Social DAOs support social networking within crypto communities via digital democracy, where every idea is worth hearing. Blockster is a social DAO.
• Collector DAOs allow NFT artists to demonstrate ownership of their work. PleasrDAO, for instance, brings together NFT collectors, DeFi promoters and digital creators.
• Media DAOs reinvent how content producers and consumers engage with media. Instead of advertising-based revenue models, these DAOs use token incentives to reward producers and consumers for their time with an ownership stake in a given outlet. Forefront is an example.
• Entertainment DAOs let creators bring ideas to life while maintaining control over their administration. Flufworld is an example where members customize 3D NFT Fluffs and license them.
• Philanthropy DAOs aid social responsibility projects in Web 3.0. The Big Green DAO is the first charity organization raising awareness about growing food.

Purpose

DAOs are a way to organize a project, fund or organization, which is futile without a purpose and reason. What is the underlying purpose driving your DAO?

Voting mechanism

A DAO needs to start with a chosen third-party or custom-created voting mechanism. This is the primary way a DAO’s participants interact among themselves and propose and vote for changes.

Governance token- supply, allocation and incentives

Getting the governance token right allows a DAO to fundraise efficiently and garner support from the original community. DAO tokens are useful in-

• Offering incentives, rewards and perks to community members.
• Voting and governance on DAO processes.
• Opening wider opportunities for community development.

Choosing token supply volume and allocating them is crucial for DAO development to achieve business growth. Like any other project, early investors of a DAO expect rewards in return. So, it’s crucial to maintain funds for the capital needs of the DAO and reward the founding community.

Community

Community is one of the foundational pieces of a DAO. as the community grows, decentralization gets more robust, and power spreads across more stakeholders. Community creation is a priority when developing a DAO cluster, as it becomes the backbone of the project’s expansion.

An engaged, interactive and strong community that freely participates in the management and decision-making of the DAO defines its success.

Fund management and DAO treasury

After completing the DAO token’s ICO supply, you need to guarantee the security of the collected funds. Most DAOs have a treasury or access to some crowdfunding, usually held in a multi-signature wallet, accessible if all key participants agree. 

Some popular DAO treasury tools are Gnosis Safe– a reliable and lightweight solution for DAOs without specialized use cases, Multisis– an analytics tool built on Gnosis for multi-wallet fund tracking and reporting, Llama– a tool that allows more sophisticated analytics and proposal linkages and Parcel– a tool that enables mass payouts in ETH/ERC-20 and offers a comprehensive analytics dashboard.

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3 Solutions to Create a DAO

DAOs need a mechanism to manage votes and proposals from members. There is a wide array of open-source solutions to help do that. Here are a few popular ones-

• Aragon – Aragon facilitates DAO building on Ethereum, Polygon, Andromeda and Harmony. Aragon project is itself run by a DAO with its non-profit organization to manage its funds. Here’s more information on creating a DAO using Aragon.

• Snapshot – This is a customizable off-chain voting mechanism using digital signatures via wallets to cast votes based on a snapshot of token owners. A block is selected, and all token holders have their holdings captured. This prevents users from buying more tokens to influence a vote. Off-chain voting works best for multi-chain projects where users hold governance tokens across blockchains. Here’s more information on creating your voting system on Snapshot.

• DAOstack Alchemy – DAOstack Alchemy allows DAO creation on Ethereum and Gnosis Chain (previously xDAI). Their interface allows users to create a simple DAO, add members and start an organization. Learn more about DAOstack Alchemy here.

Successful DAOs

Here are successful DAO examples to get inspired.

MakerDAO

MakerDAO is one of the most stable and earliest DAOs. It enables the generation of DAI, cited as the world’s first unbiased currency and a leading decentralized stablecoin. The peer-to-peer decentralized protocol is based on the Ethereum network and facilitates borrowing, lending and saving. It allows borrowing funds in DAI.

Users need Ethereum and a MetaMask wallet to lend themselves money in DAI. Users can lock up some ETH in MakerDAO’s smart contract to create DAI.

Aave

Aave is a DeFi lending platform originally built on the Ethereum network, with all tokens (ERC20) also using the Ethereum blockchain. Aave has since expanded to other blockchains, including Avalanche, Fantom and Harmony.

Aave uses a DAO in that it’s governed and operated by users who hold and vote with AAVE tokens. Besides project changes, Aave governance also votes on new projects on the protocol and Aave Grants to fund ideas.

Uniswap

Uniswap was one of the first DeFi applications to gain huge traction on Ethereum. It is a decentralized exchange that uses the governance token UNI to allow users to vote on protocol changes. The multi-chain Automated Market Maker (AMM) inspired many DeFi projects.

Users must hold at least 0.25% of the UNI’s total supply to submit a new proposal to the DAO. And, a governance forum exists where users debate changes.

Related: Why Build in Web3

Challenges of Managing a DAO

• Legal liabilities – Members of a DAO may face unlimited liability, so they don’t just risk capital investment. DAOs aren’t corporations and don’t conform to the legal formalities expected of a traditional organization. Since DAOs aren’t recognized as legal entities in the US, they don’t enjoy corporate privileges or government protection. This means legal issues within a DAO are extremely hard to resolve. Furthermore, DAO members are anonymous and not accountable for their identity in the community. In this case, KYC is a luxury, and the lack of it is a legal liability.

• Free-rider problem – Smart contracts are logical and must be balanced with social contracts and staking mechanisms like reputation. Without value, purpose and incentive assigned to each member of a DAO, some individual contributors can avoid taking any responsibility while still benefitting from the system. DAOs often address the free-rider issue with tools such as community events, social value propositions and exclusivity. Inactive token holders can derail decisions and disrupt the functionality of a DAO.

• Decision-making challenges – When decision-making requires expertise, decentralization might backfire. Consider everyone in a large traditional organization voting to decide on a content strategy for the quarter. A large token holder in a DAO without adequate experience may negatively impact decisions. Some DAOs may navigate this problem with a governance structure where members vote to select qualified personnel who then make critical decisions transparently. However, that departs us from complete decentralization, a dear vision for many web3 enthusiasts.

The technical part of creating a DAO isn’t the only aspect of it, as running it successfully involves a lot of other moving parts. For assistance and consultation around your DAO idea, speak to an expert at KiwiTech.