Article by Vic Kalchev Cover Art by Ornella

Let’s be honest — DAOs are the future of organizations. The elements of DAOs (Decentralized Autonomous Organizations) have been around for a long time, but the time has finally arrived for these elements to come together and form something greater than the whole.

COVID pushed us to discover what many in tech already knew — distributed teams can work effectively. Compound, Gitcoin and others showed us that merging those teams with the community and letting them make decisions also works.

So, does this mean that every startup should create a DAO?

Not quite.

For one, not every business is suited for a DAO (for example, your socks store on Shopify). Even if it is suitable, there is quite a bit of work to be done well in advance of the first on-chain vote.

DAOs are communities. Communities form a shared vision and develop a mission on how to make that vision a reality. Hector Espinal built We Run Uptown around a shared mission, “to build a network to uplift and inspire NYC runners to be their best and have fun while doing it.”

But this wasn’t how he got his Washington Heights neighbours to run with him. Instead, he simply posted on Facebook: “Meet me at 168th and Broadway. We’re going for a run on the bridge.”

Those joining Hector knew precisely what they were about to do (run) and with whom (neighbours). As for the why, everyone had their own personal reason, but a shared vision must have been to get fit.

The same is true for DAOs. You can’t start one before you know the what, how, and why of your project, and whether others care about those ideas too.

As well as a sense of community, DAOs need governance and incentives. While the community will build these, you need to erect the scaffolding. Governance and incentive structures will carry your blueprint vision, outline the general direction of the DAO,and ultimately be a major reason people will join.

So, if not on day one, when should you start building a DAO? Jesse Walden from a16z has some answers:

Walden argues that crypto startups should decentralize gradually:

“… Much of what it takes to build a successful product at the outset — product leadership, rapid iteration, a managed go-to-market — complicates the path to community ownership and regulatory compliance, which guarantee long-term health.”

Building a community around an untested idea distracts from the most critical task: testing the idea. To avoid such missteps, Walden recommends going through three stages:

1. Discover a product-market fit

2. Build an active community

3. Transition to community ownership

The journey to a full DAO

Things move fast and direction changes quickly. You work in sprint mode: define the problem, draft a solution, and test it. A core team can tweak and repeat until your product clicks with the market.

Focus and rapid iteration are critical. To optimize for speed, you need to stay small and agile. Walden says decentralization should not be even a thought at this stage.

You’ve found your market. You’re solving a real problem for a large group of people. Your product is still in rough draft, but customers keep asking for it. Some may even reach out with feature requests. This is when you start building a community.

A community is a good idea even if a DAO is not in your plans. There are two main reasons:

• Gain customer insights to help you fine-tune your product;

• Increase customer stickiness. It’s a much easier choice for customers to stop using a product they’ve not become attached to via a community.

In Web2, businesses build communities in order to extract value from them. Coda — the doc app I used to write this article — has a vibrant online workspace where people share templates, develop workflows and exchange experiences. While members benefit from these interactions, the largest slice of value goes to Coda. It can mine the forum for use cases, feedback, and ideas. In return, the users get to pay for a product they help build.

If this seems exploitative, it is — even when communities are voluntary. But things don’t have to be this way.

In Web 2 the company and community are two separate groups. In Web 3 they become one.

If Coda decides to take the DAO route, it could:

• Enable community members to make proposals for product developments.

• Set up governance and incentive structures at a community level.

• Flow-back value by paying members for their contributions (e.g. template creation, workflow development).

• Introduce a token to enable the transfer of value among community members.

All the efforts in the previous two stages culminate here. The founding team gives complete control to the community. Tokenholders will now make all decisions about the future of the organization.

The biggest challenge in making the leap from a supportive but hands-off community to an operational DAO is the governance and incentives. No matter how much work you’ve done at the previous stage, it will be up to the community to enhance the governance structure and develop processes and procedures to enable the DAO to manage all aspects of the business.

Besides the daily operations, there are challenges associated with managing existing shareholders, employees, taxes and incorporation. Most states and nations don’t recognize DAOs as legal entities. Would you register the DAO as an LLC or incorporate it in Wyoming? Depending on which option you decide, how would you deal with payroll deductions and employment law compliance?

I don’t have all the answers. Frankly, I don’t think anyone does. It can take years, often more than three, to design the proper structure, as we’ll see in the examples below.

In 2017, Scott Moore and Kevin Owocki launched Gitcoin, a platform which funds the development of public goods for Web3. Earlier this year, Owocki explained that many exciting projects never get built for one simple reason: lack of funding in the initial stages. To solve the problem, Moore and Owocki started a grant program to support developers in building open source for Web3.

Gitcoin didn’t become a DAO until May 2021, when it launched its governance token (GTC). In the four years prior, Owocki and Moore were busy defining the problem, designing a solution, and growing a community of builders and sponsors. After figuring out all of the above, the team had to lay the framework for community governance and how to turn over responsibility to the DAO. The launch of GTC was the culmination of all these efforts.

Stani Kulechov started ETHLend in 2017 as a decentralized peer-to-peer lending platform.

A year into it, Kulechov and his team switched their business model to a liquidity pool platform. They also changed the name to AAVE — the Finnish word for “ghost”.

AAVE didn’t start functioning as a DAO until 2020.

What were Kulechov and his team up to in those three years? They refined their business model, rebranded, and validated their product-market fit. Once AAVE had some traction, they decided to become a DAO.

MakerDAO started as the Maker Foundation in 2015. Rune Christensen articulated a vision of building a stable token (e-Dollar) to support the exchange of value on the Ethereum network. The problem Christensen wanted to solve is one we still face today: that the major cryptocurrencies are too volatile to be practical tools for daily transactions. Crypto needed a stable token.

In the years to follow, Christensen scrapped the Maker Foundation, released a limited edition stablecoin, launched DAI, and paved the way for the formation of a DAO. You can read the full version of Maker’s journey here.

MakerDAO, along with many others, has successfully used progressive decentralization to evolve as a DAO. This approach, however, doesn’t always make sense.

Progressive decentralization works best for Layer 2 applications. Usually, these are built on Ethereum and use smart contracts. Most DeFi and Web3 applications belong to this group. Some business models, however, call for decentralization from day one.

By design, projects like Ethereum, Solana and Polkadot need a community of participants from the very beginning. Their very reason for existing is to provide specific solutions using decentralized blockchain technology.. They are networks that operate without a central authority.

Ethereum would have never worked if its founders had held all decision-making power. It would not have been trustless and permissionless. It would have been just another Amazon or AirBnB — a place where people operate within the parameters set by centralized decision-makers

The value of the blockchain networks is in their decentralization. Hence, optimizing for it from the very beginning is a must.

If it weren’t for Web3, The LAO would have been a traditional VC fund. PleasrDAO would never have existed.

The LAO’s success lies in the community of participants jointly investing in crypto projects. In the traditional VC world, The LAO would have had a general partner (GP) who pooled money from limited partners (LPs) into a fund. The GP would have been responsible for investing that money and delivering a return.

This model works in a world where LPs have little interest in the daily operations of the fund. Many LPs take this approach, and as long as the fund delivers the promised return and maintains the same risk profile, there is no need to get involved.

However, an active LP who wants to be more than just a bank account should be looking elsewhere. Decentralized organizations like The LAO and Meta Cartel are made for them.

You can’t achieve The LAO without a DAO. By design, it relies on a network of people who play different roles — investors, scouts, mentors, and founders. They work together to build projects that shape the future.

The same is true for PleasrDAO. Its premise is to collectively own digital art. It brings together a group of people with a shared common goal. Collector clubs do exist in the offline world. However, they tend to be over reliant on centralized control, and are often small in terms of membership. PleasrDAO’s dispersed and mostly anonymous members coalesced around a cause thanks to a single tweet, and now hold some of the world’s most prominent NFT art works without ever having formed a centralized entity.

While projects like The LAO and Ethereum wouldn’t have benefitted from a staged approach to decentralization, they didn’t start out fully decentralized either. Theytoo needed a small team of committed founders to get things going.

InThe Infinite Machine, Camila Russo describes how Vitalik Buterin worked with Gavin Wood, Charles Hoskinson and Anthony Di Iorio to get the project going. Each played a different role, but they all came together to make critical decisions about incorporation, legal registration, token issuance, and so on.

By Russo’s account, the first days of Ethereum were by no means a smooth ride. Squabbles and power struggles were typical. Most of the original founders left the project on ambivalent terms. The first days of any business are tough, even when founders get along. Trying to launch a DAO only makes things more challenging.

Many in the cryptoverse are familiar with the story of The DAO. Within weeks of its launch, a hacker was able to withdraw millions of dollars’ worth of ETH tokens because of a loophole in the smart contract. Researcher Quinn DuPont provides an in-depth assessment of the challenges faced during the early days of The DAO, noting that at the point of the attack, “we see the vision of future governance structures break down, and devolve into traditional models of sociality–using existing strong ties to negotiate and influence, argue and disagree–all with nary a line of code in sight.”

That’s why it is essential to clearly define both the process and timeline for the devolution to community-driven governance, to know what the shared vision is, and to execute the mission in a way that brings your community with you.

Vic Kalchev helps startup founders and investors with strategy and valuations. He writes about Web3 strategy and tokenomics at pivotup.co.

Get Together: How to Build a Community with Your People. Bailey Richardson, Kevin Huynh, Kai Elmer Sotto.

The Dao of DAOs — Not Boring by Packy McCormick

Progressive Decentralization: A Playbook for Building Crypto Applications. Jesse Walden. A16z.

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