What is a DAO? How Does It Work?

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Imagine a company that runs itself. Besides some initial rules agreed upon by its creators, this enterprise wouldn’t need any bosses or employees and would rely on crowd-based decision-making.

This is what we would call a “Decentralized Autonomous Organization” or DAO, and the Blockchain-based decision-making protocols a DAO uses are what we call “Smart Contracts”.  Smart Contracts are digitally enforced, self-regulating, and could be used for decision-making and record keeping in numerous business applications. For instance, to pay partners in the DAO when a certain condition was met, or to simultaneously apply new rules across the organization, or release funding for a project once a critical number of users agreed by vote to do so. 

Just as DAOs can be used to manage non-profit organizations, they can also function as a type of investor-directed venture capital fund. DAOs are excellent examples of how Blockchain technology could be used to ensure the democratic and transparent management of the profits and decision-making of a crowd-based enterprise. 

Ethereum and DAOs

The Ethereum Blockchain works as a ledger that allows people to exchange tokens of value, called Ether. However, people can also use the Ethereum network (a Blockchain currently running on 7000+ computers around the world) to create their own smart contracts and DAOs, and send them through the network. Sending money to these contracts is the equivalent of signing and agreeing to the terms of the contract agreed upon by the parties involved.

“The DAO” and the Ethereum fork

One of the most famous attempts at creating a DAO, called “The DAO” failed disastrously because of the same rules that made it seem so great. 
The plan was for participants to receive tokens that would go on sale in May 2016. Anyone could hold or buy these tokens and the DAO creators could put whatever rules people voted on into action. After the voting took place, these rules were deployed to the Ethereum Blockchain, where they could no longer be modified.

People around the world invested over $150 Million worth of Ether in this contract, thus agreeing to its terms.

In June 2016, someone found a type of loophole in the contract, known as a “recursive call exploit”. This exploit allowed this person to "ask" the smart contract to give the Ether back multiple times before the smart contract could update its own balance. Two main issues made this possible: one, the contract coders did not take into account the possibility of a recursive call and two, the smart contract first sent the ETH funds and then updated the internal token balance. The problem was not the technology itself.

In response, DAO participants voted for a “fork”, which would release a new version of the Ethereum software, which would wipe The DAO from Ethereum's Blockchain, effectively erasing the withdrawal of funds that the exploit executor earned from their hack of the DAO.

Since the Ethereum Blockchain was marketed as "immutable smart contracts”, this rewrite of the Blockchain's history resulted in a severe drop in the price of Ether. It also created a permanent chain split which resulted in two versions of Ethereum: Ethereum Classic: the original chain without the rewritten history, and Ethereum: the "hard fork" version with the rewritten history, which also returned the 3.6m Ether (worth around $70 million at the time) to its original owners from The DAO “hacker”.

Are There Other Types of DAOs?

Yes. Other examples of DAOs are Dash, an open source peer-to-peer cryptocurrency that aims to be the most user-friendly and most on-chain-scalable cryptocurrency, and Digix.io which aims to provide a transparent, auditable, and secure protocol that uses Ethereum's peer-to-peer decentralized consensus system and IPFS permanent document storage to facilitate the creation of transferable assets on the Blockchain. A value token called DigixDAO finished its crowdfunding campaign and the token began trading on exchanges on 28 April 2016.

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