What is a DAO?
DAO stands for Decentralized Autonomous Organization.
Depending on who you ask, a DAO may be most accurately described as:
a 'virtual' organization embodied in computer code and executed on a distributed ledger or blockchain.
-Securities Exchange Commission
an entity that lives on the internet and exists autonomously, but also heavily relies on hiring individuals to perform certain tasks that the automaton itself cannot do.
DAOs: Democratizing Corporate Structures
Decentralized Autonomous Organizations (“DAOs”) decentralize and democratize investments into organizations and projects.
DAOs allow individuals to pursue a shared purpose without vesting control into the hands of a centralized authority (assuming a majority of the governance tokens are not held by a control group).
DAOs starkly contrast to the hierarchical structure of corporations or venture funds where a centralized decision-maker (e.g., the Board or GP) decides an enterprise’s future.
Instead, DAOs leverage blockchain technology to automate the enforcement of operating procedures and protocols of the organization.
Let’s take a step back and explore the underlying concepts that make DAOs unique.
One way to understand the blockchain is to imagine a ledger written with a permanent marker. It’s possible to make additions to it, but no subtractions or modifications.
This ledger is distributed, so all network members keep an updated copy.
By leveraging cryptography and other mechanisms, blockchains allow each participant to conduct due diligence before approving a transaction—thus eliminating the dependence on any singular point of failure.
Decentralized Autonomous Organizations
DAOs are blockchain applications that leverage distributed ledger protocols to decentralize and democratize coordination to fulfill a mission.
Without DAOs, communities must rely on the integrity of the control group.
Even when leveraging a community’s assets, a centralized authority (e.g., a fund’s GP) ultimately controls the assets and their deployment.
Instead of trusting an individual or group of people, DAO members rely on software code’s transparent and impartial nature.
Generally, the community of DAO assets is the treasury where the digital assets are stored.
The use and maintenance of the treasury is subject to sophisticated smart contracts that oversee and uphold the direction of the members.
a smart contract is a mechanism involving digital assets and two or more parties, where some or all of the parties put assets in and assets are automatically redistributed among those parties according to a formula based on certain data that is not known at the time the contract is initiated.
Basically, smart contracts are contracts coded into software and stored on a blockchain.
These smart contracts cannot act outside the code’s parameters and protocols.
As a result, DAOs are comprised of smart contracts in which participating members are bound.
These lines of code are the counterparts of conventional corporate governance documents (e.g., charter, bylaws, operating agreement).
However, unlike traditional governance documents, these smart contracts are enforced without human intervention.
DAO smart contracts may include protocols surrounding minimum votes for the approval of a proposal, asset management and distribution, and rules surrounding the expulsion of members.
Like their legal counterparts, once these smart contracts are agreed upon and deployed, modifications require support from at least a majority of stakeholders.
The Role of Governance Tokens
Governance tokens (e.g., NFTs) represent voting power in a DAO.
These tokens are usually distributed in exchange for a stakeholder’s buy-in when joining an organization or through an "airdrop.”
Every aspect of the DAO revolves around these governance tokens.
To reach any decision, a member must submit a proposal.
Stakeholders can voice their opinions on the proposal through their governance tokens.
If the proposal is passed, the proposed plan is implemented.
By leveraging this democratic process powered by a trust-less asset, DAOs can execute the most sophisticated strategies (such as bidding to buy a copy of the U.S. Constitution).
The Implications of DAOs for Venture Capital
One of the most exciting applications of DAOs is venture funding.
Participants can use DAOs as a vehicle to pool funds and invest in promising ventures while ensuring a consensus across all decision-making.
Unlike LPs in a venture fund who are at the mercy of the GP, DAO participants rely on the impartial execution of software code.
The collaborative and open nature of DAOs creates a diverse environment of participants–something lacking in traditional venture capital.
Venture DAOs provide capital to founders and creators who lack the resources or connections to obtain traditional venture funding.
Web3, and the entrepreneurs within this novel technology sector, in particular, are primed for disruption provided by DAOs.
DAO members and web3 creators share a passion for decentralization and innovation.
However, unlike other investors, DAOs have a unique understanding of the intricacies of blockchain and its implications.
Blockchain-powered venture capital is no longer a promising yet distant future—it’s a part of reality for countless founders and investors today, and it’s ripe for exponential growth.
In fact, conventional VCs are taking note and following these organizations’ footsteps by launching venture DAOs.
As we have seen in The DAO Report, however, DAOs and the distribution of governance tokens are subject to securities law.
DAOs are essentially online communities with a shared wallet and decentralized control of decision-making.
These software-powered organizations can unlock a variety of use cases, including corporate coordination and venture funding.
What DAOs offer in innovation comes with a considerable tradeoff in structural guidelines and best practices.
There are no strict definitions of a DAO, and the proper structure can vary wildly from project to project.
With the guidance of experts familiar with the intricacies of both traditional and decentralized finance, founders and funders can prime their ventures for success by embracing these innovative investment vehicles.
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While I am a lawyer who enjoys operating outside the traditional lawyer and law firm “box,” I am not your lawyer. Nothing in this post should be construed as legal advice, nor does it create an attorney-client relationship. The material published above is intended for informational, educational, and entertainment purposes only. Please seek the advice of counsel, and do not apply any of the generalized material above to your individual facts or circumstances without speaking to an attorney.