DeFi 101: What Is A DAO? And How Do They Work?

A decentralised autonomous organisation (DAO) is a member-owned community with no centralised leadership. DAOs create a safe environment for internet strangers to collaborate, alongside enabling them to commit funds to a specific cause.

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Building anything meaningful with anyone requires trust. When there’s money involved, the need for trust only deepens.

But how can you trust someone you’ve only met online? That’s where decentralised autonomous organisations (DAOs) come in. DAOs avoid the need for trust by implementing rules in computer code.

The code is fully transparent, making the rules visible to (and verifiable for) anyone. And the design opens up a world of opportunities.

Let’s explore them now.

Why do we need DAOs?

A DAO lets you work with like-minded folk based anywhere in the world, all without relying on a leader to set the direction.

Moreover, no single party controls how you spend your treasury or run day-to-day operations. In their place sits a blockchain-based rulebook that defines how your organisation works and how you can spend your money.

The reason we need organisations like these is that it opens up some exciting opportunities, including:

  • Decentralised charities: imagine collecting donations from anyone worldwide and having the community vote on which causes to fund.
  • Ventures & grants: imagine if you could pool funds together and vote on which ventures to back, then automatically redistribute returns to DAO members.
  • Collective ownership: imagine if you could buy physical and digital assets with others and then vote on how to use them.


Perhaps the most powerful feature of a DAO is that no one can access its treasury without the approval of its members, with approval coming by way of proposals on which anyone can vote ‘Yes’ or ‘No.’

The unique setup creates a democratic environment in which everyone has a voice, all while ensuring everything happens on-chain.

On that note, let’s dive into the technicalities.

How do DAOs actually work?

The foundation of a DAO is the smart contract.

Smart contracts are lines of self-executing computer code, allowing an organisation to put its ‘rulebook’ on the blockchain.

Doing so ensures everyone can see how the organisation works. And once a smart contract goes live, the only way to amend its rules is by voting on changes (a design that prohibits a lone wolf from changing strategy or embezzling funds).

So as you can see: no central authority has any power in a DAO. Meaning the only way forward is through collective decision-making, with things like payments automatically authorised when a vote passes.

This works because smart contracts operate on an ‘if/then’ basis, so ‘if a vote passes, then the treasury can execute the payment.’

When it comes to governance, there are several models, as you’ll now see.

DAO governance

The above covers the inner workings of DAOs at a high level.

We’ll use the final section to explore how specific DAOs work. That’s because there are several ways to govern a DAO, including various proposal and voting mechanics. 

These are the most common designs.


Delegation is like a representative democracy. Token holders delegate votes to nominated candidates who commit to preserving the community’s interests. ENS is a good example, with holders picking engaged community members to represent them.

Automatic transaction governance

We spoke about using smart contracts to sign off payments: this is automatic transaction governance. In Nouns DAO, transactions go through automatically when the majority of the community votes ‘Yes.’

Multi-sig governance

If you don’t use automatic transaction governance, you might choose multi-sig governance. This is where 5-20 active community members take collective ownership of the wallet holding the DAO’s treasury.

And when a vote passes, these same members all have to sign the transaction to execute the community’s will. 

DAO membership

It’s all very well understanding how to vote in a DAO. But how do you actually join a DAO? Again, that depends on the organisation’s membership structure.

Here are two ways DAO membership can work.

Token-based membership

Some DAOs have tradable tokens, which anyone can buy, allowing them to join the DAO without permission. Other DAOs ask users to earn tokens by providing liquidity or through ‘proof of work.’

In the MakerDAO, anyone can buy the MKR token and give themselves voting power on the future of the Maker protocol.

Reputation-based membership

Other DAOs work based on reputations. No one can buy, transfer or delegate a reputation; members must earn one through participation. This involves submitting and voting on proposals, for which members receive reputation tokens.

Reputation-based membership is popular for decentralised development and governance protocols but could also work for charities and investment clubs alike.

Decentralisation is the future

2022 was the year of the DAO.

Thousands of decentralised organisations sprung up, covering everything from social clubs to music labels and beyond.

While questions remain over organisational design, we’re seeing progress every day. And the role of DAOs in modern society is no longer up for debate; they’re proving an effective governance model across industries.

That’s why Elitium is exploring exactly how to incorporate a decentralised structure into our future organisation design.

Keep your eyes on Twitter to be first to learn about our upcoming plans.

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