The next stop in the crypto world: How do DAOs achieve decentralized autonomy?

This article was published in Planet Daily, original title: 《Why I Say DAOs Are the Next Stop in Web3 After NFTs》，Author: Packy McCormick, Translated by: Katie Gu

From NFTs to DAOs

You may be familiar with Bitcoin, Ethereum, DeFi, and NFTs. However, you might not know what DAOs really are. Today, DAOs are re-emerging, bringing a diverse set of use cases, an ever-growing toolkit, and new governance and incentive models. DAOs are starting to gain attention just like NFTs did a few months ago.

NFTs are relatively easy to accept and can easily become eye-catching headlines. Because, at its most basic level, NFTs are quite simple and make digital media ownable and collectible, sometimes people spend high prices to purchase them, as seen in many recent high-priced NFT acquisition events.

DAOs have a role that goes beyond NFTs. DAOs can own and create NFTs, have many capabilities that NFTs do not possess, and have greater transformative potential than NFTs. An NFT is a piece of digital media, while a DAO is a complete media company.

In this article, I will begin to explore DAOs, examining their essence, how they operate, how they interact with other parts of Web3, their advantages, and what outcomes might arise from all of this. We will analyze this in depth, starting with the following seven sections:

1. Understanding DAOs

2. Ethereum and DAOs

3. Comparison of Uniswap and Coinbase

4. Forking Protocol Sushiswap

5. Gradual Decentralization

6. Four Functions of DAOs

7. The Current State and Future of DAOs

All roads lead to DAOs. If power refers to how much one person can do alone, then DAOs refer to how many goals we can achieve together.

So, the question arises, what is a DAO?

Understanding DAOs

A DAO is decentralized, running on a blockchain and giving stakeholders decision-making power, rather than being solely controlled by top-level personnel. DAOs use smart contracts to achieve autonomy; they are essentially applications or programs running on publicly accessible blockchains. If certain conditions are met, a command can be triggered with a single click without human intervention.

In simpler terms, a DAO is a new way to fund projects, govern communities, and share value. Unlike traditional top-down power structures, DAOs use Web3 technology and rapidly evolving governance and incentive systems to distribute decision-making power and rewards. This is typically achieved by issuing tokens based on participation, contribution, and investment. Token holders then have the ability to submit proposals, vote, and share in the profits.

If blockchain, NFTs, smart contracts, DeFi protocols, and DApps are tools, then DAOs are the methods of using them to create new things. They are the Web3 version of a company or community. As people continue to experiment, DAOs will exhibit properties that are difficult to predict today.

Supporters believe that DAOs have the potential to reshape how we work, make collective decisions, allocate resources, distribute wealth, and address some of the world's larger problems. DAOs are the primary reason for the birth of Ethereum.

Ethereum and DAOs

Vitalik Buterin first mentioned DAOs in the Ethereum white paper in 2013. In a previous article for Bitcoin Magazine, he attempted to propose and answer the question, "Can we approach this problem from another direction, even if we still need humans to perform certain specific tasks, can we remove the management part from the system?"

In the article, Vitalik referenced the views of Bitshares founder Daniel Larimer, who believed that Bitcoin is essentially a prototype DAO, a new type of decentralized traditional company.

Stock = Bitcoin

Shareholders = Bitcoin holders

Employees = Miners and validators

Payroll = Bitcoin rewards for adding blocks to the chain

However, the supply of Bitcoin is limited and cannot be changed. It is like gold; people use it and assign it value. If Bitcoin is akin to Artificial Narrow Intelligence (ANI), then DAOs are like Artificial General Intelligence (AGI). Bitcoin can do what programming requires well, but DAOs can theoretically do anything well.

Vitalik stated when introducing Ethereum, "Ethereum aims to provide a blockchain with a built-in fully mature Turing-complete programming language, which can be used to create 'contracts' that can encode any state transition function, allowing users to create any of the aforementioned systems, as well as many other methods we have not yet thought of, all by simply writing logic in a few lines of code."

Bitcoin is digital currency, while Ethereum is a platform where builders can create anything, from applications to entire organizations.

Ethereum, Bitcoin, and other blockchains are Layer 1 of the Web3 tech stack. For Bitcoin, most activities occur on Layer 1, while Ethereum operates primarily on Layer 2, which is the protocol and smart contract layer.

On Layer 2, protocols and smart contracts can be created, which can be arranged into countless combinations, ranging from artistic creations to cryptocurrency trading, without the need for third-party involvement.

Zora is an NFT protocol that allows any creator to create, own, and sell their works. The Uniswap protocol is a decentralized exchange that allows developers, liquidity providers, and traders to participate in a financial market open to everyone. Mirror's decentralized publishing platform has completely changed the way we express, share, and monetize our thoughts.

Zora, Mirror, and Uniswap are all protocols, but not all protocols need to be DAOs, and vice versa. To understand the distinction, let's start by comparing centralized platforms and decentralized protocols, and then we will continue to discuss the evolution from decentralized protocols to DAOs.

Comparison of Uniswap and Coinbase

Just because something involves cryptocurrency does not mean it is decentralized, and just because part of it is decentralized does not mean it is a DAO.

Coinbase allows people to buy and sell cryptocurrencies, but in other respects, it is a centralized exchange where you can trade stocks, bonds, currencies, or commodities. It pairs those looking to buy at a specific price with those looking to sell at that price and takes a commission from each transaction to facilitate trading.

As a company, Coinbase behaves like a typical centralized company. It has investors, a board of directors, and a CEO who make decisions about the company's direction. Coinbase decides which cryptocurrencies can be listed on the platform, rather than its users. The centralized nature of Coinbase makes it relatively easy to understand and use; you just connect your bank account, deposit funds, and start buying cryptocurrencies.

On the other hand, Uniswap is a decentralized exchange running on the Ethereum blockchain. Unlike Coinbase, Uniswap doesn't even have a wallet; it is purely an exchange that requires users to hold their cryptocurrencies elsewhere.

Because Uniswap is decentralized, it cannot decide what can be traded, nor can it provide liquidity or have a bank account. Uniswap is an automated market maker, allowing users to trade directly through smart contracts, setting prices based on available liquidity. There are no intermediaries, and which tokens can be traded on Uniswap is not determined by it.

Instead, anyone can become a liquidity provider on Uniswap by locking any pair of ERC20 tokens of their choice, effectively just putting them in a digital vault and not touching them for a period, like ETH and a stablecoin like USDT. In exchange, they will receive liquidity tokens representing their share of liquidity in that pool. When someone trades on Uniswap, they pay a 0.3% trading fee, which is paid to liquidity providers based on the number of liquidity tokens they hold.

Uniswap itself is just a protocol and does not charge any trading fees. Until the end of last year, Uniswap was not a DAO. It had no tokens and no market capitalization.

Today, Uniswap's daily trading volume is close to $1 billion, with daily trading fees nearing $30 million, and its current market capitalization is around $17 billion.

What changes occurred that made forking so popular?

Forking Protocol Sushiswap

One of the wonderful aspects of decentralized protocols is that their code, smart contracts, and transaction history are all public, allowing anyone to see, audit, or even copy them. This openness serves as a check and balance, encouraging normative behavior and protocol optimization. Because if enough people disagree with how the team behind the protocol is operating or believe they have a better way to create value, they can choose to fork it.

This is what the anonymous team behind SushiSwap did in response to Uniswap.

In the first two years of Uniswap's existence, it was just a simple protocol controlled by the decisions of its founder, Hayden Adams, and smart contracts. It issued tokens to limited partners, allowing them to earn a share of trading fees, but these tokens were not tied to the protocol itself, and they did not give holders a say in Uniswap governance; ownership terminated once limited partners stopped providing liquidity.

SushiSwap launched in August 2020 as an evolution of Uniswap, aiming to change this status quo.

The SushiSwap team wrote in a blog post: "By leveraging Uniswap's elegant core design, we added community-facing features that we believe improve the design of the protocol and provide more benefits to participants."

SushiSwap and Uniswap are similar in almost every way. Except for one point: on SushiSwap, the 0.3% fee is shared, with 0.25% going directly to active liquidity providers, while the remaining 0.05% is converted back to SUSHI, which is then distributed to SUSHI token holders. "The introduction of the SUSHI token and the allocation of 0.05% of the tokens means that token holders can have a say in governance, even if they are not actively providing liquidity."

So, the question arises, do you think SushiSwap is a DAO?

The answer is no.

SUSHI provides economic participation, but it is not yet a governance token. It is developing a governance framework called Omakase DAO and plans to transfer control of the protocol to the community. Currently, the community can vote on improvement proposals via Snapshot, but the votes are non-binding.

Do you now know what a DAO is?

Yes, Uniswap is one type of it.

In response to the fork from SushiSwap, to prevent people from migrating to the forked protocol, Uniswap announced the long-awaited UNI token on September 16, 2020. Unlike SUSHI, the UNI token grants holders governance rights, the right to vote on proposals, and the allocation of UNI to incentivize users, partners, and others. The Uniswap team stated:

"Verified product-market fit is particularly suited for highly decentralized financial infrastructure and independently developed platforms; Uniswap is now especially well-suited for community-led growth, development, and self-sustainability."

After the issuance of UNI, UNI holders immediately gained the following rights:

• Uniswap Governance

• UNI Community Token Management (treasury)

• Protocol Fee Conversion

• Uniswap ENS Domain Name (Ethereum Name Service)

• Uniswap Default Listing

• SOCKS Liquidity Tokens

While Uniswap does not return 0.05% to UNI like SushiSwap does to SUSHI, the community has "protocol fee conversion," which will have a 180-day delay. When the lock period ends, the community will be able to vote on whether to do so. Uniswap is a protocol that became a DAO without changing the fee distribution, while SushiSwap forked Uniswap to create a new fee distribution but has not yet become a DAO.

This example raises an important question: cryptocurrency companies do not need, and often should not, become DAOs from the start; they can evolve gradually. Unlike DAOs that launch as DAOs from day one, both Uniswap and SushiSwap are "gradually achieving decentralization."

Gradual Decentralization

When I try to understand Web3 and ownership economies, I often think, "How can we expect to design great products through a committee?" Later, I learned about Jesse Walden's article on gradual decentralization.

Jesse Walden wrote that trying to design products or distribute tokens through a committee from the beginning is pointless. Instead, Walden proposed a framework for achieving decentralization that consists of three steps, "the goal is to build a sustainable, compliant, community-owned product":

Product-Market Fit

The early stage of a crypto startup should be like that of any startup, belonging to a small but focused team that puts all its energy into building, learning, and iterating until it finds a product that fits the market. If your product is a flop, the community won't save it.

Web3 startups actually have an advantage in this regard. Because of Web3's openness, they can quickly build and test by integrating existing smart contracts, code, and products into new smart contracts. DeFi is called "money Legos" for a reason. Whenever someone builds something new, it becomes a building block that others can use. The magic lies in teams combining existing "Legos" rather than creating new ones.

Walden believes that at this stage, there should be no pretense of having achieved decentralization. A core team should drive all product decisions as necessary to find the interests that fit the product or market.

Community Participation

Once a company achieves product-market fit, it should start trying to involve more stakeholders more directly.

Walden likens this to open-source development, inviting community participation, providing bounties, grants, and other incentives, developing in the open, building community, and introducing a rough consensus in decision-making. Even non-open-source companies like Twilio and Stripe have built strong competitive advantages by creating an API-based community among developers.

However, unlike Stripe and Twilio, which do not grant equity to the developer community, cryptocurrency companies can and should start considering how to use fees and tokens to incentivize ongoing contributions to community participation and loyalty.

On the fee side, there needs to be a trade-off. Should you charge users and then give contributors, or should you not charge until the platform has built sufficient network effects? Since crypto services are open-source, charging high fees may lead someone to provide services to you, but not charging means you have no money to incentivize contributions. The balance here is that protocols should extract minimally, meaning their fees should only cover costs. For example, Uniswap only charges a 0.3% fee, which is directly paid to liquidity providers.

On the token side, teams can issue tokens to a small group of community members to test governance dynamics. This is a testing phase during which the core team can still retain enough decision-making power to implement their decisions. At this point, they should also publish and solicit feedback on the token distribution plan to balance rewards for the core team and early contributors with ongoing participation incentives. Continue to use game theory, mathematics, and observed community performance and dialogue to test new models to build, test, and iterate new incentive and governance models.

Achieving Decentralization Standards

Once the team successfully completes the first two steps, it can prepare to distribute tokens widely to the community. This is an alternative to traditional IPOs, SPACs (special purpose acquisition companies), or acquisitions, known as "Exit to Community," marking a turning point for a project or company to become a DAO.

This is achieved by triggering a smart contract that manufactures and distributes tokens based on predefined rules, which determine how many tokens are allocated today, how tokens will be distributed in the future, and the economic and governance rights conferred by token ownership.

From this point on, the future development of the protocol is in the hands of the community. The core team may still influence decisions based on their standing in the community or the number of tokens they hold, but the rules in the smart contract and any modifications made based on community voting will dictate future changes. Everything, from new products, hiring employees, fee changes to marketing campaigns, will be proposed and voted on by token holders.

At this point, your protocol has evolved from a top-down hierarchy driven by high-level personnel to a decentralized autonomous organization (DAO), gradually achieving decentralization.

But now that we understand how to gradually transform a project from an idea into a DAO, why is community participation and decentralized control needed from the beginning?

Four Functions of DAOs

Currently, DAOs are still in the experimental stage. The concept itself is in search of meta-product-market fit. At this stage, many people create DAOs out of curiosity and a desire to try new models of community participation, creation, and collaboration. For now, DAOs do not need to be gradually optimized; they just need to be novel.

However, in the long run, to realize Vitalik's vision of companies that require no management, DAOs must have competitive advantages over other forms of organization and governance.

The following lists the four sources of competitive advantages for DAOs, and let's see how the DAO structure can help teams build barriers.

Scale Economics

DAOs provide a way and incentives for people and organizations worldwide to concentrate resources to achieve larger goals. Theoretically, this allows them to lower the costs of producing new products or acquiring new users. The DAO structure can also reduce labor costs by purchasing services on demand. Compared to traditional human organizations, DAOs generate fewer conflicts in governance processes. However, DAOs do not have the same inherent advantages as traditional structures.

Network Economics

As new users join the network, the value of services for each user increases.

Network economics is a characteristic that gives DAOs the potential to thrive and outperform existing businesses, and it will be the most powerful competitive advantage for successful DAOs.

A typical example of network economics is Facebook; whenever one of your friends joins, Facebook becomes more valuable to you because you can interact with them and learn about their updates. DAOs are built on cryptocurrency networks that directly combine stateful protocols with currency, providing strong network effects. In a DAO, users are owners, and whenever others join the DAO or use the protocol, the value of users' tokens theoretically increases. Furthermore, as DAOs become stronger, more people build on top of them, making them even stronger and attracting more users.

Switching Costs

If users switch to other competing DAOs for significant purchases, it will lower the expected value of their tokens.

This is a tricky issue. On one hand, DAO members incur switching costs because their own tokens may depreciate if they convert to a competing DAO. But as seen with Sushiswap, blockchain-based protocols can fork to create new, very similar protocols that are compatible with existing ones. However, low switching costs are one of the advantages of DAOs; it creates a Darwinian dynamic of evolution through constant competition between protocols to satisfy their stakeholders and provide satisfactory rewards.

Industry Reputation

Products have higher value attributed to the strength of the seller's background.

Certain brands can charge higher prices for the same item partly because people associate their identities with those brands. A Tiffany bracelet conveys a different message than a regular silver bracelet. Similarly, people bind their identities to DAOs; they are contributing members of the DAO and also owners of the DAO. If you think of Bitcoin as a DAO, consider all the identities associated with Bitcoin holders. They are willing to promote Bitcoin, buy the dip, and actively criticize those who do not believe in Bitcoin.

But this sentiment among community members is bidirectional. When community sentiment is high, if the DAO does something that members disagree with, they may quickly exit. The Moloch DAO, which rewards contributions to the Ethereum ecosystem, even has a built-in "rage quit" mechanism, allowing members to exit and withdraw their tokens if they disagree with a specific community decision.

In summary, by providing economic incentives to users, contributors, and the broader stakeholder ecosystem of DAOs, and giving these stakeholders a voice in the governance of the DAO, DAOs will build strong barriers, the strongest being network effects.

However, DAOs should not overly rely on these characteristics, should not extract too much value from them, and should not grant too much power to a few stakeholders. They need to respond promptly to the community and avoid doing anything that might annoy many community members. If they do, they give others an opportunity. The threat of forking always exists; this is survival of the fittest.

The Current State and Future of DAOs

The present of NFTs is the future of DAOs.

DAOs have just found their market foothold. According to a survey by DeepDAO, the top DAOs manage only $952 million in assets. But by market capitalization, all DAO asset portfolios rank 86th among the most valuable cryptocurrencies.

There are several different types of DAOs:

Creator DAOs: There are currently no major examples of creator DAOs, but I suspect that some of those creating NFTs will launch DAO NFTs tomorrow.

Protocol DAOs: DeFi protocols like interest rate protocol Compound and liquidity protocol Aave allow cryptocurrency holders to earn billions of dollars in assets and share rewards and governance with their communities.

Investor DAOs: Their members have contributed 14,809 ETH to invest in blockchain-based projects, including other DAOs, which also invest in NFTs.

Like NFTs, the early experiments currently underway may only represent a small portion of their future potential. Perhaps in the future, we will see DAOs competing alongside billion-dollar publicly traded companies.

Recently, a tweet from Twitter CEO Jack Dorsey was minted on the Ethereum Cent platform; perhaps in the future, he could launch a distributed network for Twitter and transfer its ownership and governance to the community, which is a bold idea.

Today, companies that acquire Bitcoin on their balance sheets and mint NFTs (like Charmin and Taco Bell) may soon introduce DAOs for a small project or company. As more DAO tools emerge, running small DAO tests will become increasingly easier.

After diving into this rabbit hole, I am curious about what form DAOs will ultimately take and which governance and incentive models will prevail and attract the most capital.

DAOs are a novel model, but handing over ownership and control of projects and companies to the community is not the way to handle things. However, the more I think about it, the more I feel that stakeholder ownership is a natural state of affairs; we just haven't had the technology or models to coordinate such widely distributed governance and ownership before.

Considering all the modern technologies, I believe we should design a system that looks more like a DAO rather than a highly centralized circuit board-controlled system.

I believe we will eventually reach the other shore, where there will be a group of sufficiently intelligent people who are passionate and equipped with tools and motivation, along with a friendly survival-of-the-fittest culture that encourages them to boldly experiment deeper with DAOs, leading the world in an unexpected direction.

Ladies and gentlemen, please enjoy this unexpected journey down the DAO rabbit hole.