5 min read

What’s a DAO and How Are Tokens Used in a DAO?

Decentralized Autonomous Organizations (DAOs) are poised to be the future of organizing groups of people around a common goal. It’s a very broad statement because it’s a concept that can be applied to numerous group organizations. For example, DAOs will (or already) exist around these groups:

  • Investment clubs
  • Nonprofit organizations
  • Private, for-profit companies
  • Creative agencies
  • Shared IP and rights management
  • Entertainment services
  • Local governments
  • Shared interest

In essence, DAOs are groups of people with a common interest and a shared bank account, using blockchain to manage activities. With that definition in mind, you can see how widely encompassing DAOs will become.

The primary case for DAOs is that they operate more democratically than traditional organizational structures (which are often plagued by the centralization of power). This is because DAOs benefit from the transparency of the blockchain, where all transactions and users are publicly available. DAOs provide transparency into:

  1. Members. In a DAO, the wallet is the identity. Unlike a publicly-traded company, where you cannot see the entire scope of its shareholders or their stake in the company, in a DAO we can see every wallet that holds tokens in the DAO. Although most wallet holders haven’t doxxed themselves (disclosed their identity), we can still see individual holders and their stakes.
  2. Decisions. In a DAO, all decisions are made fairly by the collective group. This is made possible by issuing governance tokens which DAO members use to cast votes. In a way, they’re like preferred shares in a corporation that grant voting power. However, in a corporation, there’s always a higher-up decision-maker that can act without the majority support of its shareholders. In a DAO, these governance token votes are tracked and public, thus disincentivizing any decisions that go against the majority vote. And in some cases, smart contracts are put in place to make it impossible for a decision to be made without the votes hitting a predetermined threshold.

There are thousands of DAOs in operation today because platforms make it simple to set up and run a DAO. Some of these platforms include:

  1. Aragon – Open-source infrastructure for creating and launching a DAO from templates.
  2. Collab.Land – Form token-gated communities on Discord and Telegram.
  3. Coordinape – Create compensation mechanisms for member contributions.
  4. DAOstack – Open-source infrastructure for creating and launching a DAO from templates.
  5. DAO Masters – Explore dozens of DAO tools.
  6. Gnosis Safe – Multi-signature, community wallets that require more than one person to be involved in confirming transactions.
  7. Juicebox – Crypto fundraising tool.
  8. Open Law – Create legal agreements that work with Ethereum.
  9. Snapshot – Off-chain voting platform that makes it easy to create and vote on proposals without gas fees.
  10. Tally – On-chain governance platform for creating and voting on proposals.
  11. Utopia Labs – Collaborative payroll and expense management tool.

As I said before, there are thousands of DAOs in operation with many different goals or reasons for organizing. Here’s a small sample of DAOs:

  • GovernmentCityDAO is building a decentralized city where everything from its name to its layout will be decided by its members.
  • IP RightsNounsDAO is creating an on-chain avatar community whose treasury and initiatives are managed 100% by their buyers.
  • Shared InterestMoonDAO wants to create a self-governing colony on the moon and uses its DAO to make baby steps towards this audacious goal.
  • ServicesUniswap is a decentralized exchange service that is governed by their DAO. It has one of the largest community treasuries (bank account) among DAOs.

This brings us to tokens. Every DAO utilizes tokens in some regard, whether these are fungible or non-fungible tokens. Tokens are the lifeblood of DAOs and the reason that DAOs can operate democratically and transparently.

Why DAOs Should Use Two Tokens

Tokens provide many purposes for DAOs.

  1. Tokens can act as a utility currency within a DAO. For example, you must hold 75 $FWB tokens to join the Friends With Benefits DAO, and you also spend $FWB tokens on experiences.
  2. Tokens can be the vehicle for value accrual or monetary appreciation of a DAO (like a stock). For example, $WHALE token is supposed to track the value of the NFTs held in their community vault.
  3. Tokens can be used for governance or voting on the direction of the DAO. For example, $RARE token is used by the SuperRare NFT marketplace for members to vote on the next artists to be admitted to their platform.

The mistake I often see is DAOs using the same token for two or three of the above functions. In particular, problems arise when your token is used for both utility and value accrual. It’s a problem because the usage of your token is greatly affected by the price of that token on any given day.

I look at the $MANA token, which is technically used for all three purposes on the Decentraland metaverse platform. In the past 12 months, its token has seen nearly a 90% decrease in value. This has directly greatly impacted the number of people voting in their DAO and using the token to purchase virtual goods.

This is why I believe that all DAOs should use a combination of two tokens, preferably one set of fungible tokens and one set of non-fungible tokens.

The fungible tokens (i.e. currency or social token) would be responsible for utility and governance in the DAO. It’s what allows you to participate in activities within the DAO. Ideally, this token is as close to stable or at least protected from massive price fluctuations as possible. One of the more interesting ways that DAOs are starting to do this is through a concept called a bonding curve.

A bonding curve is a continuous token rollout model that creates liquidity through a predetermined price curve and is executed by a smart contract. Traditionally, a token might rely on exchanges, market makers, order books, and dedicated liquidity pools to create a market for buyers and sellers of a token. Under the bonding curve model, the buyers and sellers only interact with a smart contract and that token’s reserve or bank. Bonding curves are a concept invented by Simon de la Rouviere as an antidote for some of the problems with initial coin offerings like pump-and-dump schemes and price manipulation.

The non-fungible tokens (i.e. NFTs) would be responsible for all value accrual of the DAOs efforts. Value accrual means many different things to DAOs. But some examples would be NFTs that represent rights to use IP produced by the DAO or a share of the revenue produced by the DAO.

I think a project that is actually going to get this dual token (fungible and non-fungible token) model correct is CityDAO. They haven’t released a fungible token yet, but have over 5,000 citizens in their DAO through NFT sales. Because these NFTs are limited in quantity and directly correlated to being able to participate in the future of CityDAO’s governance, they are currently the mechanism for accruing the value of CityDAO’s plans.

Overall, the purpose of my two-token idea is to protect the strength of your DAO’s community and mission from the ebbs and flows of a tradable currency. You don’t want to lose all of your DAO members when the price of your token drops. And this, in theory, could protect a DAO from this.

Ultimately, we haven’t seen this exact model in action yet. We have seen dual token models (i.e. MakerDAO) that utilize two sets of fungible tokens. But not as I laid it out with fungible and non-fungible tokens. And honestly, I might have it reversed.

The reality is that tokenomics is a very complex and theoretical field right now, with a lot of experimentation taking place. Only time will tell what the best method is for tokens in a DAO.