DAOs: Governance in the Blockchain Era

Abstract

Blockchain technology promises to revolutionize not only the way we transact among peers but also the way we organize to create socio-economic value. Decentralized autonomous organizations (DAOs) are governed and owned by the community whose members follow a set of blockchain-embedded governance rules that define and control participation. In this chapter, we will clarify what governance decentralization and automation mean, examining DAOs’ distinguishing characteristics. We will also discuss the problems that DAOs solve (e.g., lack of extrinsic incentives, censorship, mismanagement and lack of transparency and accountability), as well as the problems they face (e.g., lack of participation, rigidity, voting misbehaviours and legal status).

1. Introduction

The rise of Bitcoin and blockchain brought new organizational forms called decentralized autonomous organizations (DAOs) that are blockchain-based organizations, owned and governed by members [1, 2, 3]. DAOs push forward the blockchain ideals of decentralization, inclusion and transparency, enabling the communities to own and govern cryptocurrency projects. In DAOs, the community not only owns the organizations but also can propose and vote, having a saying regarding the future of the organization. Therefore, DAOs are distributed instead of hierarchical, power is decentralized instead of centralized and management is autonomous and community-based instead of bureaucratic [2, 3]. DAOs are, thus, an alternative governance form to traditional bureaucratic and hierarchical management models, being a natural governance choice among cryptocurrencies.

One of the first examples of a DAO was Bitcoin itself. Created in 2009, Bitcoin is a cryptocurrency designed to allow people to securely transact and exchange value at a global scale without the need for costly intermediaries [4]. With the purpose to create an independent financial system, Bitcoin is sustained by a community able to validate transactions (miners) and co-create code updates (developers), which translates into new functions and participation rules without the interference or orchestration of a central sponsor. Later on, in 2016, born the first assumed decentralized autonomous organization called the DAO. The DAO raised 150 million dollars in a short period of time, making it the world’s largest crowdfunding project at that time. Despite that the DAO project suffered a massive attack due to security breaches, its governance model came to stay and prosper and thousands of DAOs have been emerging in different areas as decentralized finance (e.g., Uniswap), media (e.g., Global Coin Research and Forefront), gaming (e.g., Decentraland), art and culture (e.g., SuperRare and Rarible) and investment funds (e.g., BitDAO and MetaCartel), among others. While the DAO is a governance model that highly celebrated among cryptocurrency projects, very little is known about its characteristics, as well as the problems they solve (i.e., lack of extrinsic incentives, censorship, mismanagement and lack of transparency and accountability) and face (i.e., lack of participation, rigidity, voting misbehaviours and legal status).

2. Definition and characteristics of DAOs

DAOs are blockchain-based organizations, owned and governed by members. DAOs follow a set of self-executing governance rules that are embedded into a blockchain that run without the interference of a central authority (see Table 1 for a summary) [1, 2, 3].

Blockchain-based	DAOs run on a blockchain infrastructure that allows autonomy and decentralization.
Self-executing rules	DAOs embed a set of self-executing governance rules that are turned into computer code.
Community-owned and governed	Community members own the organization through token holding and govern the organization through proposals and voting systems.

Table 1.

Characteristics of DAOs.

DAOs are blockchain-based organizations. Blockchain is a distributed ledger technology (DLT), which translates into a public database, where information is written in “blocks” cryptographically linked to the previous blocks, forming a chain of blocks [4]. Blockchain technical features, as distributed data storage, timestamp, consensus algorithm and asymmetric encryption, allow for decentralization, immutability and auditability [5]. The blockchain is, thus, the infrastructure that enables DAOs to be decentralized and autonomous, also ensuring the security requirements and ownership authentication that DAOs require to function [2, 3]. It is important to mention that not all blockchain-based organizations (e.g., DApps and platforms) are DAOs. Indeed, there are several blockchain-based organizations that display a centralized governance system, being owned and governed by private investors, founders, developers’ teams or even by a restricted permissioned group. Nevertheless, all DAOs are blockchain-based organizations as blockchain technology is the foundation of their decentralized and autonomous governance form.

DAOs embed a set of self-executing governance rules that are turned into computer code that is embedded on the blockchain [2, 3]. Such governance rules define participation terms, voting and proposing systems as well as rewards and penalties terms. All these rules are open and transparent to all participants. By interacting with this self-executing code, participants can submit proposals that may comprise changes to the functioning of the organization, amends to the governance system or suggestions for future projects. In some DAOs, such proposals go directly for community voting (e.g., community proposal); however, in others, there are a couple of additional steps before a proposal reaches the wider community for voting (e.g., stage proposals and represented team proposals). Once the proposals are up to vote, community members can use their governance tokens to vote on the proposals. There is also a variety of voting systems, such as one person one vote, quadratic voting, weighted votes, holographic consensus, futarchy and liquid democracy, among others. After the voting process finishes, the proposals are implemented according to the parameters defined by the community. In some cases, the execution is automatic or direct (e.g., when the proposal is a code alteration that includes the code) or it might require that developers build the code to implement, leading to a delayed implementation.

DAOs are owned and governed by people without the interference of a central authority. Community members own the organization through token holding and govern the organization through proposals and voting systems that are embedded into the blockchain. Blockchain and smart contracts technologies allow DAOs to operate autonomously without centralized control or third-party intervention [2, 3]. Instead, DAOs run under the regulation rules and collaboration patterns defined by all the stakeholders. The DAO’s goal is achieved through bottom-up interaction, coordination and cooperation among members, following the principles of equality, voluntariness, reciprocity and mutual benefit [2, 3].

3. The problems that DAOs solve

3.1 Lack of extrinsic incentives

DAOs resemble online and open-source communities, with the difference that DAOs enact both intrinsic (e.g., self-satisfaction, values and beliefs fulfillment, intellectual stimulation, learning and making a positive difference) [6, 7] and extrinsic benefits (e.g., monetary rewards) such as tokens that can be converted into other cryptocurrencies or fiat currencies [8, 9]. DAOs enact intrinsic motivation as members feel a sense of ownership and excitement to contribute to new projects, but they also guarantee that members have extrinsic benefits through financial rewards for their participation. Members of DAOs have an active stake through holding tokens in the organization, and they can exert that stake, having a word to say and influencing the future of the organization through proposals submission and voting schemes. DAOs solve the problem of a lack of hard incentives shared by open-source software communities and other types of online communities because DAOs are able to offer extrinsic incentives through tokenized business models. The broader nature of DAO incentives that cover both intrinsic and extrinsic rewards allows them to attract and maintain large, engaged communities (see Table 2 for a summary).

Lack of extrinsic incentives	DAO incentives comprise intrinsic and extrinsic rewards allowing them to attract and maintain large, engaged communities.
Censorship	DAOs are censorship resistant as they cannot be shut down by anyone and no one can be censored or expelled from the community
Mismanagement	DAOs’ smart contracts enable automated and decentralized decision-making, leading to reduce mismanagement risks.
Lack of transparency and accountability	DAOs’ transactions, proposals, votes and even voter collusions are transparent, ensuring that members are accountable for their actions.

Table 2.

Summary of the problems that DAOs solve.

3.2 Censorship

DAOs solve the problem of censorship, a widely discussed issue in nowadays societies. DAOs are censorship resistant as they cannot be shut down by anyone and no one can be censored or expelled from the community. In the limit, even the DAOs’ creators cannot plug off the DAO until community of governance token holders approve the shutdown through voting. Nobody can impose their will on a DAO or DAO members regardless of their position or authority. Once members activate the smart contract by meeting some conditions [10] that are predetermined, the transactions are registered in the blockchain without (or with little) human interference and the transaction is registered in the blockchain, being immutable.

3.3 Mismanagement

Bureaucratic organizations and corporations often face mismanagement problems, in which top-down, hierarchical structures are led by managers that often put their selfish interests in front of the organizations’ interests. DAOs avoid mismanagement in two ways. First, operations are autonomously carried by smart contracts without (or with little) human interference, being transparent, auditable and equitable. Second, the DAO operates without the need to have faith on influential individuals of the boardrooms of directors that centralize the decision-making. Instead, the DAO is controlled by the token holders, who can submit proposals for improvement or protocol changes, see each other proposals, and vote on those proposals, defining the future and the success of the organization. DAOs’ smart contracts enable automated and decentralized decision-making, leading to reduce mismanagement risks.

3.4 Lack of transparency and accountability

Lack of transparency and accountability are among the biggest issues of our times. From the government to the banking system to big tech corporations, increasing concerns emerge about how governments and corporations are run, how our data and money are being held and used for and, equally important, who is accountable. DAOs’ transparency allows for the accountability of every member of the organization. Accountability and transparency are values infused in blockchain technology that are at the very heart of DAOs. Every activity translates into an immutable transaction registered in the blockchain, meaning that it cannot be erased or reversed. In the same fashion, proposals, votes and even voters’ collusions are publicly available, ensuring that members are accountable for their actions.

4. The problems that DAOs face

4.1 Lack of participation

While some DAOs display highly engaged communities that often participate in the proposals and voting processes, some face some lack of participation. As vote rights are optional and communities tend to be big, members often think that someone else will make proposals and vote on them, which may translate in low levels of participation [11]. Additionally, sometimes making proposals and voting involves time and effort, which discourages members that often participate in many DAOs simultaneously [12]. For these reasons, sometimes the promise of decentralization is not achieved, and most decisions are taken by a small group of members, resembling centralized organizations (see Table 3 for a summary).

Lack of participation	In DAOs, voting is optional, which may lead to community members’ inertia and lack of participation.
Rigidity	Proposal and voting systems are time-consuming, which can compromise the project’s ability to change, adapt or innovate.
Voting misbehaviours	Voting systems can promote power concentration, bribery and collusive behaviors.
Lack of legal status	The absence of a legal framework can promote malicious acts and attacks

Table 3.

Summary of the problems that DAOs face.

4.2 Rigidity

While DAOs promise to be decentralized, transparent and auditable, such values come at the cost of rigidity. Usually, the protocol and the smart contracts are developed by a creator or a team that launch the project. From the moment that the DAO is active and the governance tokens are distributed across members, the future of the DAO is in the community hands. However, any changes proposed will require a series of activities that encompass a proposal process (that can involve several rounds and checks), voting mechanisms and subsequent implementation. Such a process is time-consuming, which can compromises the project ability to change, adapt or innovate, limiting its growth. Additionally, changing and amending smart contracts increase the likelihood of errors and bugs; therefore, DAOs face a trade-off between flexibility and security [13].

4.3 Voting misbehaviours

The majority of DAOs base their voting rights on governance token that represents ownership, resembling companies’ shares. Depending on the voting system adopted by the DAO, it can promote or mitigate power concentration, bribery and collusive behaviors. Some DAOs have employed methods to avoid voting misbehaviours, such as defining shorter/longer periods for voting, limiting/increasing the number of tokens available, controlling voting power, establishing voting thresholds to approve proposals, communicating with all the participants and proposing consensus adaptations. Moreover, the unbalanced power voting can be produced by the technical knowledge required in some decisions giving more opportunities for deciding to developers [13]. Despite all mechanisms employed to avoid voting power asymmetries, it is impossible for DAOs to guarantee that decision-making is not affected by voting misbehaviours [11].

4.4 Lack of legal status

Since DAOs are borderless, it is difficult to define what type of organization they are [2, 3], which codes or regulations their member should follow [14] and which regulations for taxation and management they obey to. Owing to the lack of regulations, it is difficult to determine who will be responsible for liabilities, damage or failures. The absence of a legal framework can promote malicious acts and attacks. Even if the approval relies on voters, there are no clear rules or consequences that protect the ownership and the community from damage.

5. Conclusion

DAOs are owned and governed by people, democratizing ownership and decision-making in the organizational arena. While DAOs bring the promise of transparency, accountability and decentralization, they also face some growing issues that become more evident as new projects emerge and scale. The ability of DAOs to overcome problems, such as lack of participation, rigidity and voting misbehaviours, will determine the future of this new governance form.

While decentralized and autonomous governance modes are increasingly gaining popularity inside and outside the Web 3.0 space, their theoretical and practical implications remain understudied. What are the boundary conditions that enable or prevent the adoption of decentralized autonomous governance modes? How do DApps attract and retain community members to participate in governance decisions? What can other organizations outside the Web 3.0 realm learn from DAOs?