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August 22, 2022
Previously we discussed the basics of DAOs, but what are their benefits? And what can they be used for?
DAOs have gained incredible popularity within the Web 3.0 space over the last year. It seems wherever you look, there’s a new DAO popping up. DAOs that function as a social network, DAOs that give you a chance to win a million-dollar jackpot, DAOs that set out to buy a rare private copy of the US Constitution (if you are interested, Constitution DAO successfully raised over $47 million within 72 hours but failed at the auction). While DAOs are very fascinating (and it’s understandable why more and more companies want to use them) DAOs are not everyone’s cup of tea - or at least, they shouldn't be! This blog examines what DAOs are good for, and when it’s better to use traditional business structures.
Before we get started, what is a DAO? Decentralised autonomous organisations lack a central authority, and are used as a means of managing an organisation or a collective. DAOs differ greatly from traditional business structures and are collectively owned entities.
Before we deep dive into when it’s a good idea to use a DAO, it’s important to understand that DAO is a broad term that encompasses a huge number of different types of business. Two collectives can be vastly different, but still both be a DAO. With that in mind, you should take the below suggestions with a pinch of salt and evaluate your business model with legal and tax advisers before saying ‘yes’ to a DAO. Trust us, you don’t want to make a wrong decision here, as it could cost you more than heartbreak, tears, and a few sleepless nights!
The main idea behind most DAOs is to create autonomous, decentralised organisations for like-minded people where every member has a vote on what the DAO does. Therefore, DAOs are well suited for communities of 10-20 individuals who have a common goal in mind. Not only should it be simple to get members together to vote on a proposal, but members should be incentivised to work on the project to facilitate the development of the DAO.
Compared to traditional organisations, DAOs offer greater transparency. DAOs eliminate human error and the manipulation of funds which, unfortunately, happens often. As such, DAOs are well suited for fundraising projects such as UkraineDAO which was set up to collect and distribute donations to assist those affected by the war in Ukraine. Because the DAO’s balance sheet exists on a public blockchain, members can understand what happened to each transaction and ensure that the funds are used for the purpose for which they were raised.
Another reason why the structure of a DAO is suited for UkraineDAO is because their business has one specific use case. DAOs have been used for many purposes so far (such as investment, charity, fundraising, borrowing, or buying NFTs), and have seen much better successes than DAOs with multiple purposes. Another great example of this is LexDAO, whose purpose is to create smart contracts capable of automating aspects of legal services, including arbitration. With many DAOs existing in a grey area of legality, a DAO like this may see a lot of success.
Traditional organisations and the regulations that govern them often limit an individuals’ ability to join businesses outside of the country of their location. On the other hand, DAOs come with ease of global access and a lower barrier to entry. DAOs are designed for access for anyone from anywhere in the world and they support anonymous operations. As such, DAOs might be the only option for a community which is spread all around the world especially for those operating in jurisdictions where privacy is important.
While the above outlines when using a DAO might make sense, there will be scenarios where a traditional business model will be more appropriate. So, when should you say no to a DAO?
One of the biggest issues DAOs are facing is related to the decision-making process. If a DAO has over 100+ participants, it can be extremely difficult to coordinate all members to make a decision (even if the voting mechanism does not require every member to participate in the voting). This can significantly slow down the development of the DAO and in the Web 3.0 space where everything is moving at the speed of light, this can be detrimental for many projects.
One of the main downsides of DAOs is that they are presumed by law to be general partnerships, and their members, as partners of DAOs, could be jointly exposed to personal liability for all the actions and debts of the DAO. Therefore, businesses that could potentially have a high risk of being exposed to some losses are better suited for traditional limited companies’ structures, where all liabilities will sit with the business rather than its members.
DAOs are not well-suited for organisations with multiple departments and sub-departments. While the decentralisation and automation features of DAOs might work for some elements of such businesses (such as paying invoices), they will not work for all of them. For example, good luck automating the responses to member complaints. As a result, many DAOs have an overarching limited company that makes most of the DAO decisions. However, this adds an element of centralisation to a DAO, which raises the question as to whether a DAO is the right structure for the businesses after all.
While DAOs may seem like the ideal future of organisations, they are still a work in progress. Most DAOs are still testing their governance systems and trying to understand the best way to deal with imbalanced voting rights and reach full decentralisation status. Moreover, until the legislators decide how to regulate DAOs, they will continue existing in grey territory.
Nevertheless, DAOs have a lot of potential: from putting power into the hands of its members and offering huge scalability to organisations, to giving them global accessibility by removing geographical barriers and providing a great platform for funding investments.
Before setting up a DAO some technical, legal and tax issues should be considered. Our emerging technology team intimately understands the ins and outs of DAOs and their regulation in the UK. Wondering whether a DAO is for you? Discover how we can help.