DAOs, ever wondered what they are and how they help in business and cryptocurrency? With the increasing popularity of cryptocurrency and blockchain technology, no doubt there has to be a legal framework for the entities. There is decision-making involved, and since the transactions involve millions of dollars, security is a priority. Thankfully, there has been an emerging legal structure in place to cater to this; DAOs. They are set to enhance transparency and decentralization. However, what exactly are they? Are there risks involved? Please read on to find out the things you should keep in mind before you invest in one.
What is a DAO?
A decentralized autonomous organization, DAO, is a structure that allows the involvement of token holders in the process of making decisions in the entity. It also permits their participation in the same. Therefore, this is a method of having an organization that is autonomous, self-managed, and decentralized, meaning that no single institution is in control over it. Hence, there is no focal authority, nor are there hierarchies in the organization. Rather, the token holders vote and distribute power within the entity among themselves. They all have a chance to be a part of the decisions made, especially about financial management.
Remember, the technology behind DAO is blockchain. What does this mean? All the activities taking place, including the voting, are recorded here, and the users can publicly view the actions taking place. Furthermore, DAOs have treasury savings, meaning they have to prioritize security.
Importantly, the operations in a DAO depend on certain rules that rely on smart contracts which dictate the collective decision-making process.
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With purposes of a DAO such as decentralized governance, crowdfunding, and exchanges, you may consider investing. What are the things to keep in mind? Let us find out some of the risks involved in adopting and utilizing this model.
5 Risks of DAOs
As already mentioned, DAOs are decentralized and the members participate in the decision-making. Crypto advocates and enthusiasts view this structure as one that organizes individuals and secures all online crypto transactions and activities taking place. There are numerous benefits attached to the same. However, what is the potential risk? They include;
Regulatory Risk
The regulatory issue with DAOs undoubtedly goes unnoticed. Remember, there is no single institution or entity that is in charge of the decision-making in this type of model. On the contrary, there is voting, meaning that the law enforced or the direction taken has to lie on the majority of votes cast. What problem erupts in this case?
A lot of time goes into voting, and law enforcement isn’t easy either. Additionally, if there are any bugs to be fixed or any updates needed, implementation becomes a hassle. Therefore, the time involved in the transactions is a setback for such organizations, thus the investors are at a risk.
Vulnerability of Smart Contract Code
The operation of DAOs heavily relies on smart contracts on blockchain networks. Most of these organizations depend on smart contract codes to take care of each transaction. unfortunately, every code faces vulnerability, and a smart contract is no different.
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Therefore, when investing in a DAO, don’t assume that the smart contract code it uses will not be subject to vulnerability. If the smart contract code is jeopardized, the members’ safety and security are under attack. Therefore, if this happens, the DAO will have a huge challenge in its future growth.
Lack of Enough Engagement From the Community
As earlier mentioned, DAOs rely on the votes of the majority. Unfortunately, there are chances that not every voter will always participate in the process. What’s more, the moderator may not get feedback from each of the members on different platforms like Twitter. This poses a risk especially when there is an initiative to be carried out.
For instance, if there is a proposal to be pushed through, a lack of numbers in the voting may make this impossible. In case the number of voters participating keep on reducing, then the moderator may be forced to adjust the protocols of the model such that a few individuals dictate the decisions made. What is the challenge? With only a small section of the community in charge of the decision-making, e.g the investors and executives, the governance may seize being decentralized. It may lean more towards a centralized organization.
Therefore, when the community is not properly engaged, the DAOs may lose their major benefit; the involvement of the members in the decision-making.
Varying Levels of Autonomy
The concept of a DAO promises on having an autonomous and decentralized organization. Notably, many of organizations claim to adhere to this. However, this is not always the case since the level of autonomy from one DAO to the next may vary.
Also, the organizations have different levels of community participation for decisions to be made and rules remitted. Therefore, before you invest in any DAO, ensure it lives up to its name. it has to be truly decentralized and autonomous. If you confirm that it can indeed boast of having a legal structure that includes the community rather than has a section, e.g the investors and executives, take part in decision making. At least a majority should have a share and contribution to growing the project and organization in general.
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High Costs of Operation
In most cases, the funding of these digitized organizations, DAOs, solely relies on cryptocurrency. However, remember that for each crypto transaction, there are charges, also known as gas fees. Therefore, you have to pay this to have your crypto stored in the blockchain.
Another cost that DAOs have to take care of is taxation by governments. It is still unclear how this will happen. Nonetheless, the DAOs may be subject to double taxation. In other instances, the governments may pose certain unexpected taxes on DAOs.
Think Through the Possibility of DAOs
DAOs have brought a paradigm shift in decision-making in entities. This is a model based on community engagement and involvement to ensure transparency and decentralization. However, this structure of communal participation and governance also involves certain risks. If you think of investing in a DAO, you should embrace its positive impacts and potential risks. Some of the things you should keep in mind include the regulatory risk, the vulnerability of the smart contract codes used, the speed and time of the transactions, and the potential lack of engagement from the community. So, before you invest in such an organization, ensure you compare the benefits and potential risks.
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