Bo Ilsoe is Managing Partner at NGP Capital† An investor and technologist at heart Bo has a Masters in Electronics Engineering.
I’ve always thought that one of the most important innovations of mankind was the creation of a stock company. And now, due to a major innovation emerging from decentralized financial and blockchain technologies in the form of Distributed Autonomous Organizations (DAOs), the structure and fundamental premise of a company are looking to change significantly. I believe DAOs have the potential to reinvent how we think about companies.
The roots of the limited liability company go back almost a millennium† After this, the next major iteration of the concept of a incorporated corporation was the addition of limited liability. Limited liability, which first occurred in the 1500s, was more commonly enshrined in law in several countries by the mid-19th century. This is more or less the format most entrepreneurs use today.
In my last article I wrote about the adoption risks of crypto and blockchain. DAOs are a phenomenon that first emerged in 2016 as part of this decentralized movement.
In a private limited company, there is a structured division of labor. The shareholders appoint a board of directors and then a CEO takes over the day-to-day administration of the company’s affairs. Certain decision-making powers are granted to the board of directors and some to the CEO in a cascade of responsibility and authority. There is no rule to say that it is the only way to run a business – and there are many alternatives – but over the centuries it has become the popular and effective way to run a business.
It’s not perfect. A company can be hijacked for a singular, abominable purpose, or it can lead those in power to act with malicious intent. But the LLC organized by stock is probably the best method we have right now in my opinion.
The DAO governance model
Enter the DAO, which is one of the first attempts I’ve seen at building a flat, decentralized governance structure coded in a software program. The original DAO was to be an owner-led, token holder-focused venture fund that first launched with an ethereum-based crowdfunding campaign. It was an open-source code project, published on GitHub and primarily written by Christoph Jentzsch, a German with a background in mathematics and theoretical physics, and his brother Simon Jentzsch.
At its peak, Jentzsch’s DAO raised approximately $150 million. However, the DAO was immediately hacked, and on June 17, 2017, approximately $50 million worth of tokens were stolen. This was not a good start for the future structure of organizing modern companies, but it did spark a wider interest in the concept.
So, what exactly is a DAO? It is a community-led entity, which facilitates the management of common resources. It is autonomous and transparent. This means that all software and governance rules are published so that all members or potential members can investigate which mechanisms are coded to manage the DAO. So-called smart contracts are coded on a blockchain to control what happens. Community members can make suggestions about future features or rules, and are usually voted on by members in proportion to the number of tokens each community holder owns. This is no different from a shareholder vote in a limited liability company.
A DAO is essentially a partnership that performs the function of a corporation, but it is managed and looks very different from a regular LLC. Since 2016, many types of DAOs have emerged and their governance model is evolving rapidly.
So, what are DAOs used for? Collective investment activity with cryptocurrencies, shared ownership of digital assets (such as art NFTs and in-game items), layer 2 protocol applications (code running on Ethereum, for example), organizing grants and much more.
Much of the development of how DAOs work has focused on driving and encouraging token holders to participate and contribute. Those challenges have been hotly debated and experimented with, but the utopian dream of complete, broad-based decentralization, where every member is equal and contributes and participates in an altruistic way, seems to have given way to a more pragmatic approach, which I think is better is appropriate to our nature as human beings.
DAOs in Business
So in what ways can DAOs go mainstream? Shared or fractional ownership of assets is a good example. Individuals with a shared interest in, say, a prime real estate property in Paris, could raise financing to purchase a commercial building. Each token holder would receive distributions of income according to the rules encoded on the chain, and each token holder would be able to freely sell their holdings within seconds if they wished. No cumbersome legal documentation, no stamp duties. Just an opportunity to participate in a real estate market otherwise inaccessible to normal consumers.
For established companies, DAOs can be an effective way to set up subsidiaries, organize transfer pricing, and much more. Your imagination is the only limit to the absorption of DAOs. Because the rules are coded in the chain, this is usually a very efficient way to operationalize business processes between participants.
I think many observers underestimate the importance of the DAO structure, which is super efficient and transparent, even if the motivation and activity of the participants needs to be examined. As with a normal business, it is a matter of how resources are managed, allocated and distributed.
The DAO invention, materially done by programmers and engineers, has divided the world into the DAO fundamentalists and the DAO pragmatists. The first group calls the DAO the tool to overthrow the rule of nation-states and sovereign governments and the second group works to make our day-to-day services and functions more transparent and efficient. I think transparency and efficiency seem like a good place to start, even if human nature and behavior persist.