DAOs — Crowdfunding Reimagined
Over the last year, the term “DAO” has become a popular topic in the world of investing. Whether you are familiar with the subject matter or new to the term this article is for you as we dive into the basic concepts and historical significance. We at City Street Strategies hope to teach you a little more as we see the model having a lasting impact on the future of crowdfunding, charity work, and beyond!
How It Works
A Decentralized Autonomous Organization (DAO) is a transparent syndicate structure bounded by rules encoded on the blockchain. These rules lie in predetermined smart contracts which automate decision-making free from a central authority or corporate hierarchy. Smart contracts serve as the foundation of any DAO and eliminate human error while protecting members from manipulation and fraud. The blockchain that a DAO is built on— in most cases Ethereum— serves as a trusted timestamped ledger, removing the need for a trusted third party and public documents like titles and deeds.
The first DAO was created in 2016, but the idea had been in the works for many years. People have always wanted alternative avenues for investing besides stocks, bonds, and the standard derivatives market. Unfortunately, ground floor investing, like venture capital, happens behind closed doors and requires vast sums of capital. For this reason, DAOs are being utilized to either support open-source, blockchain-based projects or to crowdsource money to invest using the blockchain. It’s like Kickstarter but more transparent— here’s why.
If you want to be a part of a DAO in 2022, you will most likely have to purchase governance tokens (ERC-20 tokens) representing voting rights in every decision made by the DAO. In other cases, you will purchase an NFT (ERC-721 token) issued by the DAO creators. The reason for this is threefold. First, NFTs grant tokenized ownership of arbitrary data and enable special functions. In this case, the NFT will qualify you for the airdrops of governance tokens if the ERC-721 token does not qualify you directly. Second, the initial mint sale of the NFT is the method of crowdfunding the project. A specified amount of funds from the NFT launch are transferred to the DAO treasury where the DAO votes on their uses. Finally, as the DAO gains attention or makes promising steps in delivering the central vision of the project, the NFT can be traded on a secondary market for a premium, with a percentage of the resale being transferred back to the treasury.
Here are a few examples of popular DAOs
Constitution DAO: A community dedicated to raising money to acquire a rare copy of the U.S Constitution at a Sotheby’s auction in November 2021. The DAO raised $47 million for the auction but was ultimately outbid by Ken Griffin. All capital raised was redistributed back to the community as promised.
Maker DAO: Maker (MKR) is a cryptocurrency that allows people to create digital escrows for lending and borrowing using a stablecoin called Dai. The MakerDao is the mechanism used to determine the interest rate at which users earn Dai for lending and what they pay for borrowing. The community also determines the collateral needed to borrow and the amount of time needed to pay back the loan. MKR token holders govern the Maker Protocol’s smart contracts which power Dai.
Links DAO: A community dedicated to purchasing a top 100 golf course in the country. People who participate in purchasing a LinksDAO membership NFT help fund the project, while also entitling them to lifetime benefits. One notable contributor to the project is Steph Curry.
OpenDAO: SOS is a cryptocurrency supporting a community dedicated to promoting, protecting, and incentivizing NFT adoption. Specifically, anyone who has made a transaction on OpenSea before December 23rd 2021 gets to claim a free SOS token via an airdrop. The initial rewards from the airdrop were approximately 10-15% of the total money spent by a user on OpenSea. 20% of the SOS tokens are allocated to the OpenDAO to support emerging artists, communities, art preservation, and developer grants.
Big Green DAO: A community dedicated to promoting self-sustainable food sources for individuals, while disrupting hierarchical philanthropists by restructuring grant-making. The creators want to improve the well-being and mental health of everyday citizens by assisting them to create their own organic, clean, and nutrient-rich food gardens that directly cut out the middleman preservatives, GMOs, and other by-products in our food system.
Ultimately, a DAO serves as a way for strangers to collectively achieve a common goal. Here is an unexpected analogy:
A Fun Analogy
Twitch plays Pokémon was a popular thought experiment created by an Australian programmer in 2014. The goal of the experiment was simple; give tens of thousands of people all over the world the ability to control a single Pokémon character by typing commands into a chatroom on Twitch. For example, typing in “UP” moves the character north. At its peak, the stream had an average viewership of over 80,000 gamers and a participation rate of 10 percent. There was no reward but rather served as a challenge to see if thousands of strangers could work together to achieve a common goal—win the game. As you can imagine, tens of thousands of people inputting commands is incredibly chaotic. Simple areas of the game took days at a time. Meanwhile, some bad actors were only looking to sabotage the experiment.
After reaching a certain point in the game the creator decided to implement a democratic voting system. Players were given 30 seconds to vote on what button to press next. Over time, users began to work with one another, around time zones, to make sufficient progress. Sure, the players still could not play the game most efficiently, but they were effective enough to beat the game collectively. This will always be a lost piece of history for the internet, as its rapid popularity began to fade thereafter. There were other Pokémon games afterward that Twitch tried to solve, but not enough people were involved to make the experience as memorable.
Like Twitch plays Pokémon, a DAO is a collective process of building consensus between people you’ll probably never meet. Despite no real incentives, the Twitch community was inspired enough to prove that it could be done. Now imagine venture capital goals that can only be accomplished with the help of others. We at City Street Strategies believe there will be a real lasting demand for the collective, decentralized nature of DAO fundraising efforts that should not be overlooked. If something like Twitch plays Pokémon can work without any real incentives, then the sky is the limit for an idea that is genuine enough and has a real grassroots approach in the future of decentralized finance. Now, let's look at the past.
Historical Significance – A Cautionary Tale
While a DAO is new to public discourse and appears to be the ‘next big thing’ built on the rails of Web3 infrastructure, the concept plays a major role in the history of the Ethereum ecosystem— the world’s second-largest blockchain. Let’s rewind to the first DAO launched in April 2016.
The original DAO was known simply as “The DAO”, easy right? It was launched as a form of investor-directed venture capital on top of the Ethereum Network that was just one year old. The rest was history, quite literally. The project amassed one of the largest crowdfunding efforts ever seen. During a one-month window, The DAO raised $150 million in Ether from 18,000 stakeholders, accounting for nearly 15% of Ether in circulation. ERC-20 governance tokens, under the moniker “DAO”, were then airdropped to members and listed on exchanges starting May 28, 2016.
Unfortunately, the enthusiasm surrounding The DAO had far exceeded the creators’ original vision, leaving them ill-prepared for potential attacks. Today, you can find plenty of smart-contract validation services which ensure the safety of network codes. At the time, the Ethereum network itself was running well with no bugs, however, in June members of The DAO began raising concerns over vulnerabilities in The DAO’s code which was gatekeeping The DAO’s treasury. With so many eyes on this cutting-edge project, it was already too late.
On June 18, 2016, a recursive call in the smart contract allowed a hacker to drain $50 million worth of Ether out of the DAO’s treasury wallet into a mirrored structure called “child DAO”. Being that 15% of Ether in circulation was tied to The DAO there was a lot at stake for the Ethereum ecosystem as a whole. After the hack occurred the price of Ether fell from $20 to $13.
The saving grace in this story is the mirrored structure of The DAO that the hacker used to siphon funds. The DAO members didn’t have enough time to vote on resolutions to stop the attack (remember that the integrity of a DAO lies in the smart contracts which aren’t something to be voting on), but they did have 28 days before the funds could be released from the hacker’s wallet. This holding period mirrored The DAO’s original 28-day funding period where all treasury assets were frozen until members could eventually vote on investment opportunities.
The month-long window was enough time for Vitalik Buterin, the creator of Ethereum, to orchestrate a plan to protect Ethereum users. The ultimate solution was an aggressive “hard fork” in the Ethereum network. Going against the essence of blockchain technology— the proposal was to “rewrite history” with the support of early nodes (miners). The Ethereum Foundation released updated software that returned the stolen Ether back to The DAO to be withdrawn. In the end, all funds were restored. Interestingly, there are still nodes out there that use the old Ethereum software. Since the hard fork, those nodes continue to operate the blockchain with a purchasable token called Ethereum Classic (ETC).
Against all odds, the point of this story is not to scare you away from investing in DAOs. We want you to understand that DAOs have come a long way over the last six years. As projects receive interest, they go through the proper audit process to ensure that a doomsday scenario doesn’t repeat itself. But at the end of the day, a DAO is only as strong as the blockchain it runs on. In the case of Ethereum, the founders were faced with a difficult decision in 2016. They had a choice to ignore The DAO’s downfall or alter the history of their own blockchain to preserve the integrity of what DeFi represents—a transparent, trustless, self-sustaining financial system. DAOs are showcasing to the world that the impossible can be achieved and that more people can achieve a lot when they all work in unison. As the old saying goes: “Divided we fall, united we stand”. Democracy may die in darkness, but the DAO might just be one of the lights that saves it.
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