What is a DAO? The Backbone of Ethereum’s DeFi Movement
The Ethereum ecosystem’s buzzing with energy from the rapid growth of decentralized finance or DeFi. But, did you know that behind many of the popular products and services built on Ethereum stands a DAO? That’s right. The vast majority of protocols in the $473M DeFi market either are run by one, plan to implement one, or are built on a protocol already run by a DAO.
What is a DAO?
A DAO is a decentralized autonomous organization. Once launched as a smart contract on the Ethereum blockchain, a DAO operates according to its programming. These organizations run without a central operating authority, all the rules of the organization are enforced by its code running on the blockchain. Furthermore, DAOs often manage their own treasury and issue their own tokens. These tokens represent membership, voting rights, and/or ownership of the DAO. In the Ethereum ecosystem, DAOs fill similar roles to traditional organizations you are familiar with like corporations, cooperatives, non-profits, etc.
What was “The DAO”? Why DAOs are here to stay
People say Rome wasn’t built in a day. And, neither was DeFi. Back in 2016, the young Ethereum community was super hyped around a project called The DAO. It was one of the first attempts at a for-profit DAO which raised approx. $150M worth of Ether (ETH) at the time. Unfortunately, a hacker discovered a flaw in The DAO’s contract code which allowed them to steal a large portion of the held ETH inside. And ultimately, The DAO Hack situation caused the Ethereum community to fork the blockchain, reverting the smart contract.
The community learned about the importance of thorough code audits and smart contract security through this once-in-a-lifetime experience. Despite this initial stumble, developers continued to explore decentralized governance. And, DAOs remained a viable way to align the goals of a decentralized userbase and token stakeholders. But not every DAO is the same, DAOs can be designed for many purposes. Today, DAOs have become more sophisticated and govern DeFi protocols in control of over 1% of all Ether.
The role of DAOs in DeFi
Decentralized finance grew alongside the rise of popular for-profit DAOs which now own and operate decentralized financial (DeFi) services. As previously mentioned, many DAOs involve their own tokens with built-in incentives to keep their service running. Many smart contract platforms sold these tokens in initial coin offerings (ICOs) to get their service off the ground. Token holders became stakeholders in the future of these platforms. And, DAOs generally fit the bill for any time a smart contract platform needs to adjust its token mechanics or platform rules.
Token holders vote on issues controlling these DAOs and how their services run. Much like the shareholder of a company, token holders want the protocol to run smoothly and create demand for the token. So naturally, it’s in token holders best interest to implement features that draws users to the platform or accrues additional value for the token. For example, adding a coin burn mechanism reduces the existing supply of tokens. Or maybe, platforms add support for new tokens, decided by token holders. MakerDAO and Kyber Network are two primary examples of DeFi protocol making use of this type of token incentivized governance.
As the world of DeFi grows and protocols become more complex, it’s very likely that DAOs will become more significant. Carefully managing large protocols becomes a priority for the entire community.
Take for example the DAI stablecoin ecosystem. There’s currently 18.5M DAI locked into DeFi protocols. Services like Compound Finance and Uniswap rely on MakerDAO token holders to maintain stability for their users. This interconnected web of digital commerce systems will likely continue growing. Maybe even someday your local news might report on MakerDAO decisions alongside the stock market updates.
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