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What's Holding DAOs Back?

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In 2021, DAOs broke out of their blockchain confines and spilled out into the real world. Up until that point, most decentralized autonomous organizations stuck to managing financial protocols or stewarding digital assets.

Buoyed by a set of new DAO laws in Wyoming, Vermont and Tennessee, a wave of crypto-collectives began pursuing audacious acquisitions of real-world assets including rare art, a golf course, a copy of the U.S. Constitution, a National Basketball Association team and real estate. (Disclaimer: your author founded CityDAO, which purchased 40 acres of land in Wyoming.)

Scott Fitsimones is the founder of CityDAO and the author of "The DAO Handbook."

However, it became evident as soon as DAOs collided with the real world that these powerful new vehicles for crowdfunding and organization are constrained by immense coordination and regulatory costs that can negate the benefits of using a DAO in the first place. By understanding these costs, entrepreneurs, researchers and regulators have the opportunity to help DAOs deliver on their promise to create a fairer internet.

On the coordination side, DAOs add friction to using resources by requiring members to pass proposals. By default, most DAOs today are at risk of being what Ethereum co-founder Vitalik Buterin would call a vetocracy, where the default outcome is "no" unless a proposal sponsor rounds up sufficient support for their project. In some cases, the fact that democratic process adds friction is a feature, not a bug.

See also: DAOs Are the Real Meritocracies | Opinion

For financial protocols that steward millions in user deposits, it should be difficult to change settings that could impact upon tens of thousands of users. In the earlier stages of value creation, however, a core team should have authority to take dozens of small actions toward a goal without the friction of writing proposals.

Many projects were eager to cede that authority and adopt the "DAO'' moniker early in their lifecycle in an attempt to garner community enthusiasm, saddling themselves with the burden of coordinating hundreds of people just to take baby steps. Plus, most DAO infrastructure and tooling is built on the assumption that DAOs will be primarily interacting with smart contracts, meaning that there is a dearth of thought put into enabling members to take action in the real world.

On the regulatory side, starting a DAO is easy – you can create a multisig (a multisignature wallet, which requires multiple people to sign transactions together) in minutes. The cost of starting a compliant DAO, however, is immense.

Everything from incorporating an entity to paying contributors in jurisdictions around the world can take weeks of legal work and rack up hefty bills, making the idea of starting a DAO seem like a fool's errand. If a DAO needs a lawyer and an accountant just to operate, that's an immense barrier to entry.

When it comes to raising money, vague securities laws can make crowdfunding a risky endeavor. When it comes to spending money on anything off-chain, a DAO will need to open an institutional trading account or "off-ramp," which can be a multi-month affair.

And if the DAO owns real world assets like land and trademarks, the cherished property of forking, which allows a group that disagrees with the main group to branch off, becomes even harder or impossible.

Making DAOs work

Many of these coordination and regulatory costs can be solved with innovation. Entrepreneurs are building tools to ease burdens of DAO payroll, compliance and governance. Some of these barriers must be addressed at the policy level, for example by clarifying DAO statutes and securities laws. More research is also needed on governance mechanisms in order to move DAOs away from vetocracies and towards meritocracies.

Sometimes, though, the high coordination and regulatory costs are simply worth paying. For example, important pieces of internet infrastructure that touch the lives of many ought to be decentralized. MakerDAO, which acts as a sort of Federal Reserve guardian of the stablecoin DAI, is a great example of something that should be very decentralized because trust in the protocol is established by the fact it's (theoretically) stewarded by a large group and immune from the whims of a single person. The success of Bitcoin, Ethereum and the internet itself is largely due to decentralization, which has brought them robustness and passionate communities.

See also: The Psychological Differences Between Bitcoin and Ethereum's Governance | Opinion

Making DAOs work is an important project for humanity because they promise us a more democratic future where we own and govern the town squares of tomorrow. One thing is certainly clear – demand for democratic systems is increasing, and people are skeptical of a few platforms ruling the internet.

By lowering the coordination and regulatory costs, we can make DAOs more viable and help them fulfill their original vision to create a more level playing field and a more democratic internet.