The Pros and Cons of Building a DAO

As the world of crypto and blockchain continues to mature, various compelling use cases are being tested. If you want to learn more, please visit our website XDAO.

One opportunity that has gained traction recently is the concept of decentralized autonomous organizations, or DAOs. While DAOs show great promise, they come with both advantages and disadvantages, similar to other communication and management hierarchies.

If you're curious about what a DAO is or if building one aligns with your business goals, we're here to help! Let's dig in.

What is a DAO?

Despite its recent popularity in the cryptocurrency lexicon, the first DAO was created many years ago. Investopedia explains the origins of the first DAO: "The [original] DAO was an organization designed to be automated and decentralized. It acted as a form of venture capital fund, based on open-source code and without a typical management structure or board of directors.

To be fully decentralized, the DAO was unaffiliated with any specific nation-state, although it utilized the Ethereum network. The developers believed they could eliminate human error or manipulation of investor funds by empowering an automated system and a crowdsourced process."

Using blockchain, DAOs are structured so that anyone with voting power can participate in shaping the organization's direction. Decentralization and autonomy are considered critical components of the Web3 ethos, making DAOs appealing for those building in today's consumer-focused landscape.

Theoretically, DAOs enable a business or entity to be governed by a collective of supporters, ensuring no single individual has the final say. The foundation of DAOs rests on the introduction of tokens that can be used to vote on various improvements or protocols.

Given the significant increase in developer education, hundreds of DAOs have been created, prompting more developers and business builders to consider utilizing them.

Benefits of a DAO

DAOs provide numerous benefits, and it is reasonable to expect these advantages to grow over time for specific use cases. As blockchain technology becomes more user-friendly, more users will participate in DAOs, circumventing current technical knowledge barriers.

Here are a few noteworthy benefits:

Decentralization

DAOs aim for maximum decentralization. While achieving 100% decentralization is challenging, these organizations emphasize collective decision-making rather than allowing a single individual to dominate.

In a publicly traded company, the CEO and perhaps the board ultimately dictate decisions, leaving users and customers with minimal input. For instance, many retail workers often do not earn a livable wage. If a retail store operated under a DAO, users could vote on fair pay practices, giving them a say in the organization's direction.

Participants in DAOs have a stronger influence over the organization's path. Though voting power can be weighted, it is significantly reduced compared to traditional businesses where leadership sets the direction.

DAOs Provide "Skin in the Game" for Participants

A key mechanism that allows DAOs to thrive is the concept of participants having "skin in the game." DAOs that utilize governance tokens require users to burn or spend their tokens to cast votes, promoting careful consideration for each vote.

Moreover, every vote on the blockchain is public, meaning a user's reputation is displayed whenever they cast a vote. Referring back to the example of employee pay, it would be apparent which users supported keeping salaries the same or advocated for increases.

This literal and figurative cost encourages careful voting and minimizes the likelihood of 'bad ideas' gaining traction.

Community Driven

DAOs facilitate connections for communities worldwide, allowing them to collaborate and build a common vision. With internet access and governance tokens, virtually anyone can participate in shaping the future of Web3. This could involve influencing the future of domains through ENS or developing popular play-to-earn cryptocurrencies, making DAOs accessible to those who previously had limited opportunities.

Additionally, like owning stock in a company, participating in a DAO fosters a sense of ownership and can drive innovation and financial rewards.

Disadvantages of a DAO

Despite their numerous benefits, DAOs come with drawbacks that warrant consideration.

Reduced Speed of Decision Making

As a DAO scales, achieving timely votes on proposals can prove challenging due to time zone differences and participant priorities. Keeping DAO participants informed and engaged is critical.

If major decisions require majority stakeholder votes, the added coordination can pose challenges. Organizations choosing a DAO structure must be adept at decision-making based on their specific framework, especially in the fast-paced Web3 environment where speed can be key to long-term success.

The Bikeshed Effect

The community-driven nature of DAOs can also lead to pitfalls, one of which is the bikeshed effect. This phenomenon refers to the tendency to devote disproportionate time to trivial matters while neglecting significant issues.

As illustrated, in a financial committee meeting discussing a vast nuclear power plant proposal and two minor budget suggestions, members spent minimal time on the complex project. Instead, they focused on easier, less impactful matters. The Bikeshed effect is especially relevant in a DAO context, where discussions may gravitate toward trivialities instead of substantial topics.

Contact us to discuss your requirements at XDAO. Our experienced sales team can help you identify the best options to suit your needs.

Security

While a DAO can be launched with few lines of code, security remains a vulnerability. Implementing effective security requires significant technical expertise. The extensive tech stack necessary for a well-functioning DAO can make it cumbersome and costly to maintain best security practices. Furthermore, with many DAO participants remaining anonymous, added security risks arise.

While tools for operating DAOs are improving, weak security foundations expose DAOs to exploitation. Recent examples highlight the real threats posed by user interface exploits and phishing attempts, underscoring the importance of robust security measures.

The Bright Future of DAOs

Despite inevitable setbacks in the years to come, numerous innovative projects and businesses are utilizing the DAO structure. From Constitution DAO's efforts to purchase a copy of the U.S. Constitution to advancements in domain systems on the Ethereum Name Service (ENS), opportunities abound for entrepreneurs to engage builders globally.

As we continue to explore unique DAOs use cases spanning various industries, including music, art, and high-value asset purchasing, it remains likely that we will witness spirited collaboration in purchasing sports teams or overseeing development projects.

Launching a DAO involves creating and deploying smart contracts, essential for establishing organizational infrastructure. At Alchemy, one objective is to educate blockchain developers on available tooling and resources for improvement.

If you're interested in learning how to connect with the blockchain and deploy DAO smart contracts, check out this article: Why Use Alchemy?

Lastly, we’re available 24/7 through our Alchemy Discord. Stop by and connect; we'd love to support you on your journey to becoming an adept blockchain developer!