Thank you to Element5 Digital for the Photo
Forming a DAO in an Evolving Web2/Web3 World
@AlexandraSukin, December 2021
Disclosure: DAO frameworks discussed below not referencing existing DAO communities represent theoretical frameworks for DAO formation. There is a piece by a16z covering potential legal liabilities for DAO members here.
A revolution in business organization, DAOs, or decentralized autonomous organizations, are becoming the structure of choice for many web3 organizations.
What is a DAO? According to Ethereum.org, DAOs are “member-owned communities without centralized leadership.” DAOs operate through blockchain-based governance, meaning decisions made by the community members are implemented on a blockchain. A DAO is founded by an initial group of creators/collaborators who build the smart-contract based application on the blockchain, and make initial determinations about the governance structure and rules of the organization they are creating. Versus traditional corporate entities, DAOs:
1. Work for their community members (those holding tokens that represent rights to governance) rather than their shareholders (holders of public or private equity that represents an ownership percentage of the entity)
2. Enable easier and permissionless entrance and exit for contributors (i.e. exit liquidity is higher)
3. Allow unlimited numbers of members to gain benefits based on the verification of a token/NFT’s existence in their wallet
4. Offer a higher transparency of decision-making due to public governance methods
5. Can offer voting more quickly & often, and implement results of elections immediately or automatically by execution of a smart contract.
Examples of Different types of DAOs? DAOs are being used for a variety of use cases. Below is a short summary of the types of DAOs being created today:
* Creator DAOs: A creator releases an NFT and distributes the ownership through fractionalization to community members, in order to finance the asset’s creation. The new owners can collaborate on future creations, promote the new assets, and create & distribute their own assets. Example: John Palmer crowdfunding a long-form essay by selling NFTs before writing it (here and here).
* Gaming Guilds: Gaming Guild members invest in yield-generating NFT assets in blockchain games. Gaming Guilds are also making investments in the development of blockchain games in exchange for early access to those assets. The most famous, Yield Guild Games, also allows community members to loan assets to use in play-to-earn games. Income generated by players using rented assets is shared between individual players, the DAOs and sometimes the community manager.
* DeFi Protocols: DeFi protocols issue governance tokens that allow for members to vote on decisions like protocol changes and smart contract upgrades. DeFi protocol members are incentivized by the potential financial upside provided by participating in and creating efficient and effective decentralized financial products. (Examples: Synthetix, Index Coop).
* Investment DAOs: Members pool their assets in order to invest in NFTs and other blockchain projects. Examples: PartyBid, SyndicateDAO
* Social DAOs: Social DAOs create communities around verticalized or specific shared interests, and then use tokens to gate access to the community and incentivize participation. Examples: FWB (Friends with Benefits), CabinDAO, Poolsuite.
* Impact DAOs: Impact DAOs are created to allow groups to fundraise for impact-focused causes. Impact DAOs create and release governance tokens as a way to fundraise, and then community holders with governance tokens can influence how funds are used and allocated to causes.
* Media DAOs: Media DAOs are organizations that create and produce content for their own community or to help other DAOs with marketing and branding. A media DAO is focused on, but not limited to, media management, public relations, content generation, advertising strategy, and video production. Examples of media DAOs are Bankless HQ and ForeFront.
This is by no means an exhaustive list. DAOs are constantly emerging to service communities in new and exciting ways. However, all DAOs share some fundamental traits: some of their rules are encoded in smart contracts on the blockchain, community members are able to actively participate in governance, and community members operate from a shared treasury that holds the assets of the DAO.
How are DAOs governed? DAOs are intended to literally decentralize governance across members of the organization by allowing them to vote (through various voting methods from delegation to guilds to quadratic voting) on the future of the organization. This model runs somewhat counter to traditional organizations, where votes about the direction of the entity are sometimes delegated to superiors in a hierarchy. While in some situations shareholders in traditional organizations can vote on company proposals and directly influence decision making and company direction, with DAOs the entire proposal and voting process should be decentralized and voters should be rewarded for their participation.
In a DAO, voting members might have the power to make changes or updates to a project, determine asset allocation, and more. There are two forms of DAO governance: off-chain and on-chain governance.
* Off-chain governance involves coordination and discussion that does not get recorded on the blockchain. Instead, actors must work together (typically in online forums and meetings), to convince one another about the importance of updates, changes, and the general direction of a project. For example, with Ethereum, the core developers of the project determine if node operators and miners are willing to implement a proposed change. However, some changes that are voted on do not involve anything on-chain (for example, UI changes). For DAOs that run smart contracts on Ethereum, off-chain governance results are often implemented by core contributors. Snapshot is the most popular tool for off-chain voting (Snapshot registers the vote on chain, but does the computation off-chain).
* On-chain governance refers to voting that happens literally on-chain. A voter usually needs to hold the DAO’s token to participate in on-chain governance, and the weight of their vote might be based on the number of tokens they hold. An accepted proposal may be executable code that is directly implemented or the execution of a multi-sig transaction.
How do DAOs work in action? An example DAO structure is reflected in the setup of one of the original DeFi DAOs, Compound, (the DeFi protocol):
1. Participants receive a “governance token.” Per the above, a governance token represents a vote in on-chain governance. The typical ratio is one token = one vote.
2. The token is a standard ERC-20 (which is an Ethereum standard for fungible tokens) but also allows the holder to delegate voting rights to another address.
3. Anyone with 1% of the token delegated to their address can propose a governance action, which means changing a parameter or variable of the protocol. These proposals are immediately executable code.
4. Token-holders who hold a certain amount of tokens can submit a proposal.
5. Proposals have a time period before being executed.
How do participants receive their tokens? Mechanisms for token distribution differ based on DAOs. In some cases, tokens are “airdropped” to initial users of a protocol, meaning users automatically receive a certain amount of tokens to reward past or current participation in a network. [a][b][c][d][e][f]In DeFi, yield farming has become a primary token distribution mechanic of choice, because it allows DeFi protocols like Compound to bootstrap tremendous liquidity. What is yield farming? Yield farming describes crypto asset holders providing liquidity to networks (i.e. putting their assets into liquidity pools) in exchange for high yields on their assets as well as tokens like COMP. Users can also buy governance tokens for DAOs on DEXs (Decentralized Exchanges) and CEXs (Centralized Exchanges).
In general, DAOs and DeFi protocols give away tokens to incentivize behaviors that are good for the community. These behaviors include providing liquidity (DeFi), maintaining the protocol (DeFi), and incentivizing adoption and contribution (DAOs generally). (Thanks Zakk)
Example DAO Token Distribution: DeFi
DAO structures are hailed for their ability to enable more decentralized organizations versus traditional corporate entities. In the Compound example [also used by Underscore.vc[g][h] as an example here and discussed by a16z here], the Compound community shares responsibility for the ongoing management of the protocol. Because participants benefit from participating in the Compound network, community members who hold governance tokens are (in theory) highly incentivized to act in the best interest of the protocol.
However, the creators of a DAO control the initial token distribution. In Compound’s case, upon release of the new decentralized governance structure, tokens were distributed in the following manner:
Percent of Total
Shareholders of Compound Labs, Inc. (Created the protocol)
Founders & team, subject to 4-year vesting
Future Team Members
Reserved for Users of the Protocol
Reserved for the community to advance governance through other means
Sold or Retained by Compound Labs Inc.
Link to Sheet Here.
As per the Token Distribution Table above, Compound split governance tokens essentially 50/50; 50% among the creators and shareholders of the protocol as well as founders and current team members, and 50% reserved for future employees, user