What Is The DAO and Why Is It the Biggest Crowdfunding Project in History?

By LetsTalkPayments

If you haven’t heard yet about the biggest crowdfunding project in the history, hurry up to get to knowDAO: Decentralized Autonomous Organization.

Stock.it, the company that merges blockchain and IoT, introduced a new method that for the first time allows the creation of organizations in which (1) participants maintain direct real-time control of contributed funds and (2) governance rules are formalized, automated and enforced using software.

Although the idea of the DAO is built on leveraging the benefits of crowdfunding, it is not another crowdfunding platform, it is an organization. Written with code in the cloud, the non-legal entity of individuals (which Tim Swanson, Director of Market Research at R3CEV, calls “design-by-giant-nerd-committee“), the .DAO does not create anything and does not employ anyone in a traditional sense.

The DAO is like a democratized version of a virtual hedge fund outside of the regulatory zone where membership means pooling personal funds (exchanged to ETH) to get DAO tokens and the right to participate in governing the investments.

The DAO is closed and self-governing—its software operates autonomously and its by-laws are immutably ‘carved’ into the Ethereum blockchain. The organization brings together groups of like-minded individuals with specific projects and goals in mind. Those individuals may never meet in real life and stay anonymous to each other, but connected by DAO, they can order to create something meaningful together. And the strangers have already come together. In fact, more than 20,000 investors already fueled DAO with over $150 million. 

What makes the DAO so interesting?

The DAO is a new type of organization, best comparable to a digital company, but without an attached legal entity. Made from irrefutable computer code, it is operated entirely by its community, which backs its future growth by purchasing DAO tokens using ETH, the fuel of the Ethereum network.

DAO has four features, as described by Stock.it.

First and foremost, it’s inclusive. Using smart contracts on the Ethereum blockchain, the DAO allows anyone in the world to participate in governing common funds. As early believers and participants, members of the DAO will receive DAO tokens to use them in future voting and more.

Secondly, the DAO is flexible; it  allows to back proposals of any nature – to build a product that then can be used by the organization, to fund a venture for future returns, or to channel funds for a charitable cause (like “to” save the whales“, as the University of Toronto PHD student Quinn DuPont acknowledged). Participants can vote to allocate funds for proposals of innovative nature that further will be executed by contractors.

In case the DAO funds a product or a service, it can charge ‘outsiders’ for using it and use the potential revenue (which the DAO receives in ETH) for its growth or just redistribute earned ETHs as DAO tokens to the holders as an incentive.

A fascinating part of the DAO is that its governance is fair and decentralized. As Stock.it promises, the ETH held by a DAO will never be centrally managed. DAO token holders have the power to vote on important decisions related to governance of their DAO including the power to redistribute its ETH among themselves.

How the DAO works

The operation of a DAO goes through four stages: Proposal, Vote, Development and Deployment.

To start, any DAO token holder can submit a proposal, where the originator will specify the amount of ETH required for the development of the service or product by the service provider. The proposal also defines the amount of control over its operational responsibilities the DAO gives to the contractors.

After the proposal is submitted, DAO token holders vote on it. DAO token holders have absolute power over their funds at all time and can vote to change the service provider or any other detail of the proposal. Moreover, even if a DAO token holder decides to leave the DAO later, he/she still is entitled to the return from the service or product.

Once DAO token holders vote to accept the proposal, the service provider is obliged by an irrefutable smart contract to deliver on set objectives. The service provider receives payments in installments so the DAO and the provider engage in continuous relationships.

The purpose of the proposal is specified in the proposal itself. In case the proposal is made for building a product or service to be charged for, in the future after it is built, the DAO will be charging third parties that will use it and then use the earned ETH any way the DAO believes the best.

The controversies with the DAO

With anything fascinating and revolutionary, there is always a catch. Professionals from MIT suggest that the idea of trusting a crowd is quite risky. If not even experienced, educated and connected venture capitalists can always pick the right startup to fund, what can be expected from a versatile crowd?

MIT suggests that the people controlling the DAO will be asked to make investment decisions based on far less information than VCs get. Moreover, many won’t even be full-time or experienced investors at all.

Another pickle with DAO is its Ethereum-powered nature. The crowd can be so caught up in the hype with ETH, that it may lean towards projects involving Ethereum and related ideas — which, as some professionals believe, are very much unproven.

In addition, the DAO can hope for a wide success only if ETH is widely adopted to pay for products and services. Contractors for developing the proposal are third-party organizations conducting their financials in traditional currency. Paying them requires ETH token to be converted, which is a certain friction in the cooperation of the DAO with the outside world.

Tim Swanson, Director of Market Research at R3CEV, shared some interesting thoughts on the controversy of DAO:

“…there is a disconnect between what the DAO is, an investment fund, with what many people see it as a large vault filled with gold laying in Challenger Deep that will somehow appreciate in value and they will be able to somehow extract that value.

“Sure, we will all be able to observe that the funds exist at the bottom of the trench, but someone somewhere has to actually create value with the DAO Tokens and/or ether.”

Mr. Swanson asked legitimate questions: “Will the return-on-investment of the DAO as an asset class be positive in the “early days”?  What happens when the operators and recipients of DAO funds eventually confront the problem of securities regulation?”

Jeremy Gardner, Co-founder of Augur Project and blockchain-focused VC, also expressed doubts over the DAO and its role in the financial world bringing up the idea that VC-backed ventures have more impactful innovations and experience faster commercialization rates than angel investors.

In addition to many other points against the DAO, Mr. Gardner added, “Any business backed by the DAO has to be built entirely on the Ethereum blockchain (as opposed to having off-chain, or multi-chain, components). In other words, any money made from the proposal that isn’t earned directly through the backed smart contract will not trickle back to the DAO participants.”

Other sources recognize risks related to risk assessment and the DAOs position in a gray area of law in addition to the possibility of the DAO negatively affecting the value of ETH.

“As soon as people are able to transfer out of DAO tokens, the Ether price will drop temporarily,” said Joseph Lee, who runs London-based bitcoin trading platform Magnr. “People would want to cash out. The price has been rising rapidly.”

Dan Larimer, CTO of Steemit, noted, “The theory of jointly deciding to fund efforts will face the reality of individual self-interest, politics, and economics. There will be rapid defecting (splitting) as people realize there is little to be gained by banding together under the structure of the DAO and much to be lost.

“It might not happen at first, but over time, the Etheruem community will learn the hard way what the BitShares community has already discovered. Creating social systems to jointly fund development of projects and investments is challenging. Ultimately, technology can only aid in communication, it cannot fix the fundamental incompatibilities between individual self-interest and community decision making.”

The 20% quorum is another part of the DAO seen as controversial by some professionals. Jonathan Chester, Founder & President of Bitwage, is questioning the idea. “What happens if the 20% quorum isn’t reached? What if a DAO’s investors are so disengaged it can’t even change the rules to lower the quorum percentage? There aren’t any good answers for this one.

“What happens if a proposal receives funding, is successful, but decides to stiff the initial investors? The funds come from a transnational class of investors and the amount might be small, making a class action suit very unlikely.”

Anyway, the DAO is a widely discussed and controversial project. So far it has demonstrated unconventional interest and grew speculations around its opportunities and restraints with bets on its success/failure. Even with significant funds accumulated by the DAO so far, it is a non-existent entity, written in the cloud and able to vanish at any moment members withdraw funds. Only time and validated projects will show whether the DAO can become a viable alternative to any investments-focused organizations or not.

First appeared at LTP