Blockchain technology is transforming many different industries. While cryptocurrencies continue to revolutionize finance, secure and immutable blockchains could power everything from tracking music royalties to sharing medical records to monitoring supply chains. The technology is even changing the way that organizations themselves operate.
DAOs are transforming how organizations operate by eliminating the need for governing documents and people.
Let's look at how Decentralized Autonomous Organizations, or DAOs, are changing how organizations work on a fundamental level.
What is a DAO?
Ethereum has the most active blockchain in the crypto space, and Ether has the second-largest market capitalization after Bitcoin. As an open-source blockchain with smart contract capabilities, the platform is adaptable to many different use cases, from Decentralized Finance (DeFi) to Non-Fungible Tokens (NFTs) to distributed gaming.
What is a DAO? A Decentralized Autonomous Organization, or DAO, leverages smart contracts to codify an organization's rules and decision-making apparatus. Unlike a conventional organization, DAOs eliminate the need for governing documents and people, paving the way for a decentralized control structure that prevents bad actors.
DAOs involve a few steps:
- A group of people writes smart contracts that run the organization.
- People add funds to the DAO by purchasing tokens during a funding period that entitle them to ownership (a.k.a. an ICO).
- People can make proposals to the DAO on spending money, and token owners can vote to approve them.
DAOs have been especially helpful for open-source projects, like cryptocurrencies, that want to scale their operations efficiently. For instance, Uniswap processes a comparable number of transactions as Coinbase despite having significantly fewer employees; the organization's DAO structure crowdsources many governance requirements.
Investing in a DAO is similar to investing in a publicly-traded company—you buy a particular DAO token as you'd buy a share of stock. And, like the share of stock, the token enables you to vote on spending money and make proposals on which others can vote. A 2017 SEC ruling even found that DAO tokens were securities!
The Fall & Rise of DAO
The inherent nature of Decentralized Autonomous Organizations creates one significant security vulnerability: If a security vulnerability arises, it cannot be corrected until the majority votes on it, creating a window of opportunity for attackers to exploit the bug in the code. This vulnerability has become known as the "unstoppable code" principle.
What is DAO? The DAO is one of the first DAOs built by a German startup that aimed to create a decentralized version of Airbnb. When it launched in April 2016, The DAO raised over $150 million from more than 11,000 members thanks to a highly successful marketing campaign. By May 2016, it held up to 14% of all Ether tokens.
Unfortunately, a hacker found a vulnerability in the system and managed to steal more than 3.6 million ETH, causing the price of Ether to plummet from over $20 to less than $13 per token. Ethereum was hard forked to move the funds into a recovery address to be exchanged back to Ether by their original owners (the original is now Ethereum Classic).
Most DAO projects were sidelined after The DAO debacle until MakerDAO came around and repopularized the structure. MakerDAO is an open-source community that manages Dai—the most popular crypto-collateralized stablecoin and lending protocol in DeFi. The protocol has about $6 billion locked in as of June 2021.
DAO Tax & Legal Implications
The IRS treats cryptocurrencies as property. Therefore, when you sell a DAO token, you will owe capital gains tax on the net gain—or sale price minus the cost basis. If you held the DAO token for longer than one year, you would pay the long-term capital gains tax rate; otherwise, you would owe the short-term capital gains tax rate—or ordinary income tax rate.
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The SEC has made it clear that digital asset sales by "virtual" organizations are subject to the requirements of the federal securities laws. So, for example, Initial Coin Offerings or Token Sales must register the securities unless there's a valid exemption. But, of course, DAOs are challenging to target since they are merely software programs.
What Is Next for DAOs?
Decentralized Autonomous Organizations are ideal for crypto projects that want a decentralized structure, and there are many successful DAOs with tens of thousands of members and hundreds of proposals. DAOs could become even more popular over time as mainstream organizations adopt decentralized forms of governance.
What are the most popular DAOs?
What are the most popular DAO crypto tokens?
Despite their growing popularity, DAOs and DAO crypto still face some fundamental criticism from experts. For example, the MIT Technology Review points out that crowdsourcing financial decisions is usually a bad idea since most people are not full-time or experienced investors. Picking startups to back is hard even for experienced venture capitalists!
Traders and investors participating in DAOs should carefully track their transactions to file taxes each year accurately. With the IRS cracking down on crypto tax dodging, the community could see an increase in penalties for those that don't pay their fair share. So get started with ZenLedger to ensure that your taxes are in order this year!