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Decentralized Autonomous Organizations (DAO)

What are DAOs?

It is possible to represent a DAO (Decentralized Autonomous Organization) as a company that is owned and operated entirely by its members and which has a Treasury that no one has the power to access without group approval. Each member can also propose ideas which are then discussed and voted on.

This means that decisions are not made by a centralized entity (for example, a CEO) but by each member: all members (who to be members must acquire a specific token) have therefore Skin in the Game (literally “they risk their skin”, in the sense of having a strong economic interest in the company) and cooperate to evaluate and arrive at a decision.

The main advantage of a DAO is that everything is transparent: it is not possible for there to be unauthorized expenditure or forged documents because any action is public and saved on the Blockchain.

How does a DAO work?

To be operational, a DAO must at least possess:

  • A set of rules for operating
  • And token to incentivize members
  • A vote on DAO policy
  • A structure designed to set up the organization
  • One Smart Contract

Lo Smart Contract manages the organization of the DAO and secures the Treasury. Once it Smart Contract is active, a vote will be needed to change its parameters, and an operation that will go against the rules of the Smart Contract it will automatically fail.

No one will be able to spend the resources contained in the DAO Treasury without the group’s approval: this eliminates the need for centralized authority. The members of the DAO have de facto control over any proposal presented, this is because only the holders of token can vote on decisions and rule changes of a DAO.

Anyone can join or leave a DAO at any time by transferring or withdrawing their tokens. Instead of having to discuss and vote on everything separately, members of a DAO work together and payments are automatically authorized when majority votes pass.

I Token of Governance

To become a member of a DAO it is necessary to own digital assets called Token of Governance; they allow you to vote on ideas and proposals in a DAO.

For example we can see in figure 1 the address (user) iso30q0F which holds 8.92 governance token $POWER. Whereas the number of token $POWER in circulation is 1,800, this address has an actual voting power 0.44% (figure 1).

Example Governance Token

Figure 1. Governance tokens owned by a wallet

Tipi di DAO

There are essentially the following types of DAO:

  1. DAOs that manage projects open-source based on Blockchain
  2. DAOs that make investments on behalf of investors

The first type of DAO is designed to jointly manage a project open-source based on Blockchain: These associations can act similarly or like companies they invest in startup. An example is LidoDAO (https://lido.fi/) which decides on key parameters or makes other decisions related to staking protocol of ETHEREUM (a cryptocurrency) through the voting power of governance token $LDO (an example will be illustrated later).

Decentralized Finance

The second type makes investments on behalf of investors: these organizations are more like companies Venture Capital than anything else. An example is Waves DAO (https://app.power.tech/), where it is decided whether or not to invest the funds in the Treasury in the projects proposed through the voting power of the token of governance ($POWER) (also in this case an example will be illustrated later).

Type 1 – Lido DAO: example of governance and voting proposal

Lido.fi is a platform of decentralized finance (DeFi) which aims to offer solutions for the cryptocurrency sector related to Ethereum 2.0. Its main goal is to allow Ether (ETH) holders to participate in the strengthening of the Ethereum 2.0 network through the staking (a system for obtaining economic rewards by holding a certain amount of certain cryptocurrencies for a period), which yields an annual passive interest of 5% (approximately).

Below we can see a proposal in the forum that proposes to appoint a Committee (already existing) to control the operational expenses of the DAO. Since the cost of transactions on the blockchain Ethereum can be very high, appointing a Committee that approves the expenses of the DAO is an excellent idea! The committee is made up of people who hold government tokens on a wallet and can decide, by voting, whether to approve a DAO expense or not (figure 2).

DAO Committee Proposal Example

Figure 2 Lido DAO Proposal

For those interested in learning more, the full discussion on the proposal can be seen here (article in English): https://research.lido.fi/t/nominate-the-gas-supply-committee-as-a-supervisor- for-gas-expenditure/4724

The vote on the proposal was carried out via snapshot.orga tool that allows you to vote while saving transaction sending costs (figure 3).

DAO voting proposal example

Figure 3. Lido DAO proposal vote

The vote (which reached a quorum and was successful) can be viewed here: https://snapshot.org/#/lido-snapshot.eth/proposal/0xbfecc75c45bca53d3c5786f099d46559ac597bc3fae802d5f599b60f10b4bd4a

Type 2 – Power DAO: example of investment and voting proposal

Below you can see the proposal of an already existing project asking for additional funds (around $78k) from Waves DAO (a Child DAO Of Power DAO) to complete its 2023 roadmap (figure 4).

Power DAO investment proposal example

Figure 4. Investment proposal: 2023 roadmap

In response to this investment request, the project proposes to send a certain number of funds to the DAO treasury token of the project, on the value of which the KPIs will be calculated at the end of Observation Period (figure 5).

Example investment conditions

Figure 5. Investment proposal: investment conditions

The proposal is accompanied by a funds transfer transaction which will be automatically executed if the vote is successful (figure 6).

Project investment transaction example

Figure 6. Transaction making the investment in the project

In this case the vote reached a quorum and was successful and the project received the funds from the treasury (figure 7).

Example of proposal schedule and voting outcome

Figure 7. Proposal scheduling and voting outcome

KPI e Slashing

Waves DAO was created to invest in projects Blockchain and make profit, for which the following policy and corresponding KPIs have been defined in the same definition of the DAO:

  1. If the Net Treasury Value is in profit more than 10% in a 3 month period then 20% of the profits will be distributed to the Governors (holders of the token $POWER) and 80% to investors (who sent funds to the Treasury).
  2. If the Net Treasury Value is at a loss of more than 20% in a 3 month period then the Governors suffer a penalty (Slashing) as a percentage equivalent to their share and some of their token ($POWER) they will be burned.
  3. If the Net Treasury Value is between 9% profit and 19% loss over a 3 month period then new KPIs will be agreed for the next Observation Period.

At the end of the Observation Period, the KPIs will then be evaluated and the resulting actions will be performed. Members who make decisions will be penalized (Slashing) or rewarded depending on the goodness of their decisions.

As a further in-depth analysis, let’s look at an evaluation of the Return on investment (ROI) for the Proposal updated to 29 September 2023: the 16,295 $PUZZLE were subsequently invested by the DAO (with a further proposal) in a product of staking (lo staking can be described as a sort of deposit account with an interest rate, which in return for a ‘deposit’ of assets returns a number of digital assets to the custodian) and it is estimated that they have grown to around $18,000 PUZZLE.

If the Observation Period ended for example on 28 September, the investment would be in profit (52.54%) and according to the KPIs of the Waves DAO governors would be remunerated according to their percentage (figure 8).

DAO investment return example

Figure 8. Calculation of Return on Investment for DAO proposal

Final thoughts

DAOs are technology-based digital entities Blockchain which have captured attention in the world of cryptocurrencies and decentralized finance (DeFi) for several reasons and are an intriguing part of the cryptocurrency world as they are demonstrating the potential to redefine how organizations operate and make decisions.
However, they remain subject to significant challenges, including regulatory, security and financial risks, which require continued attention and innovation to be successfully addressed.

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