January 23, 2020

DAOs - An interesting way to coordinate

Decentralised Autonomous Organisations (DAOs) are now a thing.  This technology offers a new way to cooperate.

Humans love cooperating. We do it without conscious thought, we travel to our places of work and create things, or write reports, or train others. In exchange for doing so we receive goods we value in return (money) these goods are then exchanged at a later time for other goods we value.

To understand how phenomenally good we are at cooperating think of all the goods and services that you know exist. Then test yourself on how many you know how to produce from start to finish. Even ignoring any resource constraints, I’ll bet your list of things you know how to produce from scratch is far smaller than the list of all that exists. The difference is made up for in cooperation.

This sort of cooperation is labelled “the division of labour” by economists. And there’s another important part of it beside the technical skills of production. Knowing the technical details of how to produce a good or service is great. But to get from that knowledge to actually producing you need to own some things that make the things and do the stuff. You also need to form and utilise lots of relationships with other people. This all entails what we might call “transaction costs”, things like enforcing contracts, escrow services, securing titles…

The raison de jure of a firm is to minimise transaction costs.

One way to minimise transaction costs is to become a firm1.  Indeed the raison de jure of a firm is to minimise transaction costs, as explained by Ronald Coase in the very famous The Theory of the Firm. Firms generally use a hierarchy of decision makers from the entrepreneur who plans which goods to make where how and why. To the managers who plan more day-to-day activities such as annual leave. Sometimes these functions are performed by the same person. In this way specialisation occurs and this division of labour (cooperation!) leads to lower transaction costs.

But this hierarchy is not optimal for all businesspeople, some believe they can better serve customers by using a flat organisation structure. With no clear managerial positions they face a different set of transaction costs. These come mainly in the form of how best to align everyone strategically, but also include different transaction costs associated with property title.

To align everyone strategically an organisation might have to run numerous meetings and long email chains, as well as enforce complicated contracts. Imagine trying to maintain this structure over multiple geographies and time zones.

The challenge then, is how to minimise these transaction costs. And we now have an additional method to do so.

Since about two years ago, you can use blockchain technology to create what is called a Decentralised Autonomous Organisation (DAO)2

DAOs allow business rules to be automated.

A Decentralised Autonomous Organisation (DAO) is, in brief, a platform of trust that allows people to cooperate toward a common purpose. It is a flat organisational structure that looks pretty familiar. However, under the hood all the business logic such as aligning people strategically is handled automatically using blockchain and well-designed incentive structures3,4.

Compared to multiple meetings and contracts this system minimises the transaction costs implied by a flat organisational structure over multiple geographies and timezones.

Current DAOs (as at 2019) have a focus on giving grants to grow the DAO and crypto community. One focuses on the services of talented user interface designers5.

Is a DAO perfect for all businesses and the greatest thing since the internet gave us dank memes? Absolutely not. A DAO is just another option for organising your firm and cooperating with your fellow humans. It might not fit your business and that’s just fine, having options is always good.

To me the type of business that a DAO would suit is where the owners share a common goal of helping a particular community in some way and are spread geographically with a flat organisational structure. Social enterprises in particular often fit this description.

Social enterprises face large hurdles in securing funding and convincing creditors/investors that they can be trusted. Using a DAO with a well-designed incentive structure and a tradeable token of ownership can help a social enterprise tap in to equity financing6.

Also consider that a DAO can be used to coordinate a community around communal assets such as land, forestry, or even a city. This is a conversation for future articles. For now, you’ve had a taste of the “why” of DAOs from the perspective of an economist anyway.

1. A firm can be a company (limited liability or not), a partnership, charitable trust, … ETC the precise legal framework doesn’t matter here
2. For a blockchain 101 I refer you to Mark Pascall https://www.youtube.com/watch?v=EUDD1BnRvmU
3. For a fuller description of a DAO see https://limechain.tech/dao-vs-continuous-organizations-101/
4. For a fuller description of present DAO structures see https://www.coindesk.com/the-law-of-the-dao
5. https://raidguild.odyssy.io/
6. Equity financing is at present heavily regulated, but a common attitude in the crypto space is to break stuff and work out the legal details later. This pragmatism is key to innovation in the space.