The Ether (ETH) that hackers stole from The DAO on June 17, 2016 would be worth $6.6 billion today if it weren’t for the fork

Launched on April 30, 2016, The DAO was an early Decentralized Autonomous Organization (DAO) and venture capital fund. 11,000 people invested 11.5 million ETH, 14% of the total supply at the time, worth roughly $150 million, which they planned to collectively invest in crypto projects. 

Unlike a traditional fund, in which institutions and high net worth individuals (Limited Partners or LPs) invest money into a fund that other people (General Partners or GPs) invest into companies, investors in The DAO would be able to vote on proposals based on pre-set rules, established in smart contracts. Each person’s vote was weighted by the number of tokens they held, which was based on how much they had invested. If a proposed project received enough votes, the smart contract automatically triggered the investment of The DAO’s funds into the project’s ETH wallet.  

Two weeks into The DAO’s crowdfunding campaign, TechCrunch wrote, “The DAO is a paradigm shift in the very idea of economic organization. It offers complete transparency, total shareholder control, unprecedented flexibility and autonomous governanc

Then, less than two months in, on June 17th, hackers hit The DAO and took out 3.6 million ETH. At the time, that amounted to around $50 million. Today, with ETH trading at $1,851, the stolen ETH would be worth $6.6 billion, placing it among the most expensive hacks of all time. 

The hackers aren’t billionaires today, though. The funds were put on a 28-day hold based on the terms of the smart contract, which gave The DAO and the broader Ethereum community nearly a month to figure out what to do. After a contentious debate, the Ethereum core team, led by Vitalik Buterin, released a hard fork of the Ethereum blockchain. It was essentially a new version in which everything was the same, except in the forked version, the heist never happened. 

The Ethereum core team couldn’t force people to move over; people voted with their feet, answering this question: does the benefit of erasing the hack outweigh the cost of human interference on trust in Ethereum? To most, it did. While some people continued to use the Ethereum blockchain on which the heist had occurred, renamed Ethereum Classic, the Ethereum we all know and love is the forked version. If you look at the Ethereum blockchain today, you won’t find any trace of the heist. No harm, no foul. 

Let’s start with a definition. In her post, A Beginner’s Guide to DAOs, Scalar Capital’s Linda Xie gives a good one:

A decentralized autonomous organization (DAO) is a group organized around a mission that coordinates through a shared set of rules enforced on a blockchain.

A DAO is “decentralized” in that it runs on a blockchain and gives decision-making power to stakeholders instead of executives or board members, and “autonomous” in that it uses smart contracts, which are essentially applications or programs that run on a publicly accessible blockchain and trigger an action if certain conditions are met, without the need for human intervention. 

DAOs are a new way to finance projects, govern communities, and share value

Instead of a top-down hierarchical structure, they use Web3 technology and rapidly evolving governance and incentive systems to distribute decision-making authority and financial rewards. Typically, they do that by issuing tokens based on participation, contribution, and investment

Token holders then have the ability to submit proposals, vote, and share in the upside

If blockchains, NFTs, smart contracts, DeFi protocols, and DApps are tools, DAOs are the groups that use them to create new things. If they’re the what, DAOs are the how. They’re the Web3 version of a company or community

DAOs are why Ethereum was created in the first place

In the beginning, there were DAOs. Vitalik Buterin, the co-founder of Ethereum, mentioned Decentralized Autonomous Organizations in the introductory paragraph of the Ethereum White Paper in 2013.

Vitalik linked to a piece he’d previously written for Bitcoin Magazine (which he founded in 2011) titled Bootstrapping a Decentralized Autonomous Corporation: Part I, in which he asks and attempts to answer the question: 

Can we approach the problem from the other direction: even if we still need human beings to perform certain specialized tasks, can we remove the management from the equation instead?

Vitalik refers to Bitshares’ founder Daniel Larimer's idea that Bitcoin is actually a sort of a proto-DAO, a new kind of decentralized equivalent to a traditional company: 

Shares ≈ Bitcoin 

Shareholders ≈ Bitcoin owners 

Employees ≈ Miners and validators 

Payroll ≈  Bitcoin rewards for adding blocks to the chain 

Marketing  ≈ All of those people with laser eyes pumping Bitcoin

Bitcoin is limited. It’s kind of dumb

ifBitcoin is like Artificial Narrow Intelligence (ANI), DAOs are like Artificial General Intelligence (AGI)

Bitcoin does the thing that it was programmed to do really well, but DAOs can theoretically do anything really well

Vitalik said as much when he introduced Ethereum: 

What Ethereum intends to provide is a blockchain with a built-in fully fledged Turing-complete programming language that can be used to create "contracts" that can be used to encode arbitrary state transition functions, allowing users to create any of the systems described above, as well as many others that we have not yet imagined, simply by writing up the logic in a few lines of code

Bitcoin is digital money. Ethereum is a platform on top of which builders can create anything, from apps to entire organizations

Ethereum, Bitcoin, and other blockchains are Layer 1 in the Web3 tech stack. For Bitcoin, all of the magic happens at Layer 1, but with Ethereum, most of the magic happens in Layer 2, the protocol and smart contracts layer

The second layer is where builders create Lego blocks of protocols and smart contracts that can be arranged in countless combinations and formations to do anything from mint art to trade crypto, directly, without the need for a third-party

Two roads diverged in a wood, and I—

I took the one less traveled by,

And that has made all the difference.

-- Robert Frost, The Road Not Taken

ushiSwap is similar to Uniswap in almost every way except one: on SushiSwap, the 0.30% fee is split, such that “0.25% go directly to the active liquidity providers, while the remaining 0.05% get converted back to SUSHI (obviously through SushiSwap) and distributed to the SUSHI token holders.”

SUSHI provides economic participation, but it’s not a governance token (for now). It is working on a governance framework, the Omakase DAO, and plans to turn over control of the protocol to the community. For now, the community can vote on improvement proposals on Snapshot, but the votes are non-binding

You know what is a DAO now? Uniswap

As a response to the SushiSwap fork, in order to keep people from migrating to the forked protocol, Uniswap announced the long-anticipated UNI token on September 16, 2020

Having proven product-market fit for highly decentralized financial infrastructure with a platform that has thrived independently, Uniswap is now particularly well positioned for community-led growth, development, and self-sustainability

Immediately upon issuance of UNI, UNI holders received ownership of: 

Uniswap governance

UNI community treasury

The protocol fee switch

uniswap.eth ENS name

Uniswap Default List (tokens.uniswap.eth)

SOCKS liquidity tokens

While Uniswap doesn’t allocate 0.05% back to UNI like SushiSwap does to SUSHI today, the community owns the “protocol fee switch,” subject to a 180-day timelock delay, and the community will be able to vote on whether to do so when that lockup ends

Uniswap was a protocol that became a DAO without a change in fee splits, and SushiSwap forked Uniswap to create a new fee split, but is yet to become a DAO.

both Uniswap and SushiSwap are going through what Variant Fund’s Jesse Walden coined “Progressive Decentralization.”

Jesse Walden is the person whose work I turned to most often when I’m trying to understand Web3 and the ownership economy.

Walden wrote that it doesn’t make sense to try to design products by committee or give tokens from day one

Walden laid out a framework for tackling decentralization as a three-step process with the “goal of building a sustainable, compliant, and community-owned product”

1. Product-Market Fit

Many crypto startups raise traditional venture capital to fund product/market fit discovery, often under a Simple Agreement for Future Tokens (SAFT), a structure developed by Protocol Labs and Cooley that’s similar to Y Combinator’s SAFE, except that it converts into tokens instead of equity should the company issue tokens in the future. 

2. Community Participation

Once a company has achieved product-market fit, it should begin to experiment with getting more stakeholders involved more directly. 

Walden likens it to open source development, inviting participation from the community, giving bounties, grants, and other incentives, developing in the open, building community, and introducing rough consensus on decision-making

crypto companies can and should start thinking about how to use fees and tokens to incentivize ongoing contribution to supercharge community involvement and loyalty

On the fee side, there’s a trade-off between charging fees to users to give to contributors, or not charging fees until the platform has built up sufficient network effects

Since crypto services are open source, charging high fees could cause someone to fork your service, but not charging fees that you can pass on to contributors means that you don’t have money to incentivize contribution

The equilibrium state here is that protocols are minimally extractive, meaning that they charge just enough to cover costs. Uniswap, for example, charges just 0.30%, which they pay directly to Liquidity Providers. 

On the token side, teams can issue tokens to a small group of community members to experiment with governance dynamics

is the training wheels period, during which the core team can still give themselves enough decision-making power that they can influence decisions towards their vision

should also publish and solicit feedback on plans for distributing tokens that balance rewards for the core team and early contributors with continued incentivization for participation

New models are being tested daily using game theory, math, observed behavior, and conversation to build, test, and iterate on new incentive and governance models

another essay (or read a16z’s On Crypto Governance, watch this video on applying game theory, or read white papers like Maker DAO’s).

3. Sufficient Decentralization

After a team has successfully completed the first two steps, they’re ready to distribute tokens to the broader community. This is an alternative to a traditional IPO, SPAC, or acquisition, called “Exit to Community,” and is the point at which a project or company becomes a DAO

done by triggering a smart contract that mints and distributes tokens based on predefined rules determining everything from who gets how many today, to how tokens will be distributed in the future, to what economic and governance rights token ownership confers. 

From this point forward, future development of the protocol is in the hands of the community

core team might still influence decisions based on their standing in the community or the number of tokens they hold, but the rules in place in the smart contracts, and any modifications made based on community vote, will determine the future changes. Everything from new products, to hires, to fee changes, to marketing campaigns will be proposed and voted on by token holders. Congrats: your protocol has moved from hierarchy to DAO. 

why are community participation and decentralized control desirable in the first place?

Why DAO?

In Progressive Decentralization, Walden highlights two advantages: 

1. Community Participation and Control Results in Limited Platform Risk

Chris Dixon argues that platforms start open to attract users and developers, and then begin extracting once they reach a certain size and scale in order to increase profits and maximize shareholder value.

DAOs are all about maximizing stakeholder value

users and contributors are also the investors and owners

While community ownership seems weird and novel and almost hippie, it’s actually a more natural model than a few outside investors and board members dumping a bunch of money into a company and deciding what it should do

Done right, the DAO structure means that protocols and platforms remain aligned with stakeholders over time

2. Regulatory Compliance

Crypto tokens can be deemed securities under the Howey Test, which would make distribution challenging and expensive, but analysis suggests that tokens might switch from security to non-security if they eliminate information asymmetry and dependence on the core team to create value. 

The 7 Powers of DAO

DAOs are in the experimental phase

concept itself is working to find meta-product-market fit.

concept itself is working to find meta-product-market fit

At this stage, many people are drawn to create DAOs out of curiosity and a desire to experiment with new models of community participation, creation, and collaboration

DAOs don’t need to be better yet, just novel

Over the long-term, though, to meet Vitalik’s vision of companies without managers, DAOs will need to have competitive advantages over other forms of organization and governance

DAO should create moats, “those barriers that protect your business’ margins from the erosive forces of competition.”

In 7 Powers, Hamilton Helmer lists seven sources of competitive advantage

Scale Economies: 3/5 Helmers

A business in which per unit costs decline as production volume increases

DAOs give groups of people and organizations across the globe the means and incentives to pool resources in the pursuit of a greater goal

gives them the ability to drive down costs for each new unit they produce or new user they accept.

DAO structure may also drive down labor costs by paying for many services as-needed, with less friction than a traditional organization

there’s not as clear an inherent advantage to DAOs over traditional structures here

Network Economies: 5/5 Helmers

The value of a service to each user increases as new users join the network.

Network economies are where DAOs have the potential to thrive and knock off incumbents. This will be the strongest moat for successful DAOs. 

A canonical example of network economies is Facebook, which gets more valuable to you each time one of your friends joins because you can talk to them and see what they’re up to

DAOs, built on cryptonetworks that combine stateful protocols directly with money, provide network effects on steroids

With DAOs, users are owners, and every time someone else joins the DAO and/or uses the protocol, the user’s tokens theoretically get more valuable

as the DAO gets stronger, more people build on top of it, which makes it stronger, which attracts more people, and so on

Ethereum has platform network effects, like Windows, but with financial steroids. Once a DAO picks up steam, it’s going to be very hard to reverse it. 

Counter-Positioning: 4/5 Helmers

A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business

DAOs can build strong moats against their incumbent counterparts just by nature of being a DAO

Switching Costs: 2/5 Helmers

The value loss expected by a customer that would be incurred from switching to an alternative supplier for additional purchases.

low switching costs are part of the beauty of DAOs: it creates a Darwinian dynamic in which protocols are constantly competing to keep their stakeholders happy and well-compensated

Brand: 4/5 Helmers

The durable attribution of higher value to an objectively identical offering that arises from historic info about the seller

Part of the reason that certain brands are able to charge higher prices for the same item is that people tie their identity to those brands

Similarly, people will tie their identity to the DAOs in which they’re a contributing member and of which they’re an owner

consider Bitcoin a DAO, think about all of the people whose identities are tied up in owning Bitcoin. They’re willing to market Bitcoin, buy dips, and bash non-believers for free

Emotions are high, and if the DAO does something members don’t agree with, they might run away quickly

Moloch DAO, which awards grants to advance the Ethereum ecosystem, even has a “rage quit” mechanism built-in, through which a member can rage quit and withdraw their tokens if they don’t agree with a particular community decision

Cornered Resource: 4/5 Helmers

Preferential access at attractive terms to a coveted asset that can independently enhance value

DAO’s community is its cornered resource

many DAOs employ or otherwise compensate people for their contributions, there are many instances in which people contribute to the DAO just to make it, or the blockchain on which it’s built, more valuable

Moloch DAO gives grants from its members’ own pooled ETH in order to make ETH more valuable, and can submit proposals to do free work to make Ethereum better. Those engineers’ time is independently valuable

Process Power: 2/5 Helmers

Embedded company organisation and activity sets which enable lower costs and/or superior product.

“Good for the ecosystem, bad for the moat”

DAOs inherently and literally have embedded organization and activity sets -- they’re programmed into the smart contracts themselves -- however, for that same reason, they’re not defensible against other DAOs or protocols

challenge with making your Legos and instruction manuals public is that anyone should be able to copy and paste your processes. The best governance and incentive structures will be copied and tweaked. 

Taken together, by granting economic incentives to a DAO’s users, contributors, and broader ecosystem of stakeholders, and giving those stakeholders a say in the DAO’s governance, DAOs have the opportunity to build incredibly powerful moats

The strongest is network effects -- once a DAO hits escape velocity, it will be hard to take it down, particularly given the fact that community governance means it should be able to adapt and evolve in a way that the community believes will create the most long-term value. 

DAOs should be wary of using those moats to get too comfortable

They shouldn’t extract too much value, grant too much power to too few stakeholders, move too slowly, or do anything else that might piss off a sufficiently large piece of the community

If they do, they give others an opening. The threat of forking is ever-present. It’s survival of the fittest

According to DeepDAO, the top DAOs have only $952 million in assets under management

Louis Grx highlights a few of the different types of DAOs

Creator DAOs

Protocol DAOs

Tokenized Communities

Investor DAOs

New tools mean more access

It’s easier than ever for new companies to build, experiment, learn, iterate, remix, rebuild, test, find product-market fit, involve their community, and one day, exit to their community. 

The energy in the space is contagious, and the community is wildly inclusive and helpful

DAOs are novel, and they just feel kind of hippie. Giving ownership and control of a project or company to the community is just not how things are done

stakeholder ownership is the natural state of things, and that we just haven’t had the technology or models to coordinate such widely distributed governance and ownership before

Enough smart people with enough passion, tools, voice, and incentives, combined with a friendly survival of the fittest culture, can rapidly experiment their way to the next big thing. The world is going to be a very different place when they do.