In-depth Analysis of DAO: Governance Models, Potential Limitations, and Value Drivers

Article Authors: Researcher Nansen & Yasmine Karimi

Article Translation: Block unicorn

First DeFi, then NFT, now DAO

If you are reading this article, you are very, very early to understand something new. We believe that the 169 DAOs (according to DeepDAO) that exist today are just a drop in the ocean of the next chapter of cryptocurrency that is emerging. These DAOs set a precedent for revolutionary governance models that have the potential to replace all forms of enterprises, governments, and human organizations.

What is a DAO?

DAO stands for Decentralized Autonomous Organization, referring to crypto-native groups formed around a common purpose, which often (but not always) involve pooling funds for investment based on specific goals/tasks.

The use cases for DAOs are endless and continue to evolve. They range from purely social platforms, such as token-gated Discord servers (i.e., "friends with benefits," which a16z recently invested in), to purely investment-driven platforms, such as MetaCartel Ventures. PleasrDAO is another interesting example; a hybrid of social and art collecting that acquires culturally significant digital artworks over time. Below is a market map showing the DAO landscape in 2021.

2021 DAO Landscape, curated by Coin 98 Analytics

Given the diversity of use cases and the speed at which new DAOs are emerging, market participants and observers still find it challenging to understand the true meaning of DAOs.

This is why we believe it is useful to clarify the fundamental principles of DAOs, demonstrate how they differ from traditional organizations, and provide guidance on how to engage with this revolutionary wave.

Explaining DAO Governance Models

The simplest way to explain a DAO is to start with the acronym. First, DAOs are autonomous, meaning they are organizations run by smart contracts. These smart contracts are lines of code that are automatically executed and agreed upon by the initial developers of the DAO, stored on the blockchain. They enable the organization to self-sustain when it comes to hiring, allocating rewards, and other bureaucratic or significant issues typically found in organizations.

Secondly, unlike traditional organizations, decisions are made collectively rather than by a CEO or senior management. In fact, according to the DAO, members who hold one or a predetermined number of DAO-native tokens can submit and vote on changes to smart contracts, propose initiatives, invest in ideas, etc., allowing the DAO to evolve and grow. Notably, the ways in which members are entitled to access, economic rights, and governance rights vary by DAO.

Membership in a DAO takes the form of ownership of DAO-native tokens. The number of tokens required to join varies by DAO. People can purchase tokens on or after the release date, or they can receive these tokens for contributions, depending on the DAO. Although DAOs are generally known for being open to everyone, smaller DAOs tend to be more selective than larger protocol DAOs. In such cases, owning tokens is not enough; a written application and an invitation from other members are also required.

Once you join a DAO, owning the DAO's native tokens can provide various benefits, from voting rights to sharing in the profits generated by the organization. When demand for the token increases, met by a hard supply cap, members can also benefit from the overall appreciation of the token.

Typically, in large protocol DAOs that serve as financial service platforms (e.g., multi-chain platforms like BitDAO or lending platforms like COMP), token ownership unlocks voting rights on issues related to fees and distributions. Members primarily earn rewards by staking their tokens and providing liquidity to the protocol. In other cases of large DAOs, governance tokens may offer more governance power but lack intrinsic monetary value. For example, this is the case with Aavegotchi's native token, GHST.

In smaller DAOs (500 members or fewer), membership often involves working for the DAO. In addition to voting rights, members may receive tokens, token rewards, predetermined treasury shares, and/or cryptocurrency (such as Ether, Dai, and Cash) in exchange for their contributions. This is especially true for investment DAOs (e.g., Laos, MetaCartel Ventures) and collector DAOs (e.g., PleasrDAO). Some of these, like MetaCartel Ventures, require members to continue participating in management duties, due diligence, proposals, and investment voting if they wish to remain in the DAO.

Once you become a member, you also gain voting rights, which can vary significantly between DAOs. The minimum requirements for voting may include holding one of the DAO's native tokens, a predetermined number of tokens, or a threshold of the total supply (e.g., 1% for noun DAOs). Once a proposal is submitted and voted on, the quorum required to validate the proposal can also vary, such as 10% quorum, 20% quorum, 50% quorum (e.g., in Laos), and so on.

How DAO Models Represent a Paradigm Shift in Human Organization?

This model is revolutionary in two ways, constituting a paradigm shift in human organization. First, for the first time in history, internet users can collectively create and exchange value in a trusted environment. This environment is the blockchain. Blockchain technology first powered DeFi, then non-fungible tokens, and is now creating a space for collective work among a group of people. In fact, it eliminates the need for third parties to participate in financial transactions, as all financial transactions and rules are recorded on the blockchain. This makes DAOs independent of government institutions, as the blockchain acts as a third party.

Secondly, unlike other forms of organizations, DAOs have stronger incentive mechanisms. Members are incentivized by voting rights, which may in turn affect the fees and rewards they receive, and they can gain a share of the profits generated through tokens, token buybacks, or cryptocurrencies. Since the advent of traditional Web2 platforms, most of the value created by users has been captured by the platforms, specifically by their founders/CEOs. In the new framework that DAOs are setting up, other members can now capture a portion of the value created. The specific ways this conversion occurs depend on the particularities of economics and voting rights within each DAO. Overall, this consistency of stakes is said to incentivize each member to make the best contributions and make the organization more efficient.

Simplified Company Relations in Traditional Organizations and DAOs

Potential Limitations of the Model

However, the same characteristics that fundamentally make DAOs superior to traditional organizations can also be sources of vulnerabilities. The blockchain technology they rely on makes them trustless and transparent, but it also makes their code accessible to everyone, including potential hackers. A perfect example is the 2016 DAO hack, during which hackers exploited a flaw in the code.

Similarly, DAOs cannot be shut down by authorities or governments because they rely on the blockchain as a third party, a fact that may soon attract increasing attention from regulators.

In addition, the lack of verticality makes decision-making time-consuming. Nevertheless, we have seen the emergence of proxy voting in DAOs, which can make governance more efficient and effective. More generally, the structure of DAOs will increasingly include representatives, sub-teams, and specialized executives.

In fact, the DAO model itself has limitations and is not suitable for all types of organizations. While we do not know to what extent it will disrupt all forms of human coordination, one thing is certain— we will see more and more DAOs emerging, and at a rapid pace.

Engaging with this Revolutionary Wave

Now that you understand the basic model of DAOs and are eager to learn about this emerging trend, you may be wondering: how can I get involved? The quick answer is to join a DAO by acquiring its native tokens. Depending on the DAO, you may need to purchase one or more tokens on or after the release date, and some DAOs even distribute tokens to active contributors. However, some DAOs will succeed while others may not perform well. Therefore, it is important to conduct due diligence on the project and the quality of its members before participating and analyze how value can be driven within the DAO. Although the field is still relatively new and no metrics have been established for evaluating DAOs, we provide below some factors that drive quality membership and DAO value.

Drivers of DAO Value

Effective Incentive Mechanisms

It is crucial to understand how members are rewarded for their contributions within the DAO. Typically, governance rights, contribution rewards, or profit shares incentivize members to work for the DAO and actively participate in governance. This, in turn, makes the organization more efficient.

Another way to look at it is that the secondary market value of tokens increases as the DAO becomes more successful. If the DAO becomes increasingly successful, it will attract the attention of other market observers who wish to capture the advantages of the DAO's creative/monetary output, treasury voting rights, etc. Thus, the value of the DAO's tokens appreciates. When the tokens appreciate, it incentivizes members to work harder, thereby continuing to drive the success of the DAO and the value of the tokens.

Therefore, we can expect that, in the long run, DAOs with consistent incentive mechanisms for contributors may perform better than other DAOs. The more rewards members receive based on their work/contributions, the higher the value of the DAO will be pushed.

High Voter Participation Rates

The value of a DAO is driven not only by the work of each member but also by active participation in governance, which enables the organization to continuously adapt and grow. Having voting rights does not necessarily mean that members will vote. You can measure the extent of member participation in decision-making by considering the voter participation rate for all submitted proposals, which you can find on DeepDAO.

The smaller the DAO, the more relevant this metric becomes. You may notice below that the largest DAOs are often those with lower participation rates. The reason behind this is that they are primarily large protocol DAOs, where collective decision-making is currently limited to marginal issues.

Voter Participation Rates Relative to DAO Size

This is the overall voter participation rate, but you can take a more specific look at the main contributors within the DAO by identifying the addresses that received the most tokens from the treasury. This indicates which members received the most rewards for their contributions.

Top Balances of FwB Tokens

You may also want to see if they include notable figures in the DAO space. This indicates that the DAO has garnered the attention of experts in the field. Here are a few names:

Top 7 Outstanding Contributors in the DAO Space

Consistent Project Delivery

If there is a good incentive mechanism and members are actively contributing, then the DAO should consistently deliver projects and initiatives. DAOs that regularly push projects are often good indicators of collective engagement, execution capability, and long-term value appreciation potential.

A perfect example is PleasrDAO. Since its first purchase of Uniswap V3 NFT last March, the DAO has purchased and segmented Doge Meme NFTs, acquired the Wudang Family CD, and even organized an exclusive event for its members in New York.

Consistent delivery, in turn, drives the value of the DAO's tokens, increasing the motivation to join the DAO, stimulating participation, and feeding back into effective delivery.

Conclusion

In summary, DAOs mark a new chapter in crypto history. While we do not know to what extent they will disrupt all forms of human organization, it has been proven that the DAO governance model is particularly successful for crypto-native communities. It should surpass traditional organizations as it enables internet users to collectively create and exchange value in a trusted environment and rewards them for the value they create. Although this new governance model inherently faces challenges such as vulnerability, it will continue to thrive. Today, there are only 169 DAOs. One day, there will be tens of thousands. Now is the best time to join the revolutionary wave and participate in one or more DAOs.