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WTF is The DAO?

  • DAO had largest crowdfunding campaign ($150m)
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WTF is The DAO?

Understanding the Dao isn’t easy, especially without a PhD in computer science. Even the New York Times called the DAO “difficult to describe”. Most articles written about it can give you a headache. But the organization behind the most successful crowdfunding campaign to date ($150 million raised) is worth explaining and understanding, using terminology that doesn’t make your brain explode.

Cool, so what’s the DAO?

Hold up…before you can understand the DAO, you need to understand the building blocks behind it.

Lets start with the basics; first, you need to know what digital assets are. Simply, a digital asset is an asset that has no physical form, but has a physical value. The best examples of digital assets are cryptocurrencies (like Bitcoin, Dogecoin, and Etherium), which can be purchased but don’t have a physical form — they exist only in the digital world.

The next concept is a blockchain. Super technical essays and articles explain blockchain in depth, but keeping it simple for our discussion: A blockchain is a public ledger of a digital asset’s transaction history. Each blockchain is made up of “blocks,” and each block contains a transaction record of the asset, tied together in sequential order. Since the ledger is public, there isn’t a single controller or bookkeeper tracking transactions. Instead, blockchains have miners, people who monitor transactions to look out for fraud, and are paid with the blockchain’s digital currency (i.e. Bitcoin miners get paid with bitcoins).

Last is a DAO, or a decentralized autonomous organization, one of the more confusing concepts to understand. Lets go word by word and simplify it:

  • Decentralized: DAOs don’t have officers or board members that control the organization’s decisions. Like a democracy, users that “buy into” a DAO have control over some decision-making processes of the company. Users only have “some” control because of the next word in the acronym, autonomous.
  • Autonomous: At its core, a DAO is a computer program that makes decisions based on its own rules, known as smart contracts. A simple example of a smart contract is a computer program used by universities that filters through applications, allowing only students with minimum GPA or SAT scores to reach an admissions committee. Although the committee makes final acceptance decisions, they don’t have full control of the process since they don’t see every application. Similarly, a DAO’s programing automates parts of the decision-making process — ranging from tasks as simple as filtering to complex contract negotiations.
  • Organization: A DAO needs to have a purpose, and to have a purpose, you need money. DAOs need some sort of capital, usually a cryptocurrency, to do anything of substance. DAO members exchange cryptocurrencies for shares, or tokens, in the organization. Just like shareholders in public corporations, more shares equal more influence on decisions.

Great, now can you tell me what the DAO is?

Yes…here we go:

The DAO in question is an investment entity, structured as a distributed organization on the Etherium blockchain. Using Etherium’s cryptocurrency, Ether, the DAO identifies companies for its members to invest in, and shareholders vote to either invest or pass on deals. The DAO crowdfunded $150 million from approximately 11,000 people, making it the largest crowdfunded project in history.

Why was the DAO created?

The DAO was created in response to a desire for more transparency in investment houses. The DAO is a fully transparent organization. There can be no mismanagement by officers because there are no officers — either the shareholders or the DAO itself makes all decisions. Furthermore, since the DAO is on the Etherium blockchain, flows of funds are on public records. Creative accounting can’t be used to disguise mismanagement of company funds.

Are there any problems with the DAO?

Yes…and lots of them. Because the DAO is so “open”, the organization is more susceptible to attacks. For the sake of our conversation, we’re going to focus strictly on the business issues, instead of getting bogged down with the legal, tax, and technological issues of the DAO.

The DAO has no leadership. Decisions need to be made by a quorum, slowing operations down to a speed that makes an oil tanker look like a speed boat. The second issue is the DAO’s code itself. It’s difficult for an investor to fully understand any investment — and trying to understand the computer code that comes with an autonomous program is a near impossible feat for a majority of investors.

Both of these issues came to fruition on June 17th, 2016, when an unknown “attacker” exploited the DAO’s computer code, siphoning off over $50 million worth of Ether in 40 seconds. Many commentators don’t view the attack as a hack, but as an individual taking advantage of a weakness in the logic of the DAO’s smart contracts.

 

Accounts_-_etherchain_org_-_The_ethereum_blockchain_explorer
Blockchain record of The DAO attack

Here is where the DAO’s issues of clarity and speed are brought to light. Investors didn’t understand that the DAO could have been taken advantage of so easily, since no intelligent investor would put money into a fund that isn’t secure from theft. Regarding speed, although the hack took under a minute, a “kill switch” could have been executed by a miner who saw something shady happening. However, since all decisions need to be made by the collective, the miner could only sit and watch as money bled out of the DAO. The lack of leadership is even more apparent with the DAO’s response to the attack: it’s nearly a week after the attack, and no decision from shareholders on what to do next has been made.

What does the DAO mean for the future?

We’re at the infant stage, dipping our toes into the pool of DAOs. The issues the company ran into are similar to a business set up without full knowledge of its market size and risks. There are going to be growing pains with DAOs, and the decision what to do with this DAO won’t stop another DAO starting soon. It will be interesting to see what the next iteration of the DAO looks like, and how coders respond to the issues of the DAO.

Regardless, the establishment of the first DAO fund gives the market a measuring stick for future investments, and shows investors how careful they need to be with the fine print.

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