The new paper of Trakx on digital assets and ESG objectives is focused on the governance component. Here, the firm is exploring how the DAO concept attached to some protocols is bringing positive changes to the governance usage.
For some, Bitcoin is the earliest example of DAO as the network functions via community agreement even if it doesn’t have an organised governance mechanism. But DAO was officially made public in May 2016 on the Ethereum blockchain and stands for Decentralised Autonomous Organisation:
- Decentralised refers to the fact that no single entity nor any directory board intervenes in the decision making. Users organise and oversee themselves.
- Autonomous means that the smart contracts self-persevere without outside influence.
- Organisation refers to the group of people taking part in the project.
The smart contract is the foundation of DAO
A smart contract is an automated self-enforcing contract that can be seen as a line of code executed once certain conditions are met (if/then). DAO regulations and organisation rules are ingrained in the smart contract. No changes can be made to the rules once the contract is published on Ethereum. However, a voting system can be used to approve any changes. If any member does something that is not under the logic and rules of the created code, the action will cease to function. The DAO group decides rulings altogether without a central authority, and donations are granted automatically when votes are passed. The code of the DAO is open-source, developed in a decentralised and collaborative manner.
DAOs allow efficient governance mechanisms
Membership in a DAO can be extremely fluid compared to what traditional organisations can achieve, and DAOs have been used to manage assets, build protocols, vote on community matters, and create niche factions for interests like digital art collecting. Participation in a DAO usually goes through the ownership of a token. The DAO model enables the creation of more efficient systems by reducing the need for human inputs, which in turn reduces the overall operational costs and the risks related to human behaviour.
But they aren’t perfect.
Some limits to DAOs are to which extent they are completely decentralised. Assessing the voting turnout and voting power of a project is essential to get a sense of the community’s engagement and ability to drive the project.
In the voting turnout, often the number of votes is below the average participation of shareholder voting of publicly listed companies. But the comparison is not entirely fair as equity shareholder meetings happen only once a year while the proposals are more numerous and of strategic nature. Often voters tend to agree with each other but again it can be mitigated by the fact that proposals are typically discussed in a forum before a vote is held. This reduces the likelihood of a divided voting outcome.
The voting power is the distribution of votes among the community which can sometimes reflect a concentration of decision makers, in opposition with the idea of decentralisation.
Other typical governing risks to look at are:
- Censorship of transactions
- Accidental “forking” of the network or critical network stoppage
- Risks from the majority (mob) as much as from the minority (oligarchy)
The DAO hack in 2016 also raised security concerns and many lessons were learnt from vulnerabilities in the codebase. As a quick reminder, the DAO was launched in April 2016 on the then one-year-old Ethereum network but experienced a significant blow when an attacker took advantage of a bug and siphoned over $60 million worth of ETH from The DAO’s wallet.
DAOs use cases are expanding outside the crypto sector
Some noteworthy use cases where the DAO model are useful include automated fundraising campaigns (such as ICOs), the issuance of digital tokens and tokenization of assets, as well as decision-making and proposal voting systems.
Initially adopted by the digital assets sector, DAOs are now more widely used, even in traditional finance where there is a movement towards more distributed and democratic governance as illustrated by Blackrock’s initiative. BlackRock recently announced its intention to give investors voting powers in underlying companies. The decision was made in response to an increasing number of clients demanding more say in the direction of the companies they are passively invested in, especially when it comes to ESG and climate metrics. It will come into effect in January 2022.
In charities, the use of DAO allows approval of membership and contributions from people around the world, and the respective organisation can decide on how they can spend these donations. For example, in Finland, Pawthereum, sends a percentage of every transaction automatically to a charity crypto-wallet and donations to specific animal shelters will be voted on by Pawthereum token owners. This community-run charity cryptocurrency project was fully launched on the Ethereum blockchain last October.
In market places, a DAO can allow for the creation of a network of contractors who are willing to combine their funds for office areas and software subscriptions. Online communities are taking ownership of what they want to share.
DAOs are emerging as a new model of community governance
We are observing a move from a sharing economy to an ownership economy where individual users not only built, operated and funded a community but owned it. DAOs have the potential to disrupt the online communities and to become mainstream in the next couple of years.