Decentralized Autonomous Organizations Are Red Hot, But What Exactly Are They?

Cryptoassets continue to dominate the headlines in the mainstream financial market conversation, but that only tells one side of a wider story. Even as crypto creates and drives headlines on an almost daily basis, the integration of blockchain into organizations continues unabated. Incumbent organization across almost every industry area imaginable – from finance to logistics to healthcare – are rapidly adopting blockchain into how data is processed, stored, and reported to investors and other stakeholders.

Ongoing debates over the impact of these centralization trends continue to be waged, with advocates of decentralized crypto bemoaning these developments, while other proponents applaud the legitimacy that comes with such projects. Setting aside these arguments, which will continue to happen anyway, another trend that might supersede all other blockchain adoption stories has emerged; the rise of the Decentralized Autonomous Organization (DAO).

It might sound like something out of science fiction, but DAOs are very real, having a tangible impact on the business world, and are set to continue dramatically changing how blockchain and business interact. Let’s dive into what exactly these organizations are, and what investors should be aware of moving forward.

What is a DAO? A DAO, for the purposes of this conversation, can be thought of as an entity that seeks to replicate the decision making activities of a traditional organizations without the traditional structures and costs of an organization. DAOs operate on an underlying blockchain platform, which can either be permissioned or permissionless in nature, and make decisions governed by a combination of smart contracts and governance tokens.

Smart contracts are executable code language, which can be thought of as a series of (IF, THEN) statements, that are coded directly into the blockchain in question. Governance tokens are the process by which voting, and the percentage weight of those votes, is determined. Combining these two factors, token-denominated voting and these votes executed via smart contract, allow DAOs to operate without many of the costs and bureaucracy of traditional organizations.

In other words, a DAO is an organization – except – without technically being an organization.

Hype or the real thing? A follow-up question that needs to be asked, especially with the volatility and uncertainty that still overshadows the sector at large, is whether or not these truly decentralized organizations are legitimate or not? The answer is a resounding yes, and with the recent (possible) unmaking of the 2016 DAO hack ringleader, that ominous chapter may finally be on the verge of closing.

With certain states legally recognizing DAOs, these entities are well on the way to becoming just another form of how entities can operate, and this is having additional implications across the board. A DAO is currently in the process of being formed to purchase to Denver Broncos – valued at over $4 billion – and venture capital funds continue to pour money into projects; it is rapidly becoming a viable business model in its own right. Alongside the rise of blockchain adoption, and the continued maturation of the cryptoasset class more broadly, DAOs are a clear demonstration of just how integrated this idea is becoming alongside more traditional business structures.

With such large amounts of capital being invested and risked, what should investors keep in mind?

Investing questions remain. As DAOs emerge and continue, investors should understand what questions should be asked, especially as investment opportunities continue to arise. These include but are not limited to 1) what are the rights and obligations of token holders, 2) how are tokens issued, 3) what blockchain underpins the DAO in question, 4) how is the smart contract coded and maintained, and 5) what activities will the DAO be engaged within?

Additionally the reporting, valuation, and taxation implications of investing into DAOs are still relatively murky areas for investors to understand. Even something simple as reporting taxable income can be complicated, especially if the DAO truly operates in a decentralized manner – how will taxes even be collected in such a situation?

Valuations are also a complicated factor, especially for a newly formed DAO, a DAO whose tokens are not widely traded, or a DAO that has yet to purchase assets with a liquid and verifiable valuation. Finally, how should these investments be reported, linking back to earlier notes about governance tokens – as equity, an investment, or some third option?

DAOs are certainly a fast growing and rapidly expanding type of business organization that seeks to combine the best aspects of decentralized blockchain ownership, the tokenization of governance, and a more flexible management decision making structure. Despite this, there are still numerous questions that need to be addressed regarding just how these entities will operate, the legitimacy of said entities, and what investors should consider during the investment process. Questions remain, as with everything related to blockchain, but opportunities also exist for those forward thinking enough to embrace them.