How do you DAO? Can DAOs scale?

DAO: Decentralized Autonomous. Organization.

“The whole phrase is a misnomer. They're not decentralized, autonomous, or organizations,” says Monsterplay blockchain consultant David Freuden.

As part of the DAO initiative, Freuden coauthored a 51-page report in May 2020. “We need DAOs,” he says. “‘Shareholder first' is a 1980s/90s concept. Profits became the focus, not products.”

His predictions for DAOs have come true nearly two years later. DAOs had over 1.6 million participants by the end of 2021, up from 13,000 at the start of the year. Wyoming, in the US, will recognize DAOs and the Marshall Islands in 2021. Australia may follow that example in 2022.

But what is a DAO?

Members buy (or are rewarded with) governance tokens to vote on how the DAO operates and spends its money. “DeFi spawned DAOs as an investment vehicle. So a DAO is tokenomics,” says Freuden.

DAOs are usually built around a promise or a social cause, but they still want to make money. “If you can't explain why, the DAO will fail,” he says. “A co-op without tokenomics is not a DAO.”

Operating system DAOs, protocol DAOs, investment DAOs, grant DAOs, service DAOs, social DAOs, collector DAOs, and media DAOs are now available.

Freuden liked the idea of people rallying around a good cause. Speculators and builders make up the crypto world, so it needs a DAO for them.

,Speculators and builders, or both, have mismatched expectations, causing endless, but sometimes creative friction.

Organisms that boost output

Launching a DAO with an original product such as a cryptocurrency, an IT protocol or a VC-like investment fund like FlamingoDAO is common. DAOs enable distributed open-source contributions without borders. The goal is vital. Sometimes, after a product is launched, DAOs emerge, leaving the company to eventually transition to a DAO, as Uniswap did.

Doing things together is a DAO. So it's a way to reward a distributed workforce. DAOs are essentially productivity coordination organisms.

“Those who work for the DAO make permissionless contributions and benefit from fragmented employment,” argues Freuden. DAOs are, first and foremost, a new form of cooperation.

DAO? Distributed not decentralized

In decentralized autonomous organizations, words have multiple meanings. DAOs can emphasize one aspect over another. Autonomy is a trade-off for decentralization.

DAOstack CEO Matan Field says a DAO is a distributed governance system. Power is shared. However, there are two ways to understand a DAO's decentralized nature. This clarifies the various DAO definitions.

A decentralized infrastructure allows a DAO to be decentralized. It could be created on a public permissionless blockchain to prevent a takeover.

As opposed to a company run by executives or shareholders, a DAO is distributed. Its leadership does not wield power

Option two is clearly distributed.

But not all of this is “automated.”

Think quorum, not robot.

DAOs can be autonomous in the sense that smart contracts are self-enforcing and self-executing. So every blockchain transaction is a simplified smart contract.

Dao landscape

The DAO landscape is evolving.

Consider how Ethereum's smart contracts work. They are more like self-executing computer code, which Vitalik Buterin calls “persistent scripts”.

However, a DAO is self-enforcing once its members agree on its rules. As such, a DAO is “automated upon approval by the governance committee.” This distinguishes them from traditional organizations whose rules must be interpreted and applied.

Why a DAO? They move fast

A DAO can quickly adapt to local conditions as a governance mechanism. It's a collaborative decision-making tool.

Like UkraineDAO, created in response to Putin's invasion of Ukraine by Ukrainian expat Alona Shevchenko, Nadya Tolokonnikova, Trippy Labs, and PleasrDAO. The DAO sought to support Ukrainian charities by selling Ukrainian flag NFTs. With a single mission, a DAO can quickly raise funds for a country accepting crypto where banks are distrusted.

This could be a watershed moment for DAOs.

ConstitutionDAO was another clever use case for DAOs for Freuden. In a failed but “beautiful experiment in a single-purpose DAO,” ConstitutionDAO tried to buy a copy of the US Constitution from a Sotheby's auction. In November 2021, ConstitutionDAO raised $47 million from 19,000 people, but a hedge fund manager outbid them.

Contributions were returned or lost if transactional gas fees were too high. The ConstitutionDAO, as a “beautiful experiment,” proved exceptionally fast at organizing and crowdsourcing funds for a specific purpose.

We may soon be applauding UkraineDAO's geopolitical success in support of the DAO concept.

Some of the best use cases for DAOs today, according to Adam Miller, founder of DAOplatform.io and MIDAO Directory Services, involve DAO structures.

That is, a “flat community is vital.” Prototyping by the crowd is a good example.  To succeed,  members must be enthusiastic about DAOs as an alternative to starting a company. Because DAOs require some hierarchy, he agrees that "distributed is a better acronym."

Miller sees DAOs as a “new way of organizing people and resources.” He started DAOplatform.io, a DAO tooling advisery that is currently transitioning to a DAO due to the “woeful tech options for running a DAO,” which he says mainly comprises of just “multisig admin keys and a voting system.” So today he's advising on DAO tech stacks.

Miller identifies three key elements.

How a DAO works...

They can be more than glorified Discord groups if they have a clear mission. This mission is a mix of financial speculation and utopianism. The spectrum is vast.

The founder of Dash left the cryptocurrency project in 2017. It's the story of a prophet without an heir. So creating a global tokenized evangelical missionary community via a DAO made sense.

Evan Duffield, a “libertarian/anarchist” visionary, forked Bitcoin in January 2014 to make it instant and essentially free. He went away for a while, and DASH became a DAO.

200,000 US retailers, including Walmart and Barnes & Noble, now accept Dash as payment. This payment system works like a gift card.

Arden Goldstein, Dash's head of crypto, DAO, and blockchain marketing, claims Dash is the “first successful DAO.” It was founded in 2016 and disbanded after a hack, an Ethereum hard fork and much controversy. But what are the success metrics?

Crypto success is measured differently, says Goldstein. To achieve common goals, people must participate or be motivated in a healthy DAO. People are motivated to complete tasks in a successful DAO. And, crucially, when tasks get completed.

“Yes or no, 1 or 0, voting is not a new idea. The challenge is getting people to continue to participate and keep building a community.” A DAO motivates volunteers: Nothing keeps people from building. The DAO “philosophy is old news. You need skin in the game to play.”

MasterNodes must stake 1000 Dash. Those members are rewarded with DASH for marketing (and other tasks). It uses an outsourced team to onboard new users globally.

Joining a DAO is part of the fun of meeting crazy or “very active” people on Discord. No one gets fired (usually). If your work is noticed, you may be offered a full-time job.

DAO community members worldwide are rewarded for brand building. Dash is also a great product for developing countries with high inflation and undemocratic governments. The countries with the most Dash DAO members are Russia, Brazil, Venezuela, India, China, France, Italy, and the Philippines.

Grassroots activism makes this DAO work. A DAO is local. Venezuelans can't access Dash.org, so DAO members help them use a VPN. DAO members are investors, fervent evangelicals, and local product experts.

Every month, proposals and grant applications are voted on via the Dash platform. However, the DAO may decide not to fund you. For example, the DAO once hired a PR firm, but the community complained about the lack of press coverage. This raises a great question: How are real-world contractual obligations met by a DAO?

Does the DASH DAO work?

“I see the DAO defund projects I thought were valuable,” Goldstein says. Despite working full-time, I must submit a funding proposal. “Much faster than other companies I've worked on,” he says.

Dash DAO is a headless beast. Ryan Taylor is the CEO of the company overseeing the DASH Core Group project. 

The issue is that “we don't know who has the most tokens [...] because we don't know who our customers are.” As a result, “the loudest voices usually don't have the most MasterNodes and aren't the most invested.”

Goldstein, the only female in the DAO, says she worked hard. “I was proud of the DAO when I made the logo pink for a day and got great support from the men.” This has yet to entice a major influx of female DAO members.

Many obstacles stand in the way of utopian dreams.

Governance problems remain

And what about major token holders behaving badly?

In early February, a heated crypto Twitter debate raged on about inclusion, diversity, and cancel culture in relation to decentralized projects. In this case, the question was how a DAO addresses alleged inappropriate behavior.

In a corporation, misconduct can result in termination. In a DAO, founders usually hold a large number of tokens and the keys to the blockchain (multisignature) or otherwise.

Brantly Millegan, the director of operations of Ethereum Name Service (ENS), made disparaging remarks about the LGBTQ community and other controversial topics. The screenshotted comments were made in 2016 and brought to the ENS board's attention in early 2022.

His contract with ENS has expired. But what of his large DAO governance token holdings?

Members of the DAO proposed a motion to remove Millegan from the DAO. His “delegated” votes net 370,000. He was and is the DAO's largest delegate.

What if he had refused to accept the DAO's decision?

Freuden says the answer is not so simple.

The original mission “should be dissolved” if it no longer exists. “Does a DAO fail and return the money? They must r eturn the money with interest if the marriage fails.”

Before an IPO, VCs might try to remove a problematic CEO.

While DAOs use treasury as a governance mechanism, it is usually controlled (at least initially) by the original project creators. Or, in the case of Uniswap, the venture capital firm a16z has so much voting power that it has delegated it to student-run blockchain organizations.

So, can DAOs really work at scale? How to evolve voting paradigms beyond token holdings?

The whale token holder issue has some solutions. Multiple tokens, such as a utility token on top of a governance token, and quadratic voting for whales, are now common. Other safeguards include multisignature blockchain keys and decision time locks that allow for any automated decision to be made. The structure of each DAO will depend on the assets at stake.

In reality, voter turnout is often a bigger issue.

Is DAO governance scalable?

Many DAOs have low participation. Due to a lack of understanding of technology, apathy, or busy lives. “The bigger the DAO, the fewer voters who vote,” says Freuden.

Freuden's report cites British anthropologist Dunbar's Law, who argued that people can only maintain about 150 relationships.

Freuden says a DAO requires “understanding human relationships.” He believes DAOs work best as investment funds rooted in Cryptoland and small in scale. In just three weeks, SyndicateDAO enabled the creation of 450 new investment group DAOs.

Due to SEC regulations, FlamingoDAO, a famous NFT curation investment DAO, could only have 100 investors. The “LAO” is a member-directed venture capital fund and a US LLC. To comply with US securities law, they only allow 100 members with a 120ETH minimum staking contribution.

But how did FlamingoDAO make investment decisions? How often did all 70 members vote? Art and NFTs are highly speculative.

So, investment DAOs are thought to work well in a small petri dish environment. This is due to a crypto-native club's pooled capital (maximum 7% per member) and crowdsourced knowledge.

While scalability is a concern, each DAO will operate differently depending on the goal, technology stage, and personalities. Meetups and hackathons are common ways for techies to collaborate on a cause or test an idea. But somebody still organizes the hack.

Holographic consensus voting

But clever people are working on creative solutions to every problem.

Miller of DAOplatform.io cites DXdao as a successful DAO. Decentralized product and service creator DXdao runs the DAO entirely on-chain. “You earn voting rights by contributing to the community.”

DXdao, a DAOstack fork, uses holographic consensus, a voting algorithm invented by DAOstack founder Matan Field. The system lets a random or semi-random subset make group-wide decisions.

By acting as a gatekeeper for voters, DXdao's Luke Keenan explains that “a small predictions market economy emerges around the likely outcome of a proposal as tokens are staked on it.” Also, proposals that have been financially boosted have fewer requirements to be successful, increasing system efficiency.” DXdao “makes decisions by removing voting power as an economic incentive.”

Field explains that holographic consensus “does not require a quorum to render a vote valid.”

You don't need big votes on everything. If only 5% vote, fine. To move significant value or make significant changes, you need a longer voting period (say 30 days) and a higher quorum,” says Miller.

Clearly, DAOs are maturing. The emphasis is on tools like Orca and processes that delegate power to smaller sub-DAOs, committees, and working groups.

Miller also claims that “studies in psychology show that rewarding people too much for volunteering disincentivizes them.” So, rather than giving out tokens for every activity, you may want to offer symbolic rewards like POAPs or contributor levels.

Culture and motivation

DAOs (and Web3 in general) can give early adopters a sense of ownership. In theory, they encourage early participation and bootstrapping before network effects.

"A double-edged sword," says Goldstein. In the developing world, they may not be fully scalable.

“There must always be a leader,” she says. “People won't volunteer if they don't want to.”

DAO members sometimes feel entitled. “They are not the boss, but they think they should be able to see my calendar or get a daily report,” Goldstein gripes. Say, “I own three MasterNodes and need to know X, Y, and Z.”

In most decentralized projects, strong community leaders are crucial to influencing culture.

Freuden says “the DAO's community builder is the cryptoland influencer.” They must “disseminate the DAO's culture, cause, and rally the troops” in English, not tech.

They must keep members happy.

So the community builder is vital. Building a community around a coin that promises riches is simple, but keeping DAO members motivated is difficult.

It's a human job. But tools like SourceCred or coordinate that measure contributions and allocate tokens are heavily marketed. Large growth funds/community funds/grant programs are common among DAOs.

The Future?

Onboarding, committed volunteers, and an iconic community builder may be all DAOs need.

It takes a DAO just one day to bring together a passionate (and sometimes obsessive) community. For organizations with a common goal, managing stakeholder expectations is critical.

A DAO's core values are community and cause, not scalable governance. “DAOs will work at scale like gaming communities, but we will have sub-DAOs everywhere like committees,” says Freuden.

So-called holographic consensuses “can handle, in principle, increasing rates of proposals by turning this tension between scale and resilience into an economical cost,” Field writes. Scalability is not guaranteed.

The DAO's key innovation is the fragmented workplace. “Voting is a subset of engagement,” says Freuden. DAO should allow for permissionless participation and engagement. DAOs allow for remote work.”

In 20 years, DAOs may be the AI-powered self-organizing concept. That seems far away now. But a new breed of productivity coordination organisms is maturing.

The international law firm Holland & Knight used an NFT built and airdropped by its asset recovery team to serve a defendant in a hacking case.

The law firms Holland & Knight and Bluestone used a nonfungible token to serve a defendant in a hacking case with a temporary restraining order, marking the first documented legal process assisted by an NFT.

The so-called "service token" or "service NFT" was served to an unknown defendant in a hacking case involving LCX, a cryptocurrency exchange based in Liechtenstein that was hacked for over $8 million in January. The attack compromised the platform's hot wallets, resulting in the loss of Ether (ETH), USD Coin (USDC), and other cryptocurrencies, according to Cointelegraph at the time.

On June 7, LCX claimed that around 60% of the stolen cash had been frozen, with investigations ongoing in Liechtenstein, Ireland, Spain, and the United States. Based on a court judgment from the New York Supreme Court, Centre Consortium, a company created by USDC issuer Circle and crypto exchange Coinbase, has frozen around $1.3 million in USDC.

The monies were laundered through Tornado Cash, according to LCX, but were later tracked using "algorithmic forensic analysis." The organization was also able to identify wallets linked to the hacker as a result of the investigation.

In light of these findings, the law firms representing LCX, Holland & Knight and Bluestone, served the unnamed defendant with a temporary restraining order issued on-chain using an NFT. According to LCX, this system "was allowed by the New York Supreme Court and is an example of how innovation can bring legitimacy and transparency to a market that some say is ungovernable."

Yuga Labs, the creators of BAYC, airdropped ApeCoin (APE) to anyone who owns one of their NFTs yesterday.

For the Bored Ape Yacht Club and Mutant Ape Yacht Club collections, the team allocated 150 million tokens, or 15% of the total ApeCoin supply, worth over $800 million. Each BAYC holder received 10,094 tokens worth $80,000 to $200,000.

But someone managed to claim the airdrop using NFTs they didn't own. They used the airdrop's specific features to carry it out. And it worked, earning them $1.1 million in ApeCoin.

The trick was that the ApeCoin airdrop wasn't based on who owned which Bored Ape at a given time. Instead, anyone with a Bored Ape at the time of the airdrop could claim it. So if you gave someone your Bored Ape and you hadn't claimed your tokens, they could claim them.

The person only needed to get hold of some Bored Apes that hadn't had their tokens claimed to claim the airdrop. They could be returned immediately.

So, what happened?

The person found a vault with five Bored Ape NFTs that hadn't been used to claim the airdrop.

A vault tokenizes an NFT or a group of NFTs. You put a bunch of NFTs in a vault and make a token. This token can then be staked for rewards or sold (representing part of the value of the collection of NFTs). Anyone with enough tokens can exchange them for NFTs.

This vault uses the NFTX protocol. In total, it contained five Bored Apes: #7594, #8214, #9915, #8167, and #4755. Nobody had claimed the airdrop because the NFTs were locked up in the vault and not controlled by anyone.

The person wanted to unlock the NFTs to claim the airdrop but didn't want to buy them outright s o they used a flash loan, a common tool for large DeFi hacks. Flash loans are a low-cost way to borrow large amounts of crypto that are repaid in the same transaction and block (meaning that the funds are never at risk of not being repaid).

With a flash loan of under $300,000 they bought a Bored Ape on NFT marketplace OpenSea. A large amount of the vault's token was then purchased, allowing them to redeem the five NFTs. The NFTs were used to claim the airdrop, before being returned, the tokens sold back, and the loan repaid.

During this process, they claimed 60,564 ApeCoin airdrops. They then sold them on Uniswap for 399 ETH ($1.1 million). Then they returned the Bored Ape NFT used as collateral to the same NFTX vault.

Attack or arbitrage?

However, security firm BlockSecTeam disagreed with many social media commentators. A flaw in the airdrop-claiming mechanism was exploited, it said.

According to BlockSecTeam's analysis, the user took advantage of a "vulnerability" in the airdrop.

"We suspect a hack due to a flaw in the airdrop mechanism. The attacker exploited this vulnerability to profit from the airdrop claim" said BlockSecTeam.

For example, the airdrop could have taken into account how long a person owned the NFT before claiming the reward.

Because Yuga Labs didn't take a snapshot, anyone could buy the NFT in real time and claim it. This is probably why BAYC sales exploded so soon after the airdrop announcement.