As we continued the conversations at Capital Club Dubai around the evolution of NFTs, cryptocurrencies, blockchain and the metaverse, it was inevitable that we needed to also understand Decentralized Autonomous Organizations or DAOs – the next hot trend in the digital realm.
- Any entity can be organized as a
- Creatives who share values as a collective can create a
- It’s a way people can gather around a passionate cause.
- DAOs are not regulated and have no boundaries, so the founders need to have clear values and governance in
Guest experts, Hubertus Thonhauser (HT), Chairman & Partner Ghaf Capital Partners; Founding Partner, Enabling Future; Danosch Zahedi (DZ), Co-Founder, Arts DAO; Founder, Arami Group; Co-founder and co-host Crypto Sheikhs Podcast; spoke to moderator by Hala Bou Alwan (HAB) LLB, LLM, ELLM, Founder and CEO, Hala Bou Alwan Consultancy.
HAB: Where does the word DAO come from? What is its history?
HT: A decentralized autonomous organization (DAO), is quite similar to some existing organizational forms that have been around for centuries, such as cooperatives and social entities where governance is based on consensus. There has been an emergence of two trends that has propelled the DAOs to the forefront. First, the culture of flat organizations that seek to decrease hierarchies, and the other trend is remote working. This has led to ‘individual brands’ becoming more important than corporate brands. And the advent of decentralized technology like blockchain has further helped in the emergence of DAOs. The first DAO, a predecessor to Ethereum, was a decentralized venture capital fund created in 2015. The vision of the developers was to create a smart protocol-based platform that would allow investments into startups. However, the first DAO experience was a disaster because the system was hacked and US$11 billion stolen.
HAB: How is a DAO created?
DZ: A DAO is an organization that is automated with smart contracts – agreement between people or entities, embedded in code format on a blockchain with a predefined set of rules, which gets executed when those definitions are hit. A DAO is an organization where a lot of the decision making is made based on smart contracts, by the community. It is decentralized. Depending on how a DAO is structured, everyone has the right to vote depending on how many tokens you hold in the DAO, and sometimes one member has one vote. If you decide that you have a common cause that we are passionate about and that you want to pull all resources, knowledge, experiences, together, you can put it on the blockchain and create a decentralized autonomous organization.
HAB: How do you ensure good governance within a DAO?
HT: There are some fundamental issues with DAOs. They often begin with investors and over time as new members join and the community grows, the investors are less involved and are considered ‘sleeping partners.’ One way of solving the problem is by giving new token holders more rights over time and diluting the old ones. Along with purpose, a DAO needs to have a set of values which aligns everyone and would help in conflict resolution. On the execution side, you do need normal governance practices in place like a Board who are elected by the DAO token holders, however the weight of the votes is much like that of a shareholder in a public company. And there are certain votes on decisions and actions that are not taken on the blockchain because this would consume too much gas fee, and normally happens off-chain. There is an ‘off chain-on chain interaction’ in the way a DAO is governed.
HAB: What are the main risks?
DZ: There have been a few instances of DAOs that are fully decentralized, where there is no council or board that executes decisions. In such a structure, anyone in the room can suddenly just produce a proposal, with the risk it could be counterproductive to the efficiency of the DAO. A completely decentralized DAO calls for a lot of trust that everyone is competent and will put forward good proposals. However, bad decisions can take place within DAOs, and they can get hacked on the blockchain, just like any business or website on the Internet.
HT: Normally DAO token holders, is a very responsive community, and communicate over discord, Twitter, and other social platforms, which can become toxic very quickly. Case in point is the Wonderland DAO, an investment club with decentralized finance mechanisms. They set up a proper DAO governance structure and, in the beginning, it was very well managed. However, they did not check who were the co-founders of this DAO. Since, many things happen anonymously in this space, people meet over Telegram and other remote ways, they tend to trust that others are delivering proper code and solid projects, and the usual KYCs are not carried out. In this instance, one of the co-founders of the DAO, was the co-founder of one of the biggest scams in the crypto history, with an exchange in Canada. This news leaked, coinciding with the crypto market crash in 2021, and due to social media communication, the entire DAO exploded. In a normal listed company, it would be impossible for every shareholder to voice his opinion and attack the Board, as is possible with a DAO via Twitter or other social media platforms. So, this ecosystem is still at early stages and unregulated, and DAOs are legally in an unclear territory.
HAB: Can any business be suitable as a DAO?
HT: Every form of organization, in principle, can be a DAO. It doesn’t necessarily have to be a business; it can even be a movement or an association that can be organized under a DAO technically. In a creator’s economy, artists that share common values, can be embedded as a collective. The DAO model is also attractive for investment clubs and schemes such as decentralized venture capital or mutual funds. The biggest challenge is regulation.
DZ: The constitution DAO is an interesting example of a group of people who gathered around the fact that they wanted to buy the US constitution which was for sale at an auction. They accumulated almost US$40 million but lost the final bid, US$42 million. It was an extremely quick way for people to gather around a very passionate cause.
HAB: Can you tell us about the Arts DAO?
DZ: With the objective of helping traditional artists enter the metaverse and Web3, we started to build a community. Our first event had ten people gather in an artist studio, and shortly after that, we were 30 people in the same studio. It was a little bit awkward in the beginning, but then we all started to become good friends. The next event was sponsored and hosted at the Arts Club with over 100 people, including some Sheikhs, VCs, artists, investors and collectors. Since then, we’ve had a number of events and are in the process of building an Arts DAO, as well as launching our own NFT, which will be the token for direct access. The DAO will give grants to content creators and metaverse related projects in the Middle East.
HAB: What was the process for setting up the Art DAO?
DZ: We have an entity in DMCC called ADNFT DMCC. And the plan is to incorporate a foundation which will run the DAO.
HAB: Where does one go, if something goes wrong?
HT: There is really no need to regulate a DAO because technically there are laws already in place for cooperatives, and the same can be used for a DAO. Having said that, DAOs are international and so regulators have to figure out how to deal with cross-border rules. The DAO founders must have clear values, rules and articulate these properly, leaving no room for interpretation and conflicts. The new DAOs are well advised to be diligent right from the beginning. It needs to be a self-regulating organization – like an SRO. This concept is in Switzerland, where members regulate themselves instead of responding to a third-party governing body.
HAB: Where are DAOs headed in the coming years?
HT: DAOs are a phenomenon of the decentralized Internet and will gain more relevance. Before it was decentralized information sharing and now, its about sharing of values. At some point there will be a regulatory framework which will take care of DAOs because some of them have really grown to multimillion dollar organizations. It’s all about retail protection. On the technical side, we have more building blocks and tools that will allow DAOs to be managed and organized in a proper way. For example, Orca is a software layer which can be used for creating DAOs. It is like a plug and play building block for creating a DAO, or Snapshot, which helps you to conduct off-chain voting events on decisions.
HAB: How do you see DAOs evolve?
DZ: We are seeing DAOs popping up everywhere. With the onset of the Russian-Ukraine conflict, a charity DAO was set up to support people in Ukraine. DAOs have so many diverse types of applications, and the space is evolving constantly. But I don’t think it’s going to stop with DAOs; there’s going to be something after DAOs that’s going to be refined. We are seeing a lot of consolidation in crypto, defi, and all things Web3. You will have a few exceptionally large DAOs emerging.
HAB: If people want to be part of DAO or create a DAO, what are the top three things they need to know?
HT: The first is you need to really understand what the DAO is about and what are the values of the DAO. What are the guiding principles? It’s similar to setting up a company because a DAO is just a different form of an entity. We shouldn’t think of a DAO in an abstract way – it’s quite simple to organize an association, a charitable group, a football club, or something that is shared around a common goal. The second recommendation is to not put everything on the blockchain, because in order to be functioning, you don’t need to put all the decision-making processes on chain. It becomes expensive and very cumbersome. And finally, it would be prudent to think about proper governance early on in the process and get the right people involved, to help and protect the interest of the token holders. And because of the social media impact, the other thing to think about is communication. You need a proper community manager who is able to understand what’s going on and be transparent. Transparency is super important in DAOs, and you have to intentionally build trust in an unregulated space.
DZ: In the Web3 space, you must do your own research. Build the infrastructure in such a way that you safeguard yourself for future regulations. For investing and participating in a DAO, it’s the same as other entities; – look at the team, their background, experience, etc.
HAB: How do you preserve security in the DAO community?
HT: This is similar to any blockchain project. The security checks and audits must be done. This is an inherent part of creating a blockchain product that starts with any layer one protocol. The most important thing is to do regular smart contract audits and stress tests.
Audience 1: If you need to keep part of the DAO off-chain, and if everything is not governed by code, and you need to trust people, then what is the advantage of creating a DAO?
HT: The elements that you need to keep off-chain are not mission critical elements to the functioning of the DAO itself. The smart contract is on the blockchain and so transactions are being executed safely, even if other certain decisions, like voting are made off-chain. You can connect the wallets of the DAO holders with the API and Snapshot kind of technology that knows if the voters are eligible to participate or not. The wallet represents your digital identity, and based on that, the voting can happen off-chain, and you save a lot of complexity and gas fees. But you’re right, that it’s easier to govern pure software elements, like for instance, Tazos, which is a layer one protocol, they have something called on-chain governance. This is the only blockchain on the planet that has the functionality that people can vote on protocol upgrades on-chain.
Audience 2: What is the incentive for DAO to adapt this kind of structure? Is it the community? Is it the transparency? Is it democracy? What is the benefit for organization to adapt this kind of DAOs?
DZ: For established organizations, it’s difficult to change and become a DAO. Regarding the benefits, everyone feels that they’re part of the decision-making process. You can rally people behind a certain cause, create value by pulling together resources, incentivize people, reward them with DAO tokens, and this can all be embedded on the blockchain with smart contracts. The entire process is more efficient than in a traditional business. Remember civilizations have been built around communities.
HT: From our portfolio, there is an example of a large investment DAO that wanted to invest in a particular company, and we thought this would be more interesting than a VC investing. The benefits are that this DAO would bring 20,000 members, with every member being a potential marketer, community member, and users of the product.
Audience 3: What would a Capital Club DAO look like?
HT: It is important to understand how the club is organized, the benefits for members, the shared values of the club, principles and vision, etc. Based on these parameters, you would either airdrop or create add-on tokens to every member and allow them to become part of the Capital Club token. Each token can be either an NFT (non- fungible token) or an FT (fungible token). With these tokens, a member can access certain rights, participate in certain events, propose projects, etc. It’s an add-on automated version of how you run your business anyway, just with more features.
Audience 4: Will regulations be necessary for DAOs?
DZ: Though DAOs are not regulated at present and operate in a gray area, eventually, governments will regulate DAOs successfully. And regulation is good because it usually sorts out the bad apples from the good ones. Cryptocurrency and De-Fi is now being regulated, though the NFT space might take a few years. I think we’re still a few years away from DAOs being fully regulated.
Audience 5: Do you need an underlying legal structure to create the DAO?
DZ: You don’t have to have a legal structure to set up a DAO if it’s like an association. It is an entity structured on blockchain.
HT: As an association, when the DAO doesn’t have anything to do with money, and not raising funds, then it’s like a group of friends organizing themselves, and there is no need for regulations or legal structure. However, as soon as money is involved then it becomes a little bit tricky. Furthermore, you have to decide if you will fractionize the tokens, there are security concerns, and you need some legal structure.
HAB: If you put an MOU in place to establish the DAO, as a disclaimer or announcer of the DAO, then it does not interfere in the decision making and the financials. The regulator can get information about the DAO from the MOU, but in terms of decision making, voting, and financials – it’s completely separate. The DAO has its own governance by itself. The MOU is between the members, and for regulatory checklists.
Audience 6: Can governments run on a DAO instead of having actual people running our parliament?
DZ: It would be quite revolutionary if a nation’s government evolves as a DAO. The future of governance in and decision making could potentially be on the blockchain. In a completely decentralized structure where people can vote and it’s embedded in a smart contract, it is possible to make more decisions effectively and remove corruption.
HT: This brings the discussion to a full circle. Direct democracy is needed to have a government DAO, or else the same corruption will be in software embedded in code. Switzerland, for instance, is one of the few countries that has direct democracy. People can then vote on decisions, like the budget of a region. They would get a clear annual report on items to vote. Once this governance structure is politically accepted, you can put it on the blockchain.