Decentralized Autonomous Organizations (DAOs) Explained

What is a DAO?

Decentralized Autonomous Organizations (DAOs) are blockchain-based communities that are designed to bring a new, more open and democratic management structure to businesses and other collaborative projects in web3. So far, DAOs have formed to run several different types of organizations, including businesses, nonprofits, investment schemes, and more. DAOs are designed to operate without centralized leadership, and the parameters of their decision-making powers and processes are often determined by the smart contracts governing the project in question.

When a DAO is formed, founders frequently mint a governance token, which is a type of crypto asset that may entitle the holder to DAO membership and a certain amount of voting power on DAO decisions — typically the more tokens someone holds, the more votes they have. DAO tokens are typically initially distributed to the project’s management, users, backers, and other stakeholders, but can then be bought and sold on secondary markets like any other cryptocurrency. DAO holders may also submit project proposals, which are then voted on by the rest of the group.

While some would contend that Bitcoin was the first DAO, DAOs as we know them today began as smart contracts on the Ethereum blockchain. Similar DAOs are now built on other open-source blockchains, too. They are designed to run autonomously through smart contracts, where organizational policies are codified and executed once pre-defined criteria are met. In this article, we’ll discuss:

  • How do DAOs work?
  • Benefits of DAOs
  • What are the biggest DAOs?
  • The future of DAOs

How do DAOs work?

What do DAOs do?

DAOs raise capital for projects and initiatives by creating and selling governance tokens. When an individual acquires the DAO’s governance token, they may gain membership and voting rights, but can also delegate their voting responsibilities to another member. There are several types of DAOs associated with projects ranging from investing to grant-making to entertainment, but most DAOs have tasked themselves with governing DeFi protocols.

DAO projects have had varying degrees of success. For instance, AAVE, currently one of the largest DeFi protocols, lets borrowers and lenders interact without needing a centralized intermediary, and is one of the largest DAO-governed projects operating. By contrast, ConstitutionDAO’s project raised over $40 million to bid for a rare copy of the U.S. Constitution at a Sotheby’s auction, but was ultimately outbid by a billionaire.

Key features of DAOs

DAOs strive to be virtual, transparent, democratic, and autonomous. Given that all processes happen online, members rarely, if ever, meet in person. Much of the discussion around decisions take place publicly, on platforms like Discord or on governance forums where voting also takes place — we can look to AAVE’s as an example.

Reinforcing their transparency, DAOs operate with a flat organizational structure that affords all members ownership and participation in decision making. As mentioned earlier, the more governance tokens a person owns, the more votes they have. Last year we analyzed the distribution of ten major DAOs’ governance tokens. Across several, we found that less than 1% of all holders have 90% of the voting power. While many of today’s DAOs may not be upholding the principles of decentralized power they profess, they have the potential to become more decentralized over time, and their transparent decision-making processes hold much promise.

How do DAOs govern?

In the vast majority of cases, DAO members holding governance tokens vote on key decisions, which are then executed by smart contracts. Let’s look at Lido DAO as an example. Lido DAO governs Lido Finance, a DeFi protocol offering liquid staking for Ethereum and other tokens. Holders of Lido’s governance token, LDO, can vote on key decisions affecting the protocol’s operations and allocation of resources. For instance, here’s a recent vote that was passed and enacted to modify the Lido Finance Node Operator’s Registry, setting the maximum number of validators that a particular node operator was permitted to operate as part of the Lido Finance network. The DAO also accumulates service fees from Lido and puts those funds toward research and development, liquidity mining incentives, and protocol upgrades.

As for its proposal process, members publish all ideas on Lido DAO’s research forum, soliciting community feedback to improve plans or hear objections. If a proposal is well-received and feedback is quickly incorporated, it will move forward seven days after the initial posting on the research forum. The proposal is then put to a consensus vote on Snapshot, a decentralized voting system. Again, as is the case with DAOs, the more LDO tokens a voter has, the more decision-making power they possess. Members have seven days to vote, voting can’t end on a weekend, and it must be completed at least 24 hours prior to on-chain execution. For any proposal to pass, at least 5% of the total token supply must vote for it.

From there, the proposal moves to Aragon, a DAO framework for on-chain voting. Because the DAO may entertain many ideas at once, proposals are usually combined into a package “to reduce operational burden and voter fatigue.” Voting on Aragon lasts 72 hours and is split into two phases: the first 48 hours are when members can vote both for and against a proposal. The last 24 hours represent the objection phase, when a member can vote against a proposal or switch their vote from for to against. For a vote to pass, it needs more than 5% of the total token supply to vote “Yes”, and more than 50% of the tokens used to vote “Yes” as well. Provided this occurs, the smart contract executes and the proposal is implemented. The above flow represents Lido DAO’s main governance path, but there are alternative methods like an emergency track for voting on pressing issues, or the usage of committees to streamline routine governance operations.

While DAOs strive for decentralization and democracy, individual DAOs vary in how closely they adhere to those principles. In the vast majority of cases, DAO members vote on key decisions in processes similar to what we’ve described above. However, depending on how the DAO’s smart contracts are set up, the organization’s leadership may be able to execute certain actions without community involvement through the use of multisig wallets. For instance, while Lido DAO votes on almost all decisions, it still has multisig wallets in place that leadership can use to, for example, pause the protocol in an emergency situation.

Benefits of DAOs

One of the biggest benefits of DAOs is their democratic foundation. Fundamentally, all that’s needed to be part of a DAO is a single governance token and an internet connection, allowing individuals anywhere in the world, regardless of background, to work together on large-scale projects making real financial impact. In a sufficiently large and decentralized DAO, no single person can make a decision affecting the entire organization on their own as everyone has the opportunity to vote on proposals.

Given that these votes are logged on the blockchain, decision-making is transparent, which can motivate members to vote in a more altruistic way that both benefits the community and builds on their reputational capital. This feature of DAOs reinforces ownership and accountability across the organization.

Another benefit of DAOs is their egalitarian structure: members can submit a proposal for a project or an amendment to a protocol. Some organizations require token holders to have a minimum amount of tokens while others don’t. All members can see all proposals and share their feedback, too. In this way, everyone is more personally invested in the DAO’s success.

What are the biggest DAOs?

As of this publication in April 2023, the top three DAOs by governance token market capitalization are Uniswap, Lido DAO, and the Ape Foundation. The Uniswap Foundation is the DAO in charge of managing Uniswap, the world’s biggest decentralized exchange (DEX), and launched its UNI token in September 2020. The Ape Foundation governs ApeCoin, a DeFi protocol for community-led projects around art, gaming, and entertainment.

Top 10 DAOs by governance token market capitalization

DAO Project Token Market Capitalization Project focus Uniswap Foundation Uniswap UNI $3.4 billion DEX Lido DAO Lido LDO $2.1 billion Liquid staking protocol Ape Foundation ApeCoin APE $1.5 billion NFTs, metaverse, and entertainment in web3 Arbitrum Foundation Arbitrum ARB $1.5 billion Layer 2 blockchain on Ethereum Internet Computer Service Nervous System ICP $1.4 billion Web3 infrastructure blockchain Aave Aave Liquidity Protocol AAVE $1 billion Lending protocol BitDAO BitDAO BIT $1 billion Web3 project funding Curve.fi DAO Curve CRV $778 million DEX Synthetix Synthetix SNX $691 million Derivatives liquidity protocol MakerDAO Dai stablecoin MKR $677 million Smart contract platform

The future of DAOs

As DAOs proliferate, services to support them are growing, too. Platforms like Aragon provide user-friendly software that assists with DAO creation and management, no coding required. Open-source projects like DAOstack offer similar capabilities.

Some governments are working to support DAO innovation, too. On March 1, the state of Utah passed the Decentralized Autonomous Organizations Act, a bill allowing any DAO formed in the state that’s not registered as a for-profit or non-profit entity to be treated equivalent to a domestic limited liability company. The law goes into effect in 2024 and the state of New Hampshire is entertaining similar DAO legislation. It will be interesting to see if other states follow suit and Chainalysis will keep an eye on these developments. In the meantime, if you’re interested in diving deeper on DAOs and other web3 topics, download our State of Web3 Report.

This material is for informational purposes only, and is not intended to provide legal, tax, financial, or investment advice. Recipients should consult their own advisors before making these types of decisions. Chainalysis does not guarantee or warrant the accuracy, completeness, timeliness, suitability or validity of the information herein. Chainalysis has no responsibility or liability for any decision made or any other acts or omissions in connection with Recipient’s use of this material.

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