For all sorts of corporate entities, regulations specify what is and is not allowed. These governance guidelines could be found in private agreements between firm owners, much like shareholder contracts. Since companies historically have only been able to operate through individuals or other corporate entities, the law may also require the enforcement of such agreements.

Although the parties do not always abide by the rules, and prior consent is not always obtained before the execution of such regulations, the enforcement of laws results in two critical problems. So, who is most affected? Stakeholders with little to no influence over governance decisions or who lack the authority to identify issues are more likely to mismanage their finances and lose money. Is there a way to solve this issue?

There is a solution for the problems above, called decentralized autonomous organizations (DAOs). But what are decentralized independent organizations used for? Transparency, a solution to the Principal-Agent dilemma, is one of the advantages of DAOs (more on this later). What, though, is a DAO?

At the core of the DAO ecosystem are the distributed ledger technology known as a blockchain and smart contracts, which allow members to supervise contributed funds without the need for a third party and write, automate, and enforce governance rules.

Users must first buy the DAO’s native coin to participate in a DAO. Examples of decentralized autonomous organizations include virtual worlds like Decentraland, Augur, DASH, and MakerDAO. The first prosperous DAO was BitShares, a virtual e-commerce network. Dan Larimer, the business’s founder, coined the phrase “decentralized autonomous company,” which was used by Bitshares.

In addition, Slock. It created the DAO (investor-operated venture capital business) in 2016 as the first decentralized autonomous organization on the Ethereum blockchain. However, the DAO was compromised because of a coding error found, and the attacker stole $70 million in Ethereum (ETH).

This tutorial will describe decentralized autonomous organizations (DAOs) in the context of blockchain, how they operate, the many types of DAOs, the significance of DAOs, and how to build a DAO.

How do autonomous decentralized organizations function?

The DAO’s rules, established by a core team of community members, are built using smart contracts. These smart contracts are the foundation for the DAO’s activities and are transparent, verifiable, and open to public audit. They enable any prospective member to understand how the protocol will function at all times completely.

Once these principles have been enshrined on the blockchain, the DAO must determine how to acquire funding and impart control. To do this, a token issuance technique is typically used, in which the protocol sells tokens to generate revenue and restock the DAO’s treasury. In exchange for their money, token holders usually acquire voting rights that are proportional to their holdings. Once fundraising is finished, the DAO is prepared for deployment.

The DAO code is written in the “Solidity” programming language. A DAO is activated via deployment on the Ethereum blockchain. Once deployed, a DAO’s code requires ETH to participate in Ethereum transactions. Since a DAO cannot function without ETH, receiving ETH is the first order of business for a DAO. After a DAO’s code has been deployed, ETH can be transferred to the DAO’s smart contract address during the initial creation period specified in the code.

No specific authority has the authority to change the DAO’s rules once the code has been put into production; instead, changes must be approved by a majority of members through a vote. The choice is entirely up to the token owners of the DAO.

Also Read: All About Decentralized Autonomous Organizations (DAO Guide)

How can one begin a DAO?

To create a DAO, adhere to the steps listed below:

Lay a solid foundation

First, decide why DAO is necessary, what function it will provide, and how it will operate in conversation with your peers. To create a DAO, human decision-making is required to see the opportunity, maybe find collaborators, confirm the need, and design the processes that can be automated and included in smart contracts.

It is crucial to discuss the objective with other DAO enthusiasts to ensure that there are no misunderstandings regarding the governance structure of the DAO. It would help if you also had an encrypted wallet with storage and transactional capabilities.

The first thing investors or funders will consider when considering a firm is the source of revenue. So how does a DAO generate revenue? The primary source of income for DAOs is dividends. DAOs invest money to generate dividend income. By convincing peers to participate in the DAO based on its business model, DAO creators can also profit from their work.

Identify the owner

Once both parties have agreed on the DAO’s purpose, establishing ownership for DAO members is the following stage. This step promotes the growth and development of decentralized autonomous organizations. Because ownership is typically tokenized, a DAO can transfer ownership to its members in various ways. DAOs often employ two techniques: “airdrops” and “rewards.”

Rewards are bonuses given to members who complete tasks and reach objectives. Members acquire ownership through native token-based rewards. With airdrops, tokens are given out to participants based on their contributions and actions within the community. Additionally, tokens can be bought on decentralized markets like Uniswap.

Establish a mechanism for governing

Here, it is decided how choices will be taken when a DAO has been established. The most popular technique for establishing decision-making guidelines is “token weighted voting.” Each token that a voter holds represents one vote. Members vote based on the preferences of other members after submitting ideas using a tool like Snapshot, and the results are then automatically carried out using smart contracts.

Create incentives and rewards

Building trust involves implementing rewards and incentives as part of the many advantages provided to DAO donors and members. Members and collaborators who have ever utilized the DeFi protocol under consideration are given native governance tokens. These tokens signify ownership rights but have no intrinsic worth.

DAOs may also grant rewards in titles, grades, or even digital currencies like ETH, Tether (USDT), or USD Coin (USDC). The incentive structure can be further improvised when the DAO conceptualization step is complete.

What does it cost to launch a DAO?

There is no defined cost to form a DAO; instead, it depends on the network’s gas prices at the creation time. For instance, gas expenses, and the network charges for loading the smart contracts into the blockchain, will be incurred if you decide to build a DAO on the Ethereum blockchain.

Approximately 0.2 ETH may be charged, with a typical gas fee of 30 gwei. Additionally, depending on your business operations, you will need to file an annual report for a fee of $60 or more.

On the Aragon network, how do you start a DAO?

The basic procedures for creating a DAO on Aragon are as follows:

Obtain some ETH. It would help if you launched an Aragon DAO, as specified in the section above.

ETH should be transferred to your Web3 wallet.

When your ETH is delivered, go to https://client.aragon.org, click Connect Account, and select your wallet provider from the drop-down option. Continue to navigate through the approval process until your wallet is connected.

Go to “Create an Organization” and follow the directions to construct your DAO.

Triangle of tension for DAO

Three distinct but equally important elements—voice, departure, and loyalty—are balanced out by the tension triangle in a DAO. The degree to which a DAO allows someone to depart is a measure of how much it respects that person’s sovereign character.

The ability to participate freely in decision-making is the essence of an individual. People can decide when to enter and leave a DAO and whether to take part in and vote on all other DAO options (i.e., utilize their voice).

A governance mechanism is the voice-related, DAO-specific design space. It is comparable to the idea of free will. Participating in protocol-related choices and actively improving the DAO are both aspects of governance. Strengthening the voice and reducing exit incentives are necessary for improving the government.

Governance (voice) 

Governance rules address the organization’s legal framework, membership, mission, operations, and off-chain and on-chain voting that support its creation and demise.

Individual (exit) 

People willing to take care of themselves and who believe in self-government and the common good are frequently referred to as individuals. However, they demand the protection of individual rights. The definition can also apply to registered or unregistered corporations that are treated or classified legally as individuals and operate within the territorial sovereignty of their jurisdictions.

Decentralization (loyalty) 

Technology and politics are combined in decentralization to create a belief system that identifies the traits of those who choose to join the DAO. Loyalty determines whether members of a DAO will skew towards voice or depart when all other factors are equal.

The DAO’s decentralization, as well as the individuals behind it and their intentions, have a significant impact on how trustworthy the project is. Any DAO’s capabilities, purpose, and participation expenses determine its level of decentralization, which varies.

Why is corporate governance necessary?

The Principal-Agent issue occurs, just as it does in traditional organizations, when one person or central entity (the agent) makes decisions and plans on behalf of another person or central entity (the principal).

Moral hazard issues arise when agents act in their best interests, possibly at the expense of their ideals. One instance of this behavior is the recent and extensive share buybacks by public firms, which unfairly benefit agents through incentives at the corporation’s long-term health price.

The management of DAOs must therefore be adequately motivated to work for the organizations and all of its stakeholders’ long-term interests. Otherwise, they risk contributing to the Principal-Agent issue, which is already pervasive in many firms. Governance is, therefore, essential for the general welfare!

Even if the main use of blockchain technology for DAO governance is record keeping, this represents a huge improvement in openness over traditional infrastructure. However, individual voting decisions on corporate concerns can be carried out more effectively if proxy advisory services advise individual investors and offer oracle services to smart contracts (for smart votes) to automate individual voting.