What are DAOs? Here’s what to know about the ‘next big trend’ in crypto

Over the summer, a group of "crypto fans" pooled their money in order to collectively make a seven-figure investment: The group secretly bought the sole existing copy of the album "Once Upon a Time in Shaolin" by the Wu-Tang Clan for a whopping $4 million.

But it wasn't until Wednesday that the group, an organization known as PleasrDAO, came forward as the buyer. The announcement was a pleasant surprise for the crypto community, earning headlines in mainstream media outlets.

PleasrDAO isn't new to the world of rare collectibles, and already had a portfolio full of multimillion-dollar assets. In June, it bought the original "Doge" meme nonfungible token, or NFT, for $4 million.

But what makes PleasrDAO's purchase stand out is that while it may seem like a typical investment firm, it's not. Like its name suggests, it's a decentralized autonomous organization, or DAO, and it runs on blockchain technology.

Lately, a number of DAOs have started to grab the attention of more conventional investors, including billionaire Mark Cuban, who called them "the ultimate combination of capitalism and progressivism." Venture capital firm Andreessen Horowitz (a16z) has also led multimillion-dollar fundraising rounds in both individual DAOs and companies that support DAO creation.

As members of the crypto community predict that DAOs will become the "next big trend" in the space and mainstream investors start to take notice, you may be wondering what, exactly, is a DAO?

Here's what you should know, from how they operate to why some experts think they may soon compete with traditional business structures.

'An internet community with a shared bank account'

DAOs can come in all shapes and structures, but simply put, "a DAO is an internet community with a shared bank account," Cooper Turley, an investor and builder of several popular DAOs, tells CNBC Make It.

"Basically, a small group of people come together to form a chat group, and then they decide to pull capital together, [typically] using an Ethereum wallet," Turley says. From there, they decide how to fund their DAO's mission collectively, he says.

Many DAOs fall into one of two general buckets: Those that manage open source, blockchain-based projects together and those that make investments. They can act similar to limited liability companies (LLCs), VC firms or investment firms, like PleasrDAO.

The specifics of each DAO, including its type, structure, rules and governance, depend on the group and its goals.

To those who witnessed the hack of the first DAO in 2016, where millions of dollars were effectively stolen, the term may have a negative connotation. Though there are still risks, DAOs have made great strides since.

Types of DAOs

It's important to understand that DAO is a broad term than encompasses a huge number of different types of groups and business. Two collectives can be vastly different, but still both be DAOs.

Here are a few examples of well-known DAOs:

• The PleasrDAO collects various NFTs and invests in other assets.
• The HerStory DAO collects and funds projects by Black women and non-binary artists.
• The Komorebi Collective DAO funds women and non-binary crypto founders.
• The Friends with Benefits DAO is an exclusive social club which you pay to enter.
• The MetaCartel Venture DAO is a for-profit business that invests in early stage decentralized applications.

How DAOs operate

To understand DAOs, you first need to understand the technology behind them. Most DAOs rely on blockchain technology and smart contracts, which are collections of code than run on the blockchain.

A blockchain is a decentralized, digital ledger. While they are commonly known to publicly document transactions of different cryptocurrencies, like bitcoin, and other digital assets, like NFTs, blockchains can also be used in a number of other ways. For DAOs, the blockchain can act as a backbone, keeping the structure and rules of each on-chain.

In traditional organizations, there's typically a hierarchy. A formal board of directors, executives or upper management determine the structure and have the power to make changes.

DAOs, on the other hand, are decentralized, which means they aren't governed by one person or entity. The rules and governance of each DAO is coded in smart contracts on the blockchain and cannot be changed unless voted upon by the DAO's members.

Instead of a select few having the majority of say, members of each DAO can vote on decisions together, typically on equal footing.

For example, PleasrDAO members collectively decided to buy the Wu-Tang Clan album. After doing so, they created an NFT to represent a deed of ownership to the album. The members of PleasrDAO co-own the NFT deed, and in turn, share ownership of the album.

Sometimes, in larger DAOs, teams may form to tackle different aspects of the organization with leaders that have been voted in. That way, not every single member is needed to vote on every nuance.

The most important aspect of DAOs is transparency, Turley says. Every decision within the DAO is pitched, discussed, voted on and documented publicly.

DAO structure

Each DAO is structured differently, but usually, when joining a DAO, you agree to the code in place. It isn't easy to change that code, and any changes typically require a vote between members.

DAOs are "very participatory," says Aaron Wright, co-founder and CEO of OpenLaw, a blockchain-based protocol for the creation and execution of legal agreements. Wright has helped launch several DAOs, including FlamingoDAO, which collects NFTs.

"You don't have to wait for a quorum or a sufficient number of people to vote in order to make a decision. It kind of runs and operates like the internet, through rough consensus," Wright explains. "If there's more people that support a project, a decision is made."

To obtain voting power or membership in a DAO, you typically buy governance tokens, which are cryptocurrencies that are tied to a certain project. In some DAOs, governance tokens can only be obtained in structured funding rounds, and occasionally, demand exceeds the amount of tokens available. By holding these tokens, members are typically able to own equity in the DAO and help shape the DAO's future.

While it varies from DAO to DAO, the weight of a member's vote usually depends on the amount they contributed to the project.

If a DAO doesn't use governance tokens, it may accept investment of other forms, like in ether, the second-largest cryptocurrency by market value, Wright explains, since the Ethereum blockchain powers most DAOs. But, again, each DAO has its own system.

Beyond voting power, members can also work for their DAO. There are typically a number of internal jobs, including positions in token distribution and treasury management.

"Working for ownership means working for tokens," Turley says. For example, he's mainly compensated for his work on DAOs with governance tokens, but can also receive ether or USDC.

Challenges and unknowns

Despite their growing popularity, DAOs have a long way to go before reaching full mainstream adoption.

"Not all DAOs work out. In fact, most DAOs won't work out over the long-term. They're very ephemeral in nature," Turley says. "It's a very risky area to be poking around with."

It's always possible that the governance token value for a DAO may hit zero. Potential investors should do their homework first and only spend what they can afford to lose.

However, the potential upsides can be significant, Turley says. Take governance tokens, for instance, which often have a secondary market value. Owning a governance token is a bit like holding equity in an early stage start-up — if it becomes successful later on, that equity will be extremely valuable.

DAOs will also need to overcome many potential regulatory and legal challenges, especially in the U.S. There are several unknowns regarding how potential legal framework across the U.S. could impact DAOs and how they operate.

"One issue with the whole space right now is the lack of regulatory clarity," says Luiz Ramalho, co-founder of Polvo Technologies, a firm that develops machine-learning strategies to trade bitcoin and digital assets. Ramalho also helped create FingerprintsDAO, which collects NFTs.

Looking ahead

Despite the unknowns, those in the space think that DAOs will be disruptive to traditional structures of business.

"I think DAOs are the new LLCs," Turley says. "I think in five years, companies won't have equity anymore. They'll have tokens, and they'll be represented as DAOs."

Billionaire investor Mark Cuban has also said that he sees value in DAOs. "The future of corporations could be very different as DAOs take on legacy businesses," he tweeted in May. "Entrepreneurs that enable DAOs can make money. If the community excels at governance, everyone shares in the upside."

Cuban admitted DAOs "won't be a fit for every type of venture," but, in his opinion, "[t]here are so many features and processes in any given company that can be more efficient and productive using a decentralized, trustless approach."

The recent wave of mainstream, institutional investment in DAOs is also a sign of growth for the industry. It also shows the potential for more widespread adoption, leading to potential competition with traditional businesses and organizations.

Turley predicts that the mega-popular and successful companies of the future may be DAOs. "I believe that the next Facebook-like company will be formed as a DAO rather than an LLC," he says.

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