In the News and Trending: Decentralized Autonomous Organizations (DAOs): What Are They and Why Are They Potentially Changing the Way Businesses Are Governed?

“In the News and Trending” includes the perspectives of accomplished Whitman professors on timely issues impacting business. Stated wording and opinions are those of the author. 

Cristiano Bellavitis is an assistant professor of entrepreneurship at the Whitman School. He is also an editor of Entrepreneurship Theory and Practice and co-editor of Venture Capital: An International Journal of Entrepreneurial Finance. His research focuses on entrepreneurial finance, more precisely venture capital, initial coin offerings and blockchain. 

Since the rise of blockchain technology and the use of smart contracts, there has been movement around decentralization and disintermediation of organizations that have grown out of blockchain technology and use this as their platform. One of these new models of organizations is the recent rise of decentralized autonomous organizations (called DAOs.) DAOs have exploded in number and value since 2019. And for good reason, since these organizations can potentially reduce overall transaction costs, agency costs and offer a foundation for trustless social and economic interactions. (Trustless means people don’t have to trust a third party: a bank, a person, or any intermediary that could operate between you and your cryptocurrency transactions or holdings.) 

DAOs can truly revolutionize governance models in corporate decision making. They are block chain native decentralized organizations that are owned and managed by their members, via the use of smart contracts. This model uses a distributed and digital ledger that records transactions in a transparent way. 

DAOs are different from our current and traditional organizational governance models in two ways: 

1. They operate through public and distributed decision making, where any member can create proposals for corporate decision making, unlike the top-down private decision making in traditional models. This fosters collaboration and community engagement among members of the DAO. For example, a DAO can operate as a distributed venture capital firm where its members pool their capital and invest those funds in ventures that the members deem promising. This is a community-driven investment arm. 

2. The decentralized nature of DAOs enables new business models that are catalysts for disintermediation, reducing the use of intermediaries for transactions. The core of this movement allows more favorable rent sharing among the entrepreneurs, investors and sellers or buyers since you don’t have to pay extra for services or intermediation. 

DAOs’ voting mechanisms are also different than traditional models. The mechanisms work to distribute ownership and voting transparency and efficiency. The smart contract defines the rules of the organization and holds its treasury. The smart contract can only be changed by a vote of the DAO’s members. Most DAOs are governed by token-based voting. One token equals one vote. A majority is sufficient to pass a proposal. There are a number of less common but innovative models of voting practices, such as quadratic voting, where a larger number of tokens have a disproportionately high voting power; conviction voting, where a vote’s weight increases with time; or holographic consensus voting, where a multistep vote involves boosting of and staking on (betting on) proposals and liquid democracy tries to resolve the resiliency issue using a delegation of voters. 

The promise of DAOs is complete transparency in the decision making process and disintermediation for the organization, but also transparency at the market, industry and economy levels. 

Significant benefits of the DAO structure include: 
- reduction of potential agency costs associated with conflicts of interest between managers and shareholders, 
- public voting for all to see on the digital platforms, 
- reduction of costs for all, by reducing transaction costs—executing smart contracts is significantly less costly than corporate board meetings, labor union involvement and so on, and 
- the wisdom of crowd-based decisions, which are known to be more likely to fund new products and innovative ideas, and back technology-based startups. 

Challenges are also found with the uncertainty of the legal status of DAOs in most jurisdictions. DAOs are unincorporated and the members are often not identified. This translates to the increased uncertainty that is prevalent in the entire crypto industry. Most regulatory groups have tried to embed DAOs into existing laws. But much more work is needed to confirm the legal status of DAOs. The lack of specific regulation is surprising, considering the increased numbers of DAOs. 

My observations — as well as those of a number of my colleagues — see hope in this new organizational structure since it has the trajectory to disrupt how we see, value and become part of organizations and view governance. 

This brief overview shares what DAOs are, how they are managed, and a few of the challenges and opportunities that exist with this critical innovation and evolution of governance, based on entirely new sources of entrepreneurial finance and business models. 

My hope is that my current research in this area will spur further research on how this may be the model of the future, changing the global corporate landscape from hierarchical to democratic and distributed organizations that invest in innovation and new products and so much more.