DAOs tackle an age-old problem of governance, which political scientists and economists refer to as the principal-agent dilemma. This occurs when the agent of an organization has the power to make decisions on behalf of, or impacting, the principal – another person or entity in the organization. Examples hereof could be managers that act on behalf of shareholders or politicians that act on behalf of citizens. In such setups, moral hazard occurs when one person takes more risks than they normally would, because others bear the cost of those risks. More generally, it occurs when the agent acts in his own interest rather than the interest of the principal because the principal cannot fully control the agent‘s actions. This dilemma usually increases when there is underlying information asymmetry at play.

 

Traditional Organizations VS. DAOs

In traditional companies, all agents of a company have employment contracts that regulate their relationship with the organization and with each other. Their rights and obligations are regulated by legal contracts and enforced by a legal system which is subject to the underlying governing law of the country they reside in. If anything goes wrong, or someone does not stick to their end of the bargain, the legal contract will define who can be sued for what in a court of law.

DAOs, on the other hand, involve a set of people interacting with each other according to a self-enforcing open-source protocol. Keeping the network safe and performing other network tasks is rewarded with the native network tokens. Blockchains and smart contracts hereby reduce transaction costs of management at higher levels of transparency, aligning the interests of all stakeholders by the consensus rules tied to the native token. Individual behaviour is incentivized with a token to collectively contribute to a common goal. Members of a DAO are not bound together by a legal entity, nor have they entered into any formal legal contracts.21 Instead, they are steered by incentives tied to the network tokens, and fully transparent rules that are written into the piece of so ware, which is enforced by machine consensus. There are no bilateral agreements. There is only one governing law – the protocol or smart contract – regulating the behaviour of all network participants.

As opposed to traditional companies that are structured in a top-down manner, with many layers of management and bureaucratic coordination, DAOs provide an operating system for people and institutions that do not know nor trust each other, who might live in different geographical areas, speak different languages, and therefore be subject to different jurisdictions. Instead of legal contracts managing the relations of the people, in the Bitcoin Network, all agreements are in the form of open-source code that is self-enforced by majority consensus of all network actors. DAOs do not have a hierarchical structure, except for the code. Once deployed, this entity is independent of its creator and cannot be censored by one single entity, but instead by a predefined majority of the organization’s participants. The exact majority rules are defined in the consensus protocol or the smart contract, and will vary from use case to use case. In some countries, like Austria for example, there are trends in the legal literature to see DAOs as a civil law partnership.

A DAO can be formalized by a smart contract. Use cases range from simple to complex. The complexity depends on the number of stakeholders, as well as the number and complexity of processes within that organization that will be governed by the smart contract. Depending on the purpose and governance rules of the organization, these use cases can have a resemblance to companies or nation-states. The more centralized governance rules are, the more it resembles a traditional company. In a more decentralized setup, the governance rules might resemble nation-states, automatically steering behaviour with tokenized incentives and disincentives. In such cases, the token governance rules incentivize and steer a network of actors without centralized intermediaries, thereby replacing the need for top-down organizations managed by a group of people, with self-enforcing code. Such decentralized organizations can use the legal system for some protection of physical property, but such usage is secondary to the preemptive security mechanisms smart contracts o er. A complex stack of technologies, steered by consensus protocols, has to be put in place in order to create a functioning autonomous infrastructure. Their native protocol tokens enable distributed Internet tribes to emerge.

DAOs are open-source, thus transparent and, in theory, incorruptible. All transactions of the organization are recorded and maintained on a blockchain. Interests of the members of the organization are – if designed correctly – aligned by the incentive rules tied to the native token. Proposals take the primary way for making decisions within a DAO, which are voted for by majority consensus of involved network actors. As such, DAOs can be seen as distributed organisms, or distributed Internet tribes, that live on the Internet and exist autonomously, but also heavily rely on specialist individuals or smaller organisations to perform certain tasks that cannot be replaced with automation. We will likely see many more DAOs, with a wide range of purposes, evolve on top of the technology that Bitcoin once pioneered. In combination with the “Internet of Things,” smart property governance can also be integrated into the blockchain directly, potentially allowing decentralized organizations to control vehicles, safety deposit boxes and buildings.

The Bitcoin Network can be considered to be the first true decentralized and autonomous organization, coordinated by a consensus protocol which anybody is free to adopt. It provides an operating system for money without banks and bank managers, and has stayed attack resistant and fault-tolerant since the first block was created in 2009. No central entity controls Bitcoin, which means that as long as people keep participating in the network, only a worldwide power outage could shut down Bitcoin. The underlying blockchain protocol enables an incentive network, powered by the governance rules tied to its cryptographic token. These token governance rulesets of the consensus layer allow for automated and transparent coordination of a disparate group of people who do not know or trust each other. The Bitcoin Network has shown that tokens can be used as a means of programming behaviour, aka steering the economic behaviour of network nodes. This incentive mechanism has proven to be a motivator in performing services to a network.