A Decentralized Autonomous Organization (DAO) is an organizational architecture composed of smart contracts.
DAO is the application of blockchain to the fundamentals of what it means to be an “organization.” Blockchain is a technology that decentralizes ownership and control in a network. You can think of a DAO as the application of this concept to organizational form. Just as Bitcoin uses blockchain to verify transactions, a DAO uses blockchain to run an organization. Just as mining is the process of decision-making for updates to the Bitcoin ledger, a DAO uses blockchain consensus mechanisms for all forms of decision-making.
The autonomous in decentralized autonomous organization relates to the use of smart contracts. This is why DAOs are built primarily on the Ethereum blockchain rather than other blockchains like Bitcoin that do not allow smart contracts. A smart contract is a set of code with defined inputs and outputs that acts like a set of rules for a process. We typically think of smart contracts as being applied to transactions, but a DAO is an organizational entity built on smart contracts. This is why DAOs are organizations runs by computer code rather than human institutions.
A DAO has no centralized leadership. This is one of the fundamental characteristics of a fully decentralized blockchain and, in this way, it is being applied to the organization. Bitcoin does not rely on governments or banks as trusted third parties, which means that there are no centralized organizations running the Bitcoin network. Similarly, a DAO is an organization without a centralized point of leadership. There is no board of directors who have authority to make decisions for the organization.
The idea of a decentralized organization might seem quite unfamiliar, but one could view DAOs as the evolution of existing organizational forms, like democracies and corporations.
Democracies are a decentralized form of political organization. Rather than relying on a centralized king or dictator for ultimate decision-making, democracies use a voting mechanism. Political offices like president and congressperson are intended to function as a representation of the underlying will of the people. Therefore, government institutions in a democracy function as decentralized organizations built on voting. The disconnect is in the periods between voting when these institutions function more as a delegated authority. Even in democracies, government institutions are given power by the people, which results in a form of centralization.
Corporations are a decentralized form of economic organization. The most basic organizational form for a provider of goods and services is the sole proprietor. This is equivalent to complete centralization, because there is only one person involved. The sole proprietor, or solo entrepreneur, makes all of the decisions about the business. There is no need to coordinate with any other people. A family-owned business is a slight extension of this case. The family runs the business and must coordinate interests among the family members who are co-owners of the business. Beyond this are startups or small businesses that have a small number of investors whose interests must be incorporated into the decision making. The most dramatic form of decentralization in economic form is the corporation, because it can fully decentralize the ownership structure of an economic entity. Consider a publicly-traded company in a large financial market. This entity can be owned by thousands of shareholders who ultimately possess the authority to run the company through their voting authority. At a shareholder meeting, the shareholders elect the board of directors who then hire and fire the management team. Just like democracy, the shareholder authority is delegated at some point in the process, but the underlying voting authority is decentralized.
One could argue that DAOs are an evolution of this gradual decentralization of organizational form. The key innovation is that there is no delegation of authority at a later stage in the process. Unlike a democracy or a corporation, there is no representative body that oversees the organization on behalf of the underlying voting network. Every decision is decentralized.
Governance is a key term to understand in the context of DAOs. Governance is the mechanism by which organizations make decisions. Therefore, DAOs all use some form of decentralized voting mechanism as the basis for governance.
Most DAOs use a token as the mechanism for identifying participation in a network and the authority to vote on organizational decisions. For instance, Dai is a stablecoin managed by MakerDAO. MakerDAO is a DAO composed of owners of its governance token, MKR. Owners of MKR vote on changes to parameters of the smart contracts to ensure the stability of Dai.
Tokens associated with DAOs function both as an investment and as a voting mechanism. In this way, they are similar to shares in a corporation. The value of the token can increase just like the share in a company. The token can be used for voting just like a shareholder can vote at a shareholders meeting. As already mentioned, the key distinction between DAOs and corporations is the fully non-delegated decentralized authority. This makes the tokens in the DAO even more essential to the governance of the organization. As an organization grows in its value to its participants, the value of the governance token will increase. This is why DAO tokens offer an investment opportunity to those who believe in the future potential of a DAO.