What is a DAO? How does it work?

By | March 25, 2022

Imagine an organization with no boss, no employees, no hierarchy, but just collective ownership and authority—that is a Decentralized Autonomous Organization or a DAO. Such an organization functions around a set of rules that are coded onto the blockchain and are enforced with pre-defined logics.

In the absence of any central leadership or governing authority, the decisions in a DAO are made collectively by the members and the finances are also distributed accordingly. Every member has a stake.

Decisions in a DAO are made via group voting on different proposals during a specified period.

What is a DAO

How to form a DAO?

The first step is to define your goal and set the rules. These governance rules of a DAO are embedded in smart contracts, which are deployed to the blockchain.

So, creating a DAO not very complicated: Define the rules, create the smart contracts, and deploy to the blockchain.

All members that have a stake in the DAO can vote on governance proposals and influence the direction that DAO takes.

Who makes these proposals?

The proposals are made by the members themselves and for any proposal to be accepted, it needs to be vote-approved by majority stakeholders. This is done in order to avoid spamming by too many proposals.

First, everyone votes to approve a proposal to be voted on, and then they vote on it to see which way to go. Complex? Well, crucial decision-making in DAOs will be really slow if we follow this process.

Who provides the funding?

Participating members make their own investments and receive tokens in return. These tokens are similar to your share holding in a company—they decide the value of your stake and give you voting rights. The risks and rewards are all shared collectively.

Transparency and autonomy

Blockchains are open-source and their nodes are distributed throughout the world. So essentially, all the data and information stored in the DAO is not under the control of any single entity. The whole system is not only fully autonomous, but also completely transparent, so much so that the financial records stored on the blockchain will also be visible to anyone.

The initiators of the organization or the people who wrote the smart contracts also have no more influence in the DAO than any other members who hold the same tokens.

Advantages of DAOs and possible problems

Trust and transparency

Publicly available code is easier to trust than any group or individual and community governance allows more trust and transparency than a typical organization.

However, that could also be a problem when it comes to decision making. No matter how efficient, code cannot be adapted to anticipate every issue or possible problem that can arise in an organization and such issues often require quick decisions and resolutions, which will be impossible in a DAO.

Distribution of work

The interests of all members in a DAO are aligned; they get a return on their investments/efforts only if the DAO succeeds. So, everyone is incentivized to act in the best interest of the organization, even if it is acting against their own self-interests.

However, in this situation, bringing everyone to the same table could be a problem. Token holders will obviously have different opinions and disagree over regulations, finances, etc. and the majority may not always be right on such decisions.


An open, easily-accessible treasury makes it difficult for any individual to abuse the finances for their personal benefits, and allows for a more-efficient utilization of financial resources.

However, it also raises significant security concerns as open-source code makes DAOs more vulnerable to cyberattacks.

There are several examples of DAOs that raised massive funding, only to leave their investors in the lurch.

The very first DAO, named The DAO, was seen as a revolutionary project that raised $150 million in Ether from crowdfunding. It was set up as a VC fund on Ethereum.

The investors were given tokens, which would increase in value and pay dividends as their price appreciates. However, some programmers expressed security concerns with the DAOs smart contracts, which could allow somebody to drain all the funds.

They set up a governance proposal to decide, but in the meantime, a malicious actor exploited the vulnerability and siphoned over $60 million worth of ETH from their account.


Typically, a conventional organization functions under its local laws, but with distributed ownership, the DAOs will find it difficult to comply with all regional legal regulations.

Lack of regulatory harmonization in different sectors makes the legal framework of DAOs highly complicated and they may have to place certain restrictions on participating members based on their geographical location.


On the surface, a DAO sound like a promising idea—collective ownership clearly has significant upside and it would be great to break the monopoly of the few big players on the internet, who define all the rules.

However, the delay in decision-making, always having to get approval of the majority, vulnerabilities arising from too much transparency, and complications due to legal irregularities and many other such problems threaten the efficiency of a DAO and although we are still in the very early days of web 3.0, I don’t clearly see how a completely autonomous organization can function expeditiously.

Even if the legal regulations are harmonized with the assistance of our governments and security and financial aspects are taken care of with more sophisticated technology, relying on the majority’s opinion for everything is just not ideal.

Individuals who have invested years researching, experimenting, making mistakes and learning from them are in a better position to make decisions than a collective majority with limited liability. Maybe, authority is not such a bad thing as long as it is not abused.

What do you think? Do DAOs, as we know them now, have a future?


COINTELEGRAPH: What is a decentralized autonomous organization, and how does a DAO work? https://cointelegraph.com/ethereum-for-beginners/what-is-a-decentralized-autonomous-organization-and-how-does-a-dao-work

OBERHEIDEN P.C: Blockchain & Cryptocurrency Lawyers Leading the Way in Web3, Blockchain and DeFi https://federal-lawyer.com/blockchain/