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The DAO: Investments Meet the Invisible Hand

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A new way of running an investment fund

So, this is new. Or is it? The concept of a distributed autonomous organization (a DAO) has been talked about ever since bitcoin enabled rudimentary smart contracts. The launch of alternative cryptocurrency Ethereum pushed the chatter up several notches with their smart contract-friendly platform. And over the past week it seems that DAO-talk has become mainstream. Yet few know what they are, how they work and why they are so interesting. Because few have been put into real-world practice. And none have attracted significant public attention. Until now.

Backing up a bit, let’s briefly talk about Ethereum. Ethereum is a public distributed blockchain, similar to that of bitcoin, but with operational differences and a more intense focus on smart contracts. Its virtual currency is ether, which is used to power the mini-programs embedded in the transactions on the network. Executing a loop or completing an if-then statement will cost a certain (tiny) amount of ether. Ether can be mined as a reward for validating blocks of ether transactions, or it can be purchased on digital currency exchanges, just like bitcoin. Ether is still at a fraction of bitcoin’s market capitalization ($1.2bn vs $6.9bn), but its liquidity and value seems to be building.

A Distributed Autonomous Organization is what the name says: an organization that does not have a hierarchy, and functions pretty much on its own. No CEO, no Executive Directors, no central chain of command. Therein lies the “decentralized”. No administration staff, marketing executives or sales representatives. Therein lies the “autonomous”. There aren’t even any incorporation papers. The functions the company needs to fulfil are written in code and automatically executed when the time comes. The filing of accounts, the sending of emails, the disbursement of payments – there is no one person asking that these be done, and no one in charge of doing them. They just get done, because they are written in code. It runs itself. It exists as long as there is an internet connection.

What kind of organization can run like that, I hear you ask? Obviously relatively simple ones, such as a crowdfunding campaign (if enough money is collected, ship the product), voting (if enough votes are gathered, such-and-such happens), etc. But also more complicated scenarios have been implemented, such astransport management, content distribution, cloud storage… And even more complicated ones are possible. Just think of everything a business does, and ask yourself, how would I go about automating this?

So why have so few been put into real-world practice? Because the concept is relatively new, and the execution is risky. We can’t count on bitcoin for this (for now), as the protocol does not allow complicated scripts, and the currency’s scalability problem has not yet been overcome (although some DAOs run on topof bitcoin, which means they run off-chain but connect to the bitcoin blockchain for verifying and locking in).

Ethereum does give us that capability. With Ethereum we can program functions, with if/then/else queries and conditional responses. With Ethereum we can create all sorts of DAOs.

Such as the one launched with little fanfare at the end of April. Although often called the “Ethereum DAO” in the press, Ethereum neither owns it, nor did it develop the software. That credit goes to Slock.it, a Germany-based developer of blockchain IoT solutions. On the 30th of April they announced in their blog the activation of the confusingly named The DAO (a bit like naming your company, “The Company”), an automated association whose purpose is to invest in Ethereum applications. And they invited the community to participate by purchasing DAO tokens with Ethereum’s currency ether. DAO tokens give holders the right to vote in the investment decisions. Which makes The DAO, In effect, a crowd-sourced, crowd-run investment fund.

from the Ethereum Community Forum - DAO

In just 20 days, it has become the world’s largest crowdfunded project, by far. Up until now that honour has been held by the video game Star Citizen, which to date, as far as I know, has raised almost $110 million (the actual amount fluctuates in line with the ether exchange rate). As of this morning and with only two hours to go (the campaign ends today), The DAO had accumulated almost $130 million of ether (although this valuation fluctuates in line with ether’s exchange rate), which accounts for 15% of all ether ever mined. It also is now the most funded cryptocurrency startup ever, beating Coinbase’s $75m, Digital Asset Holding’s $60m and Blockstream’s $55m. And The DAO funds did not come from institutional investors. They came from ordinary crypto enthusiasts.

The blown-away success of the campaign has even surprised the developers. In an interview with the Wall Street Journal, Slock.it’s founder Stephen Tual said that they had hoped to raise perhaps $20 million.

What will the DAO do with the funds? Once the crowdfunding closes on the 28th of May, it will start accepting proposals from developers for their ideas for Ethereum applications, services, etc.. The token holders will then get to vote on which proposals will receive funding. The successful projects then reward The DAO with a percentage of the revenue from their deployed service (or some similar arrangement – each proposal specifies the terms of the funding and the terms of the payout).

This is similar to a VC fund, but without the VCs, without the high salaries, without the paperwork and without the interminable meetings. And, obviously, with ideas limited to projects on the Ethereum blockchain (for now).

Why has it attracted so much interest? Most of the PR has come after the fact, with headlines over the past few days heralding a new form of funding and a new way of developing. The bulk of the interest has not come from professional investors, but from the cryptocurrency community, a rapidly increasing collection of individuals all over the world that are fascinated by the potential of this new distributed consensus system.

The DAO

Yet there are increasing concerns that this may be over-blown hype. First, the legality is still dubious. Who owns the funds? Who owns the ideas? Holding tokens does not make you a shareholder, so while you can vote, you don’t technically own a share of the profits. Can The DAO be hacked? How good will an untrained “crowd” be at spotting worthwhile investments? Would it be possible for someone to buy lots of tokens and then fund their own business idea with The DAO’s money? What if the ether exchange rate crashes?

Whether The DAO ends up a success or not, it is testing new waters, and opening our eyes to what could become possible through automated transactions and governance. It is showing us the power of the community, and the interest in change. And it highlights the potential of cryptocurrencies and blockchains to show us a new way of looking at business. Whatever happens, things are about to get very interesting.

(This article was previously published on LinkedIn.)

The post The DAO: Investments Meet the Invisible Hand appeared first on fintechblue.


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