Decentralized Autonomous Organizations (DAOs): the Most Underrated Layer of Web3

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In all the talk about NFTs and Web3, probably the best kept secret is the concept of a decentralized autonomous organizations (DAO). It is surprising that many firms have not yet latched on to this concept.

What is a DAO?

In late 2021, a group of eight friends pooled their money to buy the last privately owned copy of the U.S. Constitution. They did this using a Web3 concept called DAO. In the span of just a few days, what they named the ConstitutionDAO managed to raise over $48 million dollars from 8,000 members who were galvanized by the mission of owning a piece of U.S. history.

Though they ultimately failed in their mission, the fact that they could collect more than $48 million using Web3 technology did not go unnoticed. The group came together online from various corners of the Earth to form a DAO for this single purpose. It is unclear if they ever could have been successful; even if they had the winning bid, they would have needed a physical person to participate in the Sotheby’s auction and wire U.S. dollars to an escrow agent.

But, on the day this made headlines, Web3 became more than just the world of crypto. Crypto had derived its value from the world of decentralized finance (DeFi) and bitcoin. Events like the founding of the ConstitutionDAO introduced a social aspect of the token economy – and showed the world there is more to Web3 than DeFi.

A DAO is an autonomous group of interested participants who come together for a common purpose – be it for profit or non-profit. They use the financial constructs and digital assets of Web3 to pool financial resources so funds can be used to further their cause. Each member has a share and voting rights in how the funds get used; these decisions are programmatically defined in the form of smart contracts.

Members of a DAO are akin to shareholders coming together to own parts of an LLC and steer how the firm uses the capital that has been collected.

Today, there are already a handful of DAOs, each with greater than $1 billion in capital controlled by their treasuries. We are entering a world in which communities are coming together at a grassroots level to deploy massive amounts of capital in ways that have never been seen before. And yes – there are many open questions.

To learn more about DAO and its relationship with the Web3 tech stack, read How Business Should Think Strategically about Web3 and the Metaverse.

Are DAOs the next breakthrough for organizing humanity?

As I write this (in June 2022), we are witnessing a crypto crisis. However, it is clear the concept of DAO is breaking ground and here to stay. The concept of DAO lends itself very well to the post-COVID future of work. The decentralized nature of DAOs allows them to operate with the kind of flexibility that will put digital-native Web2 firms to shame.

DAOs will also reboot the concept of employment. They are organized in terms of project-based and result-based workstreams instead of 40-hour week employment contracts. This will not only free up talent to work across firms, it will also attract key talent as needed. Job postings will turn into bounty programs – which are better designed for performance-based payouts.

Reputations on platforms like GitHub and Discord are soon going to trump the old world of resumes.

Understanding a DAO as an “Organization as Code”

DAOs are organizations whose rules are codified in a written charter or bylaws. The rules that govern a DAO are encoded into the very structure of the organization itself through smart contract technology. DAOs marry rules with code. Think of a traditional organization as a set of rules attached to a governance structure. Now think of those rules and governance embedded in code, realized through a smart contract, which is a decentralized application (DApp) that automatically runs when predetermined conditions are met. A smart contract, therefore, becomes the foundational element of a DAO.

Codifying organizations in this way can get interesting because these entities are borderless and internet native. They run completely on blockchains; there is no human intervention or central intermediary. In that sense, DAOs lend themselves much better to 21st century workflows, which are more byte-driven than they are atom-driven.

The degree of transparency and predictability that smart contracts allow is unparalleled – workflows and business logic programming in technology are no longer dependent on the whims of a team of developers sitting in California. Smart contracts will continue to execute long after the original team that designed them has moved on.

The right way to understand the true meaning of a DAO, then, is to use the term “organization as code” and/or “community as code.” A DAO will bring in greater stakeholder diversity than a traditional business structure. And more people will participate in governance decisions with the help of fewer layers of management, leading to a flat, value-based hierarchy.

Will DAOs change the nature of capital acquisition?

The ConstitutionDAO collected $48 million without any formal business structures. Initial coin offerings (ICOs) in 2016-2017 also heralded alternate routes to capital. The fact that DAOs are built on blockchain-based voting systems and can enable smart contracts is powerful. This helps DAOs streamline both the capital acquisition process and the deployment of capital through algorithmic proposals, which are based on voting via blockchain and are executed transparently in smart contracts.

This removes multiple layers of bureaucracy that are normally put in place to eliminate and make up for human error. It also allows DAOs to hyperscale with very little impact to overhead costs. All of this is possible because business decisions are programmed onto permissionless blockchains that are purpose-built. And these blockchains can transact at non-linear scale at very low cost.

Moving from the early stages of DAO

We are still in the experimental stages of DAO. The first DAOs are going through some growing pains, including low voter participation. This means a few people are making decisions for the rest of the DAO – which has led to operating structures that are decentralized-in-name-only (nicknamed DINO) as the hoped-for decentralization gets lost in execution.

Also the right balance of on-chain and off-chain business process execution has yet to be worked out. There are multiple real-world transactions that are not yet possible on blockchain. And DAOs should not be seen as the silver bullet to all problems.

However, there are certain businesses and processes that lend themselves to complete on-chain operations. These are online transaction-heavy processes that involve matching, discovery and clearing – and they are the businesses and processes that will likely get disrupted in the coming months. A good example is investment DAOs that invest Ethereum cryptocurrency in exchange for tokens that are made available on an automated market. In such cases, there would be no need to centralize power in the hands of a few. This would operate entirely on smart contracts and scale at extremely low costs.

What is next for DAOs?

Web2 unleashed a new era in business-to-customer (B2C) relationships, but the hidden leaders in Web2 were those that catered to business-to-business (B2B) opportunities. When DAOs enter the B2B realm, we will see new challenges and opportunities emerge. Imagine a DAO purpose-built for lending money to other DAOs – and what this can do to the lending business of banks.

If anything, DAOs have shown us there is much more to Web3 than NFTs and metaverses. It would be reckless to fail to pay attention to this emerging technology.

The victims of the DAO will be the processes, businesses and transactions that lend themselves to on-chain handling. Organizations that are currently making money based on the inefficiencies in such markets – be it either in discovery, matching or transactions – will be the first to feel the pain of this new market in the coming months.

A DAO as a mode of organizing capital – be it human, talent or financial – is here to stay. And those who ignore it do so at their own peril.

ISG helps enterprises understand the relevance of emerging technology concepts like Web3, metaverse and DAO – to define impact on business models and partnerships that can bring it to bear. Contact us to find out how we can help you.

About the author

Prashant Kelker leads ISG’s Digital Advisory Services and is the Chief Strategy Officer of ISG. He offers ISG’s clients 21 years of experience in Technology Strategy & Management. He works with enterprises to shape their operating models for a digital journey and brings 25 years of expertise in all aspects of applications and platforms, from designing transformations through the whole sourcing lifecycle. Prashant’s experience spans a range of industries, including Financial Services, Telecom and Media, Automotive and Utilities, and a range of geographies, including Europe, the Americas and India. Recently, he helped a Fortune 50 industrial manufacturing giant define its enterprise wide Digital Thread strategy. He has helped firms consolidate next-generation sourcing for applications, and execute digital transformations. His experience spans from leading core software product development to delivering IT services for application portfolios both onsite as well as offshore – which he combines this with digital trends to bring thought leadership to his engagements.

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