Decentralized Autonomous Organizations (DAOs) as Innovative Means to Supplement Transition Governance

Abstract

The following contribution explains how a DAO (Decentralized Autonomous Organization) can technologically supplement the governance process in complex environments, in this case urban environments where Fab City is active. DAOs are implementations of the blockchain technology which can be considered as coordination tools and de facto “decentralized ERP* (Enterprise Resource Planning) systems on the internet”. They can enable organizations and communities to address challenges that are otherwise too complex in a tangible, dynamic and sustainable manner which caters to the general need for transition governance. To facilitate collaboration and coordination, the idea of a DAO is to effectively capture the various rule sets, actor constellations and general conditions to address the four universal problems in organizing-task division, task allocation, reward distribution, and information flows. The following conceptualization aims to provide a practical solution alternative to supplement cooperation and coordination between various actors within the wider ecosystem using a DAO. The current state of blockchain and DAO research serves as a rich backdrop when exploring the given opportunity and shedding light on the most important requirements, risks, and success factors. Despite remaining challenges in particular the legal domain, the focus of this article is to showcase how a progressive path forward can lead to a setting in which DAOs can be successfully integrated and become an operational part of an urban environment.

1 Introduction

1.1 Governance Acceleration

Large-scale transformations set in motion in response to pressing and complex challenges (in this case, with a transformation of urban environments such as Fab Cities to circular economies) not only require a thorough understanding of situational analysis and target setting but an exhaustive overview of variables involved in the capturing of the various rule sets, actor constellations and specific conditions that have to be dealt with. Considering such a process which is not only lengthy but difficult to administer creates the need for transparency and dynamic adjustment of the status quo.

Governance is the key to the provision of an approach to systematic transitions as it rests on effective coordination with accountability, predictability, and common understanding (Okhuysen & Bechky, 2009). Traditional analog approaches to guide such processes are prone to issues like information asymmetry, missing transparency, lack of consensus in decision-making, and corruption among other things (Kim, 2021).

While technology alone holds no ultimate answer to real-world challenges, recent decades have brought massive advancements in computational, storage and bandwidth capacity to deploy and scale solutions, in this case with decentralized technology. Blockchain, the decentralized state machine and economic middleware¹ (see Fig. 7.1) for the internet of ownership, serves as a governance tool that facilitates coordination and builds on simultaneous transparency and privacy. The technology acts as a de facto ERP system² for the internet as it provides a general settlement layer on the TCP/IP³ protocol to prevent any single point of failure and offers both transparency and privacy in the process (Haddara et al., 2021). The novel aspect that comes to attention is decentralization.

Fig. 7.1

Schematic blockchain-based system

Blockchain technology is a digital system that records ownership and transactions without relying on a central authority. This is achieved through the use of digital signatures and validation from independent nodes. Each ledger entry is controlled by its respective owner, and updates to the ledger are decentralized through a consensus mechanism such as Proof of Work or Proof of Stake. This ensures that any changes to the ledger are agreed upon by all nodes holding the ledger. The ledger is tamper-proof and provides a complete and accurate history of all transactions, allowing for an auditable trail of events (Davidson et al., 2016).

A technical solution to large-scale transformations that captures activities and offers provenance over events in near real-time may find an answer in blockchain technology and additionally the creation of dApps.⁴ The result may provide governance acceleration as coordination with accountability, predictability, and a common understanding for more manageable parameters.

The following article describes a pragmatic approach to DAO implementation in urban environments, in this case Fac Cities. First, I will lay out the theoretical background on the subject matter before describing the solution alternative and providing a discussion around its relevance.

2 Theoretical Background

2.1 DAOs (Decentralized Autonomous Organizations)

DAOs have only emerged in recent years but have come under increased attention as a niche application of blockchain technology and the interplay between machine consensus, social consensus, and decentralization mechanisms. In the simplest terms, a DAO defines an entity with a group of interest at its core that uses the blockchain and related technologies to coordinate common activities (Faqir-Rhazoui et al., 2021).

Coined in the 1990s by German computer scientist Werner Dilger (1997), a DAO offers a new form of organizational control and potential solution to the four universal problems – task division, task allocation, reward distribution, and information flows (Puranam et al., 2014). Traditional corporate governance involves management and formal legal structures to operate a company. However, DAOs (decentralized autonomous organizations) aim to operate in a decentralized manner. They run on public, so-called permissionless blockchains and follow behavioral rules that are encoded in open-source software protocols. These rules are enforced by smart contracts,⁵ which eliminate the need for intermediaries and create a transparent and efficient system (Tse, 2020).

DAOs operate differently from traditional businesses or entities by distributing control among their supporters or members instead of allocating it to a single individual or group. This approach eliminates the traditional principal-agent relationship and replaces third-party supervision with automated rules and machine algorithms, leading to a transformation in the overall perception of governance (DuPont, 2017).

An otherwise analog governance process can benefit from this novel set of coordination mechanisms based on machine consensus, which interact with coordination mechanisms around social consensus and decentralized decision-making on improvement proposals.⁶ The concept works on three levels (see Fig. 7.2):

• I. Decentralization of decision-making with the institution

Fig. 7.2

Coordination with DAOs

Example: developers and network validators in a non-profit institution decide collectively on the strategic direction of digital and physical infrastructure. Loosely coupled, the organization uses the DAO to decide collectively on the strategic direction while aligning all parties’ interests in the process.

• II. Human consensus in the peer-to-peer network

Example: updates to the ecosystem (digital and physical infrastructure) are approved by the community and need to be activated by validators who vote and commit resources (e.g., computing power).

• III. Machine consensus among network validators

Example: network validators write machine routines into the blockchain’s open-source code.

In addition, the DAO process uses governance tokens to both showcase the membership to the community and the qualification to submission of improvement proposals and decision-making (stimulation by participation). Greater transparency, trust, adaptability, and speed enable rapid experimentation and the potential to direct activities towards a multiplicity of goals (Tse, 2020). At the same time, the elimination of agency costs without a particular board of directors may drive efficiency through automation and boost accountability, predictability, and common understanding in the collaborative effort (Hsieh, 2018).

3 Solution Alternative

3.1 Potential

Due to the high complexity in rule sets, actor constellations and conditions of the host environment, a transition to a circular economy requires a high degree of coordination when implemented, aiding the transitioning phase of user onboarding and ongoing efforts to uphold onboarding and continuous engagement. Supplementing such an undertaking with coordination technology, thus, provides the ideal precedent for a DAO to facilitate and accelerate a governance approach that is based on collaborative visioning, learning, and experimentation (Bocken & Antikainen, 2018). The design of a decentralized governance system with a DAO implementation might be characterized as showcased in Table 7.1.

Table 7.1 Overview of DAO characterizations

Development of the DAO on transparent and open-source infrastructure, participation from developers, projects, and subject matter experts are welcomed, to both shift to this new economy and be rewarded for their contributions.

From a systematic perspective (see Fig. 7.3), a simple DAO embedded in an urban environment may consist of a treasury, network validators (nodes), and projects including members acting on those projects. Table 7.2 illustrates the associated process.

Fig. 7.3

Simple DAO concept

Table 7.2 Elements in simple DAO concept

3.2 Requirements for Set-Up and Management

Setting up and running a DAO will involve several requirements when conceptualizing the operation of this novel organizational model. The first critical step in DAO formation is gathering like-minded individuals around a common purpose. In many cases, DAOs will find their first momentum in social media platforms or result from real-world organizations. The foundational members work together to determine the DAO’s purpose, agree on parameters for governance and develop a rollout plan. DAO communities are also built around an existing community or blockchain-based application.

The set-up will usually begin with the manifestation of a community goal or purpose, for instance, a concrete and measurable or abstract goal like a collective investment or outcome. This phase will likely be established in founding documents, either articulated informally or captured explicitly in a “constitution”. With an initial purpose defined, a DAO will, over time, morph into a movement, a grants organization or much more (WEF, 2022). Table 7.3 lists the most basic requirements.

Table 7.3 Basic requirements in DAO formation

After the group has reached a consensus, they can translate their mandate and regulations into smart contracts, which will hold the group accountable for their decisions. Some DAOs prefer to write their own rules, but DAO creation platforms offer pre-made resources to generate smart contract code. Individuals who use DAO creation services can customize various parameters like the main token, proposal frequency, voting duration, as well as voting and proposal mechanisms (WEF, 2022).

DAOs typically use a digital asset to represent membership, which is called a “governance token”. Holders of these tokens can suggest and vote on modifications to the protocol. The voting mechanism in DAOs provides an alternative to traditional hierarchical and managerial decision-making processes used by conventional companies. In a DAO, different stakeholders could hold varying amounts of governance tokens that give them the right to vote based on the number of tokens they possess (Kondova & Barba, 2019).

As of July 2021, Wyoming became the first state in the US to establish regulations explicitly for DAOs to be based in that state. The updated rules designate DAOs in Wyoming as a unique kind of limited liability company (LLC), providing them with legal status and offering numerous rights, including limited liability for its members. If a DAO does not have this legal protection, it may be seen as a general partnership, and its members could face personal liability for the DAO’s commitments or activities. To comply with these new laws, every DAO must appoint a registered agent located in Wyoming. This agent must establish a physical address and maintain a register of names and addresses of the entity’s directors or individuals serving in a similar capacity (Wyoming Secretary of State – Business Division 2022).

3.3 Challenges

Before DAOs can establish themselves as functioning entities, there are several legal/regulatory, social/systemic, and technical challenges ahead. These are summarized in Table 7.4.

Table 7.4 Overview of DAO challenges (Tse, 2020)

4 Discussion

DAOs are fascinating innovations that bring great potential to purpose-driven organizations and movements. These novel entities attempt to bring a higher degree of transparency into functional and financial information flows by empowering members to participate in decision-making. Making decisions, directing resources, and coordinating activities has led an ever-increasing number of organizations (approx. 11,500 DAOs, according to the tracking tool deepdao.io/organizations, March 2023) to use either blockchains, digital assets or related technologies. With the private sector from various industries, functions and use cases leading the uptrend in DAO innovation, it is imperative for both regulators and policymakers to make sense and develop a reflected viewpoint of both the technology and its implications.

DAO advocates persist that this novel innovation can offer a path to democratize management and a wide variety of aims, including prosocial objectives and generally address the limits of centralized governance. With advantages around increased transparency, adaptability, and speed efficiencies, blockchain technology, open-source software, and smart contracts are here to stay.

While promising in potential, DAOs have yet to resolve several impending challenges around privacy and regulatory uncertainty, cybersecurity, engagement, and scalability that hinder a greater expansion in both business and society. Advocates are optimistic about the prospect of a total global shift from centralized to decentralized organizations. As ironic and simple as this proposition might appear, the technology quickly expands its potential (Tse, 2020). However, for the DAO to become a business structure that is both viable and competitive, it will have to be integrated into the existing legal system. Likewise, relationships between incumbents and DAOs need to be closely monitored, be it by governments or competing organizations.

Maintaining the decentralized structure will pose yet another challenge as it requires a comprehensive approach to structuring the DAO in a manner that resists the natural tendency of centralization. On the other hand, power concentration needs to shift away from the creators who are responsible for the design and set-up (Tse, 2020).

Assuming we remain on a steady path to improved technology from an engineering perspective and considering all other challenges mentioned, a hybrid future of centralized, partly decentralized, and fully decentralized organizations may seem most likely from today’s perspective (Tse, 2020). With great innovations underway, deployment of DAOs is following its increasing global interest and adoption, from functions as varied as grant-making, social networking, or social impact.

The potential for Fab City itself lies in the proposal of changes to both physical and digital infrastructure, the election of core contributors and personnel but also fundraising and allocation of funds. It may even expand to legislation and drafting of legal bills or frameworks that undermine the path towards a circular economy.

5 Conclusion and Outlook

The potential of DAOs as governance tools powered by blockchain technology is enormous. They can be used to address large-scale transitions that involve various variables and complexities in coordination and collaboration.

Fab City has a vision of transforming the urban landscape worldwide into a sustainable model of self-governing entities that reduce physical flows of goods and prioritize the exchange of data and information. In this context, DAOs offer an interesting solution to the scalability of Fab Cities and the general shift towards circular economies. They can assist in aligning associated entities in a federated network, which is essential for managing the complexity of these transitions.

In the coming years, we can expect to witness a blended method for incorporating DAOs into society. This approach will involve multiple aspects. Firstly, DAOs and traditional corporations will coexist and collaborate with each other. Secondly, there will be combined regulatory approaches to address associated challenges. Lastly, there will be differing levels of centralization within DAOs, with some resembling traditional corporations and others being fully self-governing (Tse, 2020).

This article anticipates a gradual adoption of DAOs into society, taking into consideration the challenges that come with technological advancements. To overcome these obstacles, a hybrid approach that combines temporary legal solutions and varying levels of automation and decentralization is likely to be used (Tse, 2020). The combination of DAOs and artificial intelligence (AI) can potentially address at least some of the challenges faced by DAOs. As AI technology advances and becomes more accessible (e.g., ChatGPT), there may be several use cases where it can benefit DAO development.

In the short- to mid-term, AI bots and assistants are expected to enhance productivity and improve the quality of products/services offered by DAOs. Over time, AI is likely to become more integrated with the core smart contract of the DAO and may even act as a token holder (Aragon’s Blog, n.d.). In the long-term, we may even see AI connectors within or between DAOs, which may form a “swarm intelligence” or a DAO that governs AI as a public good to ensure AI safety (Aragon’s Blog, n.d.). In any way, the future is likely to witness more progress in exploring the interconnection between social material practices, human-machine agency, and institutional change with decentralized, automated, and autonomous principles.