What is a DAO?

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what is a DAO

If you’re a business owner, think back to when you were learning different business types. Limited liability company (LLC), corporation, sole proprietorship, and others all came up, right?

What about a decentralized autonomous organization (DAO)?

The term sounds like something out of a science fiction movie, but DAOs can be a safe and effective method to work with like-minded people around the world. Let’s take a look at what DAOs are.

DAO Meaning

DAOs work in a very unique way, and explaining their structure involves a lot of technical jargon. But bear with us as we’ll try to simplify this information.

How a DAO Works

A DAO is an organization whose rules are encoded as a transparent computer program. The DAO’s members control this code and outside parties can’t influence it.

Since the organization’s rules are in this code, the DAO doesn’t need a managerial structure. It can operate free of any hurdles caused by a hierarchy and/or bureaucracy.

Blockchains and Smart Contracts

The organization’s finances and rules are recorded using a blockchain. According to Investopedia.com, “As a database, a blockchain stores information electronically in digital format.” Using a blockchain can get rid of the need for an outside party in financial transactions.

Instead, transactions are simplified through “smart contracts,” which a DAO heavily relies on. These contracts are self-executing and contain important information, like agreements between buyers and sellers, written as lines of code.

Transparent Rules

A DAO’s rules can’t be changed without anyone noticing since these organizations are transparent and public.

Taxes

How is a DAO taxed? This is a topic that’s in a very grey area right now. The IRS has no rules about taxing DAOs. As of February 2022, if you go to the agency’s website and search for DAOs, you’ll get no results.

As DAOs lack a form of centralized authority, they can’t file taxes like other business types. Another concern is if they’ll face taxes as foreign corporations if any of its members are outside of the U.S.

There’s speculation that these organizations can be taxed as “pass-through” entities like LLCs. Seek the help of a licensed professional for more information about DAO-related taxes.

Advantages of a DAO

If a DAO sounds like something you want to avoid due to its complexity, here are some advantages to consider.

Democratized Organization

Compared to traditional business structures, DAOs focus on democratized organization. Each member needs to vote for changes to the organization. There’s not a single person responsible for changes.

Funding

A DAO’s funding focuses mainly on crowdfunding through tokens (a form of cryptocurrency). People interested in participating in a DAO will need to buy said DAO’s native token. These people get voting rights that are proportional to their holdings. They can also hold equity in the DAO.

Governance and Operational Structure

Executives, investors, board directors, etc. run traditional companies, but a DAO relies on community. The organization’s operations are also global and transparent. A traditional company’s operations tend to be private and domestic.

Addressing the Principal-Agent Dilemma

DAOs address a major challenge in most industries and organizations: the principal-agent dilemma.

Many business structures allow a specific individual or entity (an agent) to decide or take action on behalf of other individuals or entities (the principal).

This can pose a risk to the principal since a motivation may exist for the agent to act in its own self-interest. DAOs eliminate this concern since it lacks a central authority.

Disadvantages of a DAO

Like all business models, DAOs can have disadvantages. One is what happened to the very first DAO, which we’ll discuss later. Here are a coupe of others.

DAO’s lack “legal personhood.” A legal person is an entity (human or non-human) that, for limited legal purposes, is treated as a person. Legal persons can enter into contracts, be sued, and own property. Lacking legal personhood can place the DAO into a tricky, legal situation.

There is Still a lot to Learn About Them

One thing to keep in mind is that DAOs are a new concept. There is still a lot to learn to properly use them, which can take time.

Why Form a DAO?

DAOs offer many benefits, most of which we’ve already gone over. The one that stands out the most is how DAOs allow large groups of like-minded people (a business, fund, or non-profit) to operate how they want.

They can do this without having to worry about an overarching authority figure. This allows equal members to self-govern the organization with full transparency. If you’re ready to form your DAO, use our step-by-step guide to create your own DAO.

Types of DAOs

As with other business types, there are many DAO types. A few include:

Note that this is not a closed list.

Additional DAO Information

One thing many people wonder about DAOs is which types of tokens can establish one.

Types of Tokens

There are countless DAO tokens on the market, each differing in value. As of the this article’s publishing, a few of the most popular/valuable DAO tokens include:

History: What was The DAO?

This unique model started with the very first DAO entity.

In April 2016, a few Ethereum community members created “The DAO.” It was also known as Genesis DAO. It started as a smart contract on the Ethereum blockchain.

The organization was a form of venture capital fund and was based on open-source code that lacked a traditional business management structure.

During its creation period, people sent Ether (a form of cryptocurrency or crypto token), to a unique wallet address. In exchange, these people received DAO tokens on a 1 to 100 scale. In total, 12.7 million Ether was gathered during the creation period, about 150 million USD at the time.

The Fall of The DAO

Things changed in June 2016 when users discovered and exploited a vulnerability in The DAO’s code. The exploit allowed them to siphon one-third of the organization’s funds into a subsidiary account.

After a series of drawbacks over the course of the next few months, which included the Ethereum blockchain being split into two branches, The DAO was delisted from cryptocurrency exchanges, rendering it defunct.

Despite what happened to the first DAO, the model itself has received a warm reception.

Summary

A DAO is a very exciting and interesting model that’s growing in popularity each year. Although not as popular as most business types, DAOs may join the party soon. Hopefully, the information in this article has given a you a solid idea if a DAO model is right for you. If you’re ready to make your DAO an official business, create an LLC for it today.

We Can Help

We offer several services for business formation. This includes starting an LLC or corporation, reserving a business name, and securing an employer identification number (EIN). Take a look at what we can do and what we’ve done to help countless entrepreneurs start their dream business. Get started today!

DAO FAQs

  • How are DAOs being used today?

    DAOs are essentially a “bottom-up” model where the organization’s decisions are made by members rather than executives and other higher-ups.

    Today, they appeal to people who want to eliminate the hierarchy seen in most business types.

    And with many opportunities available to participate in a DAO through token ownership, they’re growing in popularity.

  • Do we need DAOs? 

    Since DAOs are internet-native, they offer many advantages in the digital age. Trust among owners is one of the many things traditional business models need in order to grow.

    DAOs eliminate that need thanks to its code. Said code is 100% verifiable by anyone and transparent, making it easier to work with others.

  • Can you create your own DAO?

    Yes, you can form your own DAO.

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