In this article, I will explain what DAO is, how it works, what the principal-agent dilemma is and how DAOs solve it, plus what it takes to get a DAO membership.
What Is DAO?
A decentralized autonomous organization (DAO) is a blockchain-based system that lets people coordinate and govern themselves while being mediated by a series of self-executing rules deployed on a public blockchain with decentralized governance, meaning independent from central control.
Decentralized refers to the fact that there isn’t any need for central government intervention. Autonomous is about the amplification of smart contracts and encoded transactions on the blockchain.
How Does DAO Work?
Probably the most important feature of DAO is the smart contract. The contract is the one that establishes the rules of the organisation, and it is also responsible for holding the group’s treasury.
After the contract has gone live on Ethereum, its rules can only be changed following a vote. If someone tries to do something that doesn’t follow the rules or logic of the code, it will simply fail. Since the treasury is also defined by the smart contract, this means that the money can not be spent without having the approval of the group.
This translates into DAO not needing a central authority as it relies on the group to make a collective decision while payments are authorized automatically when votes pass.
All of this is possible thanks to the fact that smart contracts are tamper-proof once they are live on the Ethereum network. The DAO rules prohibit edits to the code without being caught as everything is public.
The Principal-Agent Dilemma
Maybe the most important advantage of DAO is that it solves the principal-agent dilemma.
When a system has a structure that may allow an entity (the “agent”) to make decisions or take actions in the name of another entity (the “principal”), there is intrinsic risk in the divergent goals, priorities, or access to important information of the respective parties.
This represents the principal-agent dilemma, and it refers to the fact that the agent could act in its own self-interest, despite the fact that the agent was picked to make decisions on behalf of the interests of the principal.
Since DAO doesn’t allow changes to be made without a vote, such an issue can not exist – save for extreme cases of hacking, which are extremely rare.
How To Get A DAO Membership?
There are two ways to get a DAO membership. Membership is able to determine how voting works and other important parts of the DAO.
The first one is the token-based membership. This one is usually completely permissionless. These tokens can be traded on a decentralized exchange. Others can be earned through providing liquidity or other types of proof of work. Basically, holding a token offers the right to vote.
This option is usually utilized in governing broad decentralized protocols or even tokens themselves. MakerDAO would be a good example of this. Its token, MRK, can be found on different decentralized exchanges, which means that anybody can influence the future of the protocol by acquiring the token.
The second one is the share-based membership. This one is more permissioned but remains quite open. A prospective member has the option of submitting a proposal in order to join the DAO, usually offering some tokens as tribute. Shares mean direct voting power and ownership.
This type is more common in closer-knit, human-centric organizations, such as investment clubs or charities. It can also govern protocols and tokens. A good example would be MolochDAO which is focused on funding Ethereum projects. It asks for a proposal for membership so that the group can evaluate if said person has the needed capital and expertise in order to make the right decisions for the protocol.
DAO permits entities to govern themselves by relying on the power of voting without any outside interference. It serves as proof that centralized governance is not always needed. DAOs solve the principal-agent dilemma by their very nature, and getting a DAO membership can be fairly easy.