If you're going to spend more time in Web3, having an idea of the role DAOs play, will help you better navigate the ecosystem. Two years ago — which feels like a decade in Web3 terms — DAOs were associated predominantly with DeFi (decentralized finance) projects. However, they have since exploded in popularity across other parts of the ecosystem. Though not without its challenges, the DAO structure provides an effective alternative for running organizations in a decentralized way.

Listen: WTF Is... A DAO

‍DAO (or a Decentralized Autonomous Organization) is a name for a community-driven organization with no central authority. It’s a term that covers a variety of Web3 organizations – from small groups of people with a group chat in Telegram and a shared bank account, to large, decentralized protocols, involving thousands of members and with millions of dollars in market capitalization. 

In very basic terms, two elements really set a DAO apart from a traditional organization – decentralization and the use of blockchain technology.

If you think about traditional organizations (let’s take an LLC as an example), these are generally structured as a pyramid, with a leader, perhaps a CEO, at the top. The decision-making rests with one or a small number of individuals within that organization. While in a decentralized scenario, decisions are voted on by the members of the organization and there is no one set leader (although in some cases councils or committees may be formed within a DAO). The decentralization is facilitated by open-source, distributed ledger technology (blockchain) and the use of smart contracts.

Though still niche, the number of people participating in DAOs went up 130x during 2021 to 1.3million users, according to data from the analytics platform DeepDAO. Why would someone want to be a part of a decentralized organization? Well, because these structures provide their members with greater ownership, decision-making power and transparency when compared to traditional organizations.

In a web3 world where decentralization and ownership are core values, a standard centralized company structure no longer works. Here, DAOs operate as collectives and can represent a very efficient way to raise capital, efficiently coordinate activities and engage communities. Generally, these collectives are united by a common purpose.

To better understand DAOs, it might be useful to consider the different types of DAOs. Although there are no “official” categorizations, the recent World Economic Forum report identified as many as 9 categories of DAOs, but in this article we will consider four broader types:

Community DAO

The simplest form of DAO to understand. In the real world, these would look like any type of club coming together based on a common interest – think a book or a sporting club for instance (but with a token and on a blockchain). The members of this community would contribute (to different extents) to keep the organisation running and make decisions. An example of a community DAO would be Friends With Benefits and Nouns.

Resource-Allocation DAO

Investment, philanthropic, and special purpose acquisition DAOs would all loosely fall under this category. This is where a group of people form a collective to raise funds and then allocate those funds into 1) investing in an asset (with a view of generating a return), 2) donating to a cause or 3) purchasing a specific thing (to collectively own it and not necessarily from an investment point of view). A good example of the latter would be Constitution DAO, formed to pool funds with the goal of purchasing one of the original printed copies of the US Constitution.

Project DAO

This is essentially the decentralized version of running a start-up, except there is no CEO in place. Many DeFi protocols and Web3 projects building products operate as DAOs or hybrids, with various degrees of decentralization. An example of a project DAOs would be Decentraland, as well as the DeFi protocol DAOs such as Uniswap and Maker.

Talent-Allocation DAO

These are also known as service DAOs. This is referring to a group of people of the same profession or industry forming a collective to be able to provide services to various other organizations in the Web3 ecosystem. For example, RaidGuild DAO is a Web3 marketing and design agency and its members are freelance builders and designers.

How do you set up a DAO?

In its simplest form, a DAO can be founded by one individual, with a particular purpose in mind. Platforms like SuperDAO make it easy for anyone to set up a DAO. All you need to start is an Ethereum wallet address. You would choose a communication platform such as Telegram or Discord, to be able to communicate with your community and most likely you would issue a token (either fungible or non-fungible) that would represent the membership. From there, you grow a community around your purpose.

Why choose a DAO?

DAOs make sense when your organization is based around a community, and you want your community to participate not only in the consumption of goods or services but also in the decision-making, creation and ownership of those goods or services.

“We wanted this to be a community-led initiative, where we as founders are not making all the decisions but rather the decisions on which projects to invest in are voted on by the community,” said Lily Wu, co-founder of WoW Pixies, an investment DAO focused on investing in women-led NFT projects. “But more importantly it’s really about giving people the power, the decision making and a social cause that they can get behind.”

Since its inception, WoW Pixies has evolved into more than an investment DAO, with members having the option to contribute to various workstations (marketing, community management, commercial) allowing them to build out their Web3 resumes and make the first steps towards a career in web3 while earning some ETH in the process.

The true test of decentralization may reside  in a simple question – who controls the money? At WoW Pixies, the treasury is controlled by a 50/50 split between the co-founders and the representatives who were voted in by the community. Wu makes it clear that founding a DAO is quite different to being a traditional start-up founder. In a DAO structure there is no space for a founder’s ego because even though you may have started it if done well, it very quickly will become bigger than you. 

“When you are running a DAO, there is no incentive for you [as a founder] to act in your own self-interest, even financially, so you really need to be truly passionate about the mission [of the project],” she said. 

Outside of Web3 native projects, more traditional industries are also exploring DAOs as alternative organizational structures. Joni Pirovich, a lawyer based in Australia (and a fellow BFF holder), is looking at a DAO as a way of making legal services more affordable to web3 founders. She recently founded LawFi DAO and describes it as “an experiment to do law differently.”

The premise of LawFi DAO is a ‘pay-to-rely’ model around legal products (such as a legal opinion on a token). 

“My existing law firm could be a core contributor to LawFi DAO and receive a share of ETH revenue when someone ‘pays to rely’ on a legal opinion I’ve contributed through my firm. It is intended to be a global enabler for law firms to do law differently,” she said.

‍Shortfalls of DAOs

There are several challenges that DAO structures present, however the elephant in the room for DAOs, and indeed the entire crypto industry, remains regulation. As it stands now, DAOs are not recognized legal entities in most countries (DAOs are only recognized as legal entities in the Republic of the Marshall Islands, the state of Wyoming (USA) and to an extent in the state of Vermont (USA)). But that does not mean that laws do not apply, it simply means there are no specific laws in place. 

"Most DAOs only prepare a whitepaper and forget about rules or a constitution and run the risk of being characterized as a partnership which exposes all members to joint and several liability," said Pirovich. 

Some other potential challenges of DAOs include low voter participation and quality control of work produced by the contributors. Wu explains that a lot of these challenges can be overcome by having the right frameworks in place such as voter incentives and having work stream leads that are nominated based on their experience and ability.

There are a lot of discussions in the space on whether DAOs will change the future of work. Time will tell, but there is no doubt that this innovative approach has the potential to significantly shift how we think not only about side hustles but perhaps employment more broadly. 

DAOs are unlikely to replace the traditional LLC structures any time soon, but they are great instruments for innovation and experimenting, particularly if the world keeps moving towards the Web3 idea of a decentralized future.  

This is not financial advice. If you don't want to spend money investing in crypto or Web3 — you don’t have to. The intent of this article is to help others educate themselves and learn.

Liya Dashkina is a VC, contributor to a number of DAOs, web3 consultant, chapter lead at the Australian DeFi Association and an advocate for women in web3.