(Bloomberg) -- A loosely-organized group of investors made casual and even some long-time observers of the crypto world wonder what’s a DAO, or decentralized autonomous organization, after they mounted a crowdfunding-like campaign to buy a rare copy of the U.S. Constitution.
While the bid from the project known as ConstitutionDAO fell short at a Sotheby’s auction on Thursday, the effort showed the power of the DAO, and how the idea has the potential to change the way people buy things, build companies, share resources and run nonprofits. The Ethereum-based project ended up raising $46.3 million from thousands of donors, one of the largest amounts ever through the process.
Here’s how the community owned blockchain projects work and some of the questions being raised.
In a traditional company, a CEO and management typically make all decisions. In a DAO, thousands or even millions of people can be involved in deciding on product features, strategy and fees. Their votes are counted, and they impact what the project’s funds go toward.
Developers, investors and users first often have to put some money or work into a project to get special digital tokens, with which they can vote, and which are often available for sale on crypto exchanges. A share of the tokens issued is also usually put into the project’s treasury. That treasury is governed by a smart contract -- a piece of software that sits on a blockchain, a digital ledger similar to that underpinning Bitcoin. The smart contract only allocates funds to efforts approved by the token holders. No one can access the treasury without the approval of the group.
The smart contract can also let participants make operational decisions. In the case of ConstitutionDAO, contributors were promised a governance token with which they could have voted on where the constitution would be displayed.
Unsurprisingly, it turns out that users are more loyal to projects that reward them with governance tokens. The tokens often have various additional incentives baked in. Holders of tokens of decentralized exchange dYdX, for example, get discounts on trades. Users can also make the project more agile.
Centralized or traditional organizations “can be slow to change and have difficulty scaling and resolving multiple goals,” said Aaron Brown, a crypto investor who writes for Bloomberg Opinion. “Decentralized organizations can be much more flexible and innovative, self-interested people have more difficulty co-opting them.”
Over the years, DAOs have been created to run venture funds, distribute money to nonprofits, and lend and borrow digital coins while earning interest via decentralized-finance, or DeFi apps. In one of the best-known examples, PleasrDAO paid $4 million in July for a copy of a single-issue Wu-Tang Clan album once owned by Martin Shkreli.
To be sure, investing in a DAO can end up being more expensive than it initially seems. A median donation to ConstitutionDAO was $206.26. To process the donation, many investors likely paid a substantial amount in so-called gas fees to complete the transaction. With the bid lost, ConstitutionDAO will need to send the funds back, minus gas fees needed to process the reimbursement. As a result, many small investors could end up losing half or more of the funds contributed. That’s why many DAOs are now being set up newer networks such as Solana, in part because the transaction fees are so high on Ethereum.
No matter the ownership structure, DAO projects have to abide by existing laws and regulations -- and, in many cases, may need to register with authorities.
©2021 Bloomberg L.P.