What is a DAO?

What does DAO stand for?

DAO stands for decentralised autonomous organisation. ethereum.org defines it simply: “A DAO is a collectively-owned organization working towards a shared mission.” The US Securities and Exchange Commission (SEC) used similar language in 2017, describing a DAO as “a ‘virtual’ organization embodied in computer code and executed on a distributed ledger or blockchain.”

DAOs rely on smart contracts — programs that run on a blockchain such as Ethereum.

How does a DAO work?

According to ethereum.org, “The backbone of a DAO is its smart contract, which defines the rules of the organization and holds the group’s treasury.” In practice the cycle looks like this:

1. Proposal. A member suggests something — for example, spending part of the treasury or changing a rule.
2. Vote. Members vote according to the DAO’s rules.
3. Execution. If the vote passes, the smart contract can carry out the decision, such as releasing funds.

ethereum.org says decisions are governed by proposals and voting so everyone in the organisation has a voice, and everything happens transparently. It contrasts DAOs, which are usually flat, with traditional organisations, which are usually hierarchical.

Who gets to vote in a DAO?

It depends on the membership model. ethereum.org describes three:

On token-based DAOs, ethereum.org notes: “Mostly these governance tokens can be traded permissionlessly on a decentralized exchange.” That means voting power can be bought.

Illustrative example (hypothetical numbers): in a DAO where one token equals one vote, a member holding 500 of 100,000 voting tokens controls 500 ÷ 100,000 = 0.5% of the vote. Real DAOs use different voting rules, so always read the DAO’s own documentation.

What happened to The DAO in 2016?

“The DAO” was an early project on Ethereum; the SEC calls it “one example of a Decentralized Autonomous Organization”. According to the SEC, from 30 April to 28 May 2016 it sold approximately 1.15 billion DAO Tokens in exchange for approximately 12 million ether.

On 17 June 2016, the SEC says, an unknown attacker began diverting ETH from The DAO, moving approximately 3.6 million ETH — one-third of everything it had raised — to an address the attacker controlled. The US National Institute of Standards and Technology (NIST) says flaws in how the smart contract was built allowed the theft. Ethereum’s community responded with a “hard fork” — a change to the network’s rules — which ethereum.org dates to 20 July 2016.

The lesson for beginners: putting an organisation’s money into code does not make it safe. If the code has a flaw, the money can be taken, and ethereum.org warns that assets stolen from smart contracts are mostly irrecoverable.

What did the SEC say about DAOs in 2017?

On 25 July 2017 the SEC published a Report of Investigation under Section 21(a) of the Securities Exchange Act of 1934 about The DAO (Release No. 81207). Its main conclusions:

• DAO Tokens were securities under the Securities Act of 1933 and the Securities Exchange Act of 1934.
• Holders relied on others. “Investors’ profits were to be derived from the managerial efforts of others—specifically, Slock.it and its co-founders, and The DAO’s Curators.”
• Voting was limited. “DAO Token holders could only vote on proposals that had been cleared by the Curators.”
• Code is not an exemption. “The automation of certain functions through this technology, ‘smart contracts,’ or computer code, does not remove conduct from the purview of the U.S. federal securities laws.”

The SEC chose not to bring a case: “The Commission has determined not to pursue an enforcement action in this matter based on the conduct and activities known to the Commission at this time.” The report is a 2017 document, and regulators’ approach to crypto can change.

Can a DAO be held legally responsible?

A US court has said yes, at least in one case. In June 2023 the Commodity Futures Trading Commission (CFTC) announced that a federal court held “the Ooki DAO is a ‘person’ under the Commodity Exchange Act and thus can be held liable for violations of the law.” The court ordered a civil monetary penalty of $643,542, along with trading and registration bans.

The CFTC’s enforcement director said the decision “should serve as a wake-up call to anyone who believes they can circumvent the law by adopting a DAO structure”.

Some places have written laws for DAOs. ethereum.org notes: “Currently Wyoming, Vermont, and the Virgin Islands have DAO laws in some form.” Elsewhere, check what local rules say before joining one with real money.

What are the risks of joining a DAO?

• Smart-contract bugs. The DAO lost one-third of its ETH to an attacker in 2016 (SEC). Deployed code usually cannot be changed to patch flaws (ethereum.org).
• Concentrated voting. When governance tokens can be bought on exchanges, large holders can outvote smaller ones.
• Limited control in practice. In The DAO, holders could only vote on proposals cleared by its Curators (SEC).
• Securities and legal risk. The SEC found The DAO’s tokens were securities; a court held the Ooki DAO liable as a “person” (CFTC).
• Token price risk. Governance tokens are crypto-assets. The UK Financial Conduct Authority (FCA) says crypto-assets are high risk and you should be prepared to lose all your money.
• Scams. The FBI has warned about spoofed websites that trick people into connecting their wallets to “drainer” contracts — learn the red flags of crypto scams.

Blockhorizon is an education site. Nothing here is a recommendation to join any DAO or buy any token.