What Investors Should Know About DAOs

Hedge Fund Killer or Fad?

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Blockchain technology has led to the disruption of so many industries, and perhaps none more so than the financial industry. One of the many innovations that the blockchain and decentralized finance (DeFi) has led the way for are Decentralized Autonomous Organizations (DAOs), which have been dubbed by some as “hedge fund killers.”

Over the past several years, we’ve seen DAOs bring together hundreds — if not, thousands — of strangers to attempt large investments in everything from art to historical documents. In this article, we’ll discuss what DAOs are, how they work, and what it means for individual investors.

What Are DAOs?

A DAO is an organization that operates using blockchain technology. In many ways, DAOs operate similar to hedge funds or venture capital firms. They represent a way for investors to pool their money together to make large investments. However, unlike hedge funds or VC firms, there is no central authority. Instead, it’s controlled by all of its members.

A DAO somewhat mimics the structure of a traditional corporation, in that there are governing rules and regulations, built into the organization’s code via smart contracts. But the structure is entirely different — DAOs don’t have the traditional hierarchy you’d find with a typical corporation. There’s no central governing authority, nor does a single person have total control over the direction of the DAO as a founder or CEO might in a corporation.

Everyone has the same potential risks and rewards. Members are either mutually successful or unsuccessful. And if a member of the DAO violates any of the rules, the DAO’s funds are locked to everyone.

Proponents of DAOs argue that because of their structure and lack of the traditional corporate hierarchy, these organizations are more democratic than companies. Rather than the power being in the hands of a select few, everyone who has bought into the DAO has some control and ownership in proportion to their investment.

Sure, this democratic structure exists to some level in corporations, since shareholders have the right to vote on company matters. But unlike corporations, DAOs don’t have any gatekeepers or a central authority like a board of directors or a CEO.

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How Do DAOs Work?

Because DAOs are built on the blockchain where all transactions are recorded, there’s a level of transparency you aren’t likely to find in a traditional corporation.

Like other things in the world of decentralized finance, DAOs are created using smart contracts and code that contains the organization's rules. When someone buys into the organization, they agree to follow those rules.

Everyone who buys into the DAO — meaning they buy the organization’s specific cryptocurrency — has a say. Just like a traditional corporation, owners have the right to vote on proposals. The weight of each member’s vote is proportional to the amount of cryptocurrency they have.

Because DAOs are built on the blockchain where all transactions are recorded, there’s a level of transparency you aren’t likely to find in a traditional corporation. Any member can see what’s written into the code, just as any member can submit a proposal. Actions taken by anyone within the organization are recorded in the blockchain for everyone to see. This transparency helps to create trust amongst the members of the DAO.

The Purpose of DAOs

Now that we’ve talked about what DAOs are and how they work, you might still be wondering what the purpose of these organizations is.

As an example, in late 2021, the organization PleasrDAO pooled its money together to buy the Wu-Tang Clan’s album, “Once Upon a Time in Shaolin” — the only copy that exists in the world, with special rules by the creators barring it from being released to the public — for $4 million.

It’s unlikely that many of the DAO’s members could have individually made such a large investment. However, as a group, they were able to purchase this super-rare item, mint it as a non-fungible token (NFT) as a form of a deed for the physical album, and split the ownership fractionally among its members.

Department of Justice

The exact purpose of each DAO is a bit different. Some specialize in buying tangible items, while others are solely occupied with buying NFTs and other assets in the digital space. Additionally, while some DAOs form to make a single large investment, others are a part of larger projects that plan to make any number of investments.

An important difference between DAOs and traditional investment firms is their accessibility. Historically, investment firms like hedge funds and venture capital funds have only been accessible by high net worth investors. But anyone who buys into a DAO can participate, which helps to democratize this type of collaborative investing.

What Are the Risks of Investing in a DAO?

In June 2016, a DAO built on the Ethereum blockchain was hacked and roughly $50 million of currency was stolen. And because of the lack of regulation in this area, there was little recourse for the investors who lost their money.

As mentioned above, DAOs eliminate some of the biggest downsides of the traditional investment world, such as gatekeepers and organizations led by a small, powerful group of people.

However, DAOs also have some major risks and drawbacks that investors should be aware of. First, as with any other investment, there’s always the possibility of losing all of your investments. And given the lack of regulation in this area of finance, the risk seems even greater with a DAO than with more traditional investments. Plus, because of the way DAOs operate, if a member breaks the rules of the DAO, then funds are locked up — meaning you may not be able to back out.

Lastly, just like many other areas of decentralized finance, there’s plenty of room for fraud and theft. No technology is perfect, and DAOs can be hacked. For example, in June 2016, a DAO built on the Ethereum blockchain was hacked and roughly $50 million of currency was stolen. And because of the lack of regulation in this area, there was little recourse for the investors who lost their money.

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Types of DAOs

There are literally thousands of DAOs, each founded with their own purpose in mind. The section above describes the purpose of some of the well-known DAOs. But it’s impossible to lump every DAO into that box. Below are some of the most common types of DAOs:

  • Investment DAOs, like the ones described above, allow investors to pool their money together to make large investments. These DAOs often resemble venture capital firms, as they help to back new businesses and get them off the ground.
  • Collector DAOs serve a similar purpose as investment DAOs. But instead of investing in companies, they invest in collectibles like NFTs and other artwork. Each member of the DAO becomes a partial owner of the assets they purchase.
  • Protocol DAOs were created to serve a specific purpose on the blockchain. Some Protocol DAOs serve as liquidity makers for a specific cryptocurrency, while others allow users to borrow and lend cryptocurrency.
    Grant/Philanthropy DAOs serve a similar purpose as non-profit organizations, allowing members to pool their money to support a specific social cause.
  • Social DAOs focus less on making money and more on bringing together a community of like-minded individuals. Some social DAOs seek to support businesses started by women, queer and non-binary founders, people of color, and more.

As you can see, DAOs vary widely in their missions and principles. So if there’s something out there that you’re passionate about, you can probably find a DAO that supports the same purpose!

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Best DAOs to Invest In

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If you’re new to the world of DAOs, you might be surprised to learn just how many of these organizations already exist.  Here are some of the top DAOs, based on their valuation at DeepDAO:

  • BitDAO: With a treasury of more than $2 billion, BitDAO is an open platform that “aims to support builders of the decentralized economy.” It creates and partners with other entities to support various industries, participate in token swaps, fund R&D, and more.
  • Uniswap: This well-known DAO is an open-source protocol that provides liquidity on Ethereum. The platform works as an automatic market maker. It has nearly 8,000 active members, any of whom can submit a project they’re working on.
  • Lido: This platform provides liquidity for staked digital assets. And the Lido DAO serves as a governing body for its staking protocols. The goal of the platform is to allow users to stake coins without losing their liquidity or the ability to trade or use their tokens.
  • UXDProtocol: This DAO is one of the few that doesn’t use Ethereum as its main treasury chain. Instead, it operates on the Solana blockchain. UXD Protocol is an algorithmic stablecoin, and its DAO members have authority over future design proposals.
  • Mango DAO: This DAO is also run on the Solana blockchain. The platform allows users to lend, borrow, swap, and leverage their cryptocurrencies. The platform is governed by members of the Mango DAO.

The DAOs listed above are far from the only ones out there. In fact, DeepDAO, an analytics firm dedicated to DAOs, has compiled a list of more than 4,800 of these organizations already in existence, along with a comprehensive list of DAO resources.

Should You Invest in DAOs?

Most individuals who are interested in decentralized finance will easily see the appeal of DAOs. Given the direction the financial industry is moving, it’s certainly possible that DAOs could become more prevalent and mainstream.

As an investor, you may be tempted to get in on the ground floor of this new type of organization. It’s clear there are some major benefits, including the democratic structure you won’t find in the traditional financial world.

However, before putting your money into a DAO, be sure you understand the risks you’re taking on. And as with other speculative and risky investments, be sure to only invest money you can afford to lose.

Further reading:

Erin Gobler

Erin Gobler is a freelance personal finance based in Madison, Wisconsin. After seven years working in state politics, she left to pursue writing full-time. Now she writes about financial topics including mortgages, investing, and more for major publications like Fox Business and NextAdvisor. In addition to finance writing, Erin also provides financial coaching services where she works with individuals to help them reach their money goals.

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