In 2021, crypto has been one of the biggest trends shaping technology and finance, and according to headline news, Decentralized Autonomous Organizations (DAOs) are set to be a force to be reckoned with in the future. cryptography in 2022. Mark Cuban called them the “ultimate combination of capitalism and progressivism.” Yet, while DAOs are relatively easy to understand conceptually, they are a rapidly evolving segment of the crypto market, with many innovative use cases emerging. However, setting up and managing a DAO also comes with its own set of unique challenges, which also change and grow over time.

What is a DAO?

The purest definition of a DAO is inherent in the name. An organization is a group of people and entities with a common goal or idea. It is decentralized, so there is no CEO or board of directors responsible for decision-making, and it is autonomous, which means it is autonomous. Autonomy means that there are governance rules programmed into blockchain-based smart contracts, and DAO members vote on matters affecting the DAO in accordance with those rules.

One of the first DAOs, a project called The DAO, exemplifies one of the simplest use cases for a DAO and also happens to be a pivotal point in the history of DAOs. The Genesis DAO, as it was also known, was an investment contract for holders of Ether (ETH) to deposit their funds. Projects could apply for funding from the DAO, and if DAO token holders agreed to the investment terms, the smart contract would disburse funds. However, in June 2016, a few weeks after launch, a hacker found a bug in the underlying smart contract code and managed to drain the DAO of around $70 million worth of ETH.

At the time, the incident wreaked havoc on the Ethereum community, and as a result, DAOs made little progress over the next two or three years. However, once the DeFi movement’s touch paper was lit, the idea of ​​DAOs took off again.

Related: DAOs are supposed to be completely autonomous and decentralized, but are they?

DeFi and the return of DAOs

DeFi was born out of the blockchain community’s desire to create an open, permissionless, and decentralized financial system. As such, DAOs provided an attractive way for projects to demonstrate their commitment to decentralization through community governance.

As a result, in 2020 when DeFi started gaining traction rapidly, governance tokens became very popular. Flagship DeFi applications including Compound (COMP), Uniswap (UNI), and Aave (AAVE) have launched tokens allowing users to participate in decentralized governance, while new DeFi projects have started launching their governance tokens as soon as departure.

Current and emerging trends

So why are DAOs now making so much noise, even among the mainstream media? Part of the reason is the surge in popularity of non-fungible tokens (NFTs), which are set to play a bigger role in DAO governance and who can participate.

In September, Andreessen Horowitz invested $5 million in “Friends with Benefits,” a Discord chat made up of various crypto enthusiasts, artists, and NFT collectors. The group raised a total of $10 million when it decided to operate as a DAO, demonstrating the value to be generated from the vast online communities that have formed – even without economic incentives – on platforms like Facebook and Telegram.

In November, things took an even more intriguing turn when “ConstitutionDAO” raised more than $40 million to bid for the rights to acquire an official copy of the US constitution document at a Sotheby’s auction. It was the first time Sotheby’s had worked with a DAO, which had managed to garner the support of more than 17,000 donors before the auction. Although ConstitutionDAO was ultimately outbid by Citadel CEO Ken Griffin, the experiment itself was arguably a success in that it demonstrated its concept.

Related: Decentralized Autonomous Bodies: Tax Considerations

Another emerging trend is investment DAOs, as some believe that DAOs are poised to completely disrupt the traditional venture capital funding model. These DAOs allow groups of Web3 natives to pool and deploy capital in ways that now allow individuals to compete with traditional financial entities.

It is therefore understandable that with such a wide range of applications, DAOs are generating considerable excitement and could prove to be as important as NFTs in 2021. However, there will be challenges along the way.

The road to DAO adoption is not easy

First, education is still a huge gap. Even within the cryptocurrency community, the DAO concept continues to gain traction and its implementation is far from advanced. There are still relatively few “user interfaces” for DAO governance, although more and more tools are coming online to help organize and overcome challenges that traditional organizational structures have faced for years.

Another challenge DAOs will face as they transition to the mainstream is regulation. Laws on incorporation and tax structuring are ambiguous and often outdated, leaving it up to the DAOs to do their interpretation to fill in the gaps.

It should also be noted that decentralization is spectrum and not binary. Although DAO governance tokens allow users to participate in decentralized governance, most projects still operate with a degree of centralization.

Related: Decentralization versus centralization: where does the future lie? Experts answer

Finally, decentralized governance is difficult, especially on a large scale. It is a big challenge with multiple hurdles that have plagued blockchain developers since the early days. How do you keep voters engaged once the community gets big enough and votes need to be held more and more frequently?

How do you prevent wealthy whales from buying their way to power by picking up a majority of chips? To what extent should the code have the force of law, and shouldn’t there be safeguards in place in case a malicious entity manages to wrest majority control? If so, who controls the security?

There are no easy answers to these questions, but now that crypto, NFTs, and DeFi have found a foothold in mainstream consciousness, it seems natural that DAOs follow. Also, as they become more common, it should become easier to identify simpler ways in which communities can decentralize governance.

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The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.