Do DAOs Make Sense in The Long Term?
As with many existential conundrums, the short answer is: it depends. What is the goal of the DAO? What’s your vision for what you’ll add to the Web3 ecosystem? What are you using it for? Do you have a specific task or problem to solve? The answers to these questions will determine the long-term viability of the DAO.
As much as DAOs are being hyped up as a paradigm shift in how organizations operate, and have many positive attributes regarding autonomy, privacy, and decentralization, there’s one thing that they are not. They are not here to replace corporations.
DAOs and Corporations
Earlier this year, Vitalik Buterin shared a blog about corporate governance and what, if anything, should DAOs learn and adopt from that model. Ultimately, he writes, there are benefits to how a corporation runs, and knowledge to be gained from decades of experience. But that specific model shouldn’t be used for DAOs. DAOs are more akin to a government or a monarchy, offering currency and arbitration, and most don’t exist for profit maximization. While a functional government includes a leader, like a President, King or Prime Minister, they also rely on a supreme court or a parliament/congress to make decisions.
The difference between this sovereign organization and a corporate organization is that the decisions of a government should serve their constitution (a contract) and the people they represent (the community). A corporation, on the other hand, serves to maximize profits for shareholders primarily, with the potential impact on consumers a secondary consideration. As with most economies across the world, however, corporations and governments can function side-by-side.
But, he points out, there is a change in how we construct and view DAOs that are needed, in order to survive optimally.
4 Challenges Facing DAOs
Despite everything that DAOs get right, and the potential that they possess, there are a few hurdles to get over before anyone can definitively say that DAOs aren’t going anywhere.
1. Governance by the People
One of the biggest challenges facing DAOs is that of governance. Because DAOs are decentralized and autonomous, they can be very difficult to manage and control. There is no board or C-level executive to run the show.
Decentralized governance in DAOs is primarily based on the possession of DAO tokens. While the intent is to offer accessibility and democracy, investors and other members of the DAO can accumulate major shares of tokens, thus giving them more control and concentrating the voting power to those that can “pay to play.” This can lead to problems with decision-making, as well as with accountability, not to mention if a malicious actor gets the majority of tokens and hijacks the DAO.
In cases such as this, DAOs don’t really do away with the hierarchy and centralized control by the few completely.
2. Timely Transactions
The fact that DAOs are community-based is one of the positive features of the structure. But that does lead to issues with scalability, transaction delays, and decision-making, especially in an emergency situation.
Considering that no changes can be made in a DAO without the voting mechanism, decision making takes time. If a DAO needed to modify a piece of code in their smart contract due to a security issue, for example, they’re left stranded and vulnerable until consensus is reached. This becomes more problematic when DAOs have a growing user base.
Unless someone is given temporary emergency powers in a crisis, the organization will lose time waiting. But, emergency powers didn’t work so well for the ancient Romans, when they elected a dictator for a temporary crisis. Or akin to a President entering the codes into the nuclear football in a panic. In either case, it’s a bad idea to give one person that much power, and it completely negates the principle of the DAO.
3. Deregulated Civilization
This is an attractive feature of DAOs as it takes away authority from third parties, and keeps it with the users, but it’s also a huge disadvantage. Due to lack of rules and regulations regarding taxation and management, a DAO is a regulatory nightmare. This keeps DAOs and the blockchain from going completely mainstream. It’s easier to exist as a corporation, then as a DAO.
Furthermore, the decentralization and voting protocols take away accountability. There’s no single entity responsible for all the decisions of the organization. Therefore, it’s difficult to even consider how to regulate a DAO internally. Not to mention how the Web2 world regards cryptocurrencies and other decentralized assets.
Finally, as much as DAOs are about autonomy and minimal interference from regulation, governments, and so on, you can’t ignore the fact that we need rules. Laws were created to protect the people. If there is no regulation about which side of the road we drive on, for example - imagine the outcome.
4. Vulnerability to Bad Actors
Finally, DAOs also face the risk of fraud and theft. Many DAOs think that the smart contract is immutable and the code will take care of everything. This is how the DAO environment can remain trustless; by relying on the authenticity and validity of their smart contract. Every code, however, is vulnerable. We can look at the examples of the recent Transit Swap hack due to a code bug, or the original The DAO hack. It came down to the code within the smart contract.
Because DAOs often handle large sums of money, they can be attractive targets for criminals. This can put DAO members at risk of losing their investments, and it can also damage the reputation of DAOs in general.
Since there’s no way to reverse a fraudulent transaction, both the nature of the blockchain and the lack of regulation, limits the amount of actions that can be taken against a fraudster. In some cases, the perpetrator can be tracked down, but you can’t force them to give the money back, and no laws were ‘technically’ broken, because there is no criminal code of Web3.
The Mango Markets Hack
A perfect way to sum up the points above is with the example of Solana’s recent Mango Markets hack. During the attack, the hacker stole 99% of the tokens from the Mango DAO and then submitted a proposal to absolve himself and protect himself against lawsuits or any attempts to recover the money. He then approved the absolution proposal using the 99% tokens to get his majority vote. While on one hand, an argument can be made that the concept of DAOs is fragile, a contrary argument can also be made that corporations have had decades to perfect their ecosystem. DAOs are still getting there.
This doesn’t mean that DAOs don’t have a place in the future. They absolutely do.
A Companion to Corporations
While DAOs are a great exercise allowing us to re-discover what democracy is, and how hard it is to make it work, there is the question of whether they will survive over the long term. The answer is yes. Much like how governments and sovereign rulers are still around, despite their imperfections, DAOs can also thrive alongside corporations.
Going back to Vitalik’s piece, DAOs aren’t meant to emulate corporations, or even function as they do. Nor will DAOs take the main stage. They’re meant to improve corporations and bring back their original promise.
DAOs are a great component to integrate into Corporate structures, as a way to re-introduce the concept of social contracts with corporations. It used to be that people would join a company, work there their whole life, get benefits beyond just salary for being part of the group, and then retire comfortably. But the company's social contract disappeared, because of cost cutting and maximization of profits (the grind culture of the 80s favoring big profit making companies rather than great companies). Now with DAOs, all stakeholders can have a voice in the process, and there is an opportunity to go back to a more balanced relationship for everyone involved.
In fact, there are already several pioneers who have already implemented ways to run a company like a democracy. Ricardo Semler and Semco Partners, for example, have revolutionized industrial democracy and corporate restructuring by decentralizing leadership and offering a better work-life balance. Now technology like DAOs can help bring these concepts to a larger audience of corporations.
Are DAOs Here to Stay?
Yes. DAOs, as a non-corporate, decentralized organization are here to stay.
We’re still in the early stages in the evolution of DAOs, but there is no doubt that the common issues that are identified in DAOs will be addressed and solved, thus preparing them for a long-term tenure.
There really is a need for only a handful of truly decentralized DAOs, according to Vitalik; entities that offer a more complicated solution to look beyond shareholder profits and ensure the funds are being used for the intended purpose. The remainder may need to re-address the structure of the DAO, and elect a leader or figurehead for the DAO as a form of governance for agility and adaptability.
DAOs have huge momentum in the Web3 ecosystem and there’s no doubt that improvements in the design and concept of DAOs are just over the horizon.