Part 5: Web3 Distributed Autonomous Organizations
This is article is the fifth in a series on Web3.?
DAO Definition
A Distributed Autonomous Organization (DAO) consists of three elements: (a) people, (b) a smart contract and (c) blockchain tokens to tally votes that trigger the execution of the smart contract (see Article 4 of this series, Web3: Smart Contracts). More broadly, a DAO is the Web3 consensus-based, decentralized analog to institutions such as corporations and some government bodies.?
DAOs and At-Scale Organizations
At-scale organizations are often governed by some form of representational democratic principles where individuals vote for people who make decisions on their behalf. The rationale behind representational democracy is that as an organization grows in complexity, making informed decisions requires increasing amount of expertise and time. Since most people are busy living their lives and as the number of organizations calling for their attention increases, the typical solution is to delegate day to day decisions to others.
Using a traditional corporation as an example, shareholders elect a board of directors. The board appoints executives who manage the day-to-day operations. Shareholders need only focus on the details of the corporation during shareholder votes a few times every year. There are downsides, however, to abstracting ownership from operational control. Corporate boards and executives in particular have been criticized for being high priest clubs that run organizations as much for their own benefit as for the shareholders.
DAO’s seek to remedy this by removing both the board of directors and the management team. In theory, they operate through direct democracy. A DAO token is created through an initial coin offering and sold to the public. Holders of those tokens then vote on every decision. Voting outcomes are executed by smart contracts, unambiguously coded and executed and not subject to interpretation or subversion by either a management team or outside agencies. How a DAO lives in the real world requires some investigation.
Legal Standing of a DAO
A DAO is not a legal entity. It offers no liability shield to its owners as does a corporation. Often likened to a partnership of tokens holders, its true legal effect is yet to be tested in court. In its purest form, a DAO isn’t so much ‘owned’ by anyone as ‘guided’ by token holder votes. For these reasons, DAOs are often ‘wrapped’ in a corporation. The corporation owns the assets of the DAO and is the vehicle to form legally binding relationships such as contracts. As an aside, given the partnership nature of a DAO, it's been suggested that DAO token-holders might have joint liability given their active participation through voting on the DAOs operations. This is another question not yet tested in the courts.
DAOs in Operation: Decentraland
To understand how direct stakeholder management of a DAO works for an at-scale organization, Decentraland was chosen. Decentraland is perhaps the premiere example of a decentralized metaverse competitor to Meta and Microsoft, designed to be a virtual society where people interact and engage in commerce involving digital assets and cryptocurrency. Decentraland lives in the broader metaverse, designed to be a series of Web3-based interconnected, decentralized platforms hosting different immersive virtual experiences. Within Decentraland, there are many token-holders who have a right to vote, some of whom contribute their time in support of both the idea of the metaverse and the Web3 decentralization ethos.
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Governed as a DAO https://docs.decentraland.org/decentraland/how-does-the-dao-work/, Decentraland's stated goal is to remove centralized management and governance, replacing them with consensus governance through regular DAO votes. In 2017, Decentraland issued a token called MANA through an Initial Coin Offering. MANA tokens can be used to buy virtual parcels of land in Decentraland, multiple parcels forming an estate. MANA, land and estate holders have the right to vote on DAO proposals. One MANA equals one Voting Power (VP). Land and estate holders get 2,000 VP per parcel. As of August 2022 there had been 1,153 topics voted on ranging from the banning of offensive names to liquidity swaps with other cryptocurrencies.
Decisions made by the DAO members are intended to be coded into a smart contract, but as with any complex organization, much of the work a company does is incapable of being algorithmically described. Decentraland is therefore governed by a 5-member Security Advisory Board (SAB) and a 3-member Committee. How the DAO works | Decentraland Documentation The Committee is the operations arm of Decentraland, implementing member votes and acting as a treasury holding the private keys to the DAO’s funds. The SAB has wide ranging powers.
Interpreted literally, the SAB could run the DAO against the community consensus. As a check on their power, the community can remove members of the SAB by two-thirds community vote, although a reading of the bylaws seems to give the SAB the power to block such a vote, so it’s not clear how effective this remedy is.
Of the 1,153 topics voted on by the token holders, a brief review shows that typically only 20-40 token holders vote, but with two or three large VP holders voting hundreds of thousands to millions of VPs deciding the outcome. These large VP holders appear to be the founders of Decentraland, although their identity is shielded by the blockchain.
A DAO can’t own off-blockchain assets since it isn’t a legal entity. The Decentraland terms and conditions terms.pdf (decentraland.org) shows that Decentraland is an offshore, Cayman Island-based, corporation named Metaverse Holdings Limited, which owns the trademarks and other assets of Decentraland. https://trademarks.justia.com/owners/metaverse-holdings-ltd-3791306/ Cayman Island corporations obscure the identities of the beneficial owners, so it’s not possible to know who they are.
Given all this, Decentraland looks like a variation of a traditional business organization. There’s effectively a board of directors, the SAB, elected by a supermajority of those with Voting Power. The SAB supervises a Committee that runs day to day operations. Typical token holder votes draw a small portion of the MANA community with three or four large MANA holders dominating key votes. The SAB can ignore the voting outcome at their option. Decentraland’s assets are owned by a Cayman Island corporation.
The structure of Decentraland is in many ways a reflection of the realities of running at-scale businesses. Corporate structures developed Darwinianly and, notwithstanding their deficiencies, represent best practices in the real world. The Decentraland DAO itself acts more like a club than the actual business entity. The members express their opinions through token votes but with final control in the hands of the management and owners.?
Summary
Pure DAOs are currently ill suited for an at-scale business operating in real world markets. It’s no surprise then that the example DAO, Decentraland, is a Web3 front end for what is a relatively typical high tech startup. A DAO is useful for on-blockchain operations and as a tool to regularly sample the intent of the community of token holders.
Opinions expressed are solely my own and do not represent the views or opinions of others, including my employer.