Decentralized Autonomous Organizations (DAO)
The promise of DAO
In 2018 we learned about an organizational form called the DAO, standing for decentralized autonomous organization (DAO).
- Decentralized means that decisions are made decentrally.
- Autonomous means that the organization is not dependent on any one individual but operates independently of any one person.
The promise of the DAO organization model is that decisions and ownership are distributed among a large community instead of being centralized within a small group of individuals. We were excited about this model and thought it was the solution to our search for more decentralization, more fairness, more involvement of everyone, more flexibility and better cooperation among our members.
However, we soon discovered that the reality of DAOs in practice was quite different.
The current DAO reality
In practice, startups use the DAO model to raise money but are not organized decentrally. By calling themselves DAO, startups raise funds from investors, who receive tokens in exchange. These tokens enable investors to make and vote on proposals. Tokens which give voting rights are not for workers but only for investors, and the tokens only give rights to vote on very limited proposals.
Some current DAOs use voting by tokens to make important decisions. But these kinds of DAOs generally only have a single purpose, like purchasing a constitution. And some DAOs are re-investing the money into other crypto projects. Both buying a constitution and investing in companies are very rudimentary operations in which voting by investors could make sense.
But what about more complex companies, like IT startups producing products, with people working in development, design, marketing, finance etc? Can this be organized by the DAO model in which only investors get to make decisions? No. For a real startup or any functional company it is important that people who are involved in the day-to-day operations have the majority of decision-making power.
Many current companies that describe themselves as DAOs are only organized as such in terms of their relationship with investors: investors have the right to participate in some decisions.
However, internally these DAOs can operate in an even more centralized way than traditional startups. Founders may control the funds as well as all decisions. Most importantly the founders have complete freedom to pay themselves high salaries while paying everyone else the least possible amount.
Also, all of the shares of the company after raising money via a token offering stay with the founders. So the founders are the only people that have real decision making power and all the financial rewards stay with the founders.
This is not the kind of decentralization of ownership, power and financial rewards that we are aiming for.
While the objectives of the DAO concept are great, the current implementation is generally not what a DAO purports to be. But that does not mean our objectives cannot be achieved with a DAO that is organized the way a decentralized, autonomous organization should be. We call it a True DAO.
In building a True DAO, our objectives are:
- To create an organization that is fair to everyone: every team member, founder, advisor and investor
- To have a workplace democracy
- To have more engagement from the whole team
- To offer the maximum freedom to every team member
- To take account of every team member’s situation, offering more stability and more cash to those who need it, and more ownership to those with less need for cash and financial compensation
- To create a structure that has the right incentives for everyone involved
- To achieve all of this in an agile way with fast decision making
- To create a structure in which external investors want to invest
Our DAO manifesto
We, the contributors to the DAO, do not want to be organized in a purely capitalistic and centralized way, whereby a single founder, boss or employer controls the organization and in exchange for a salary is able to reap all the profit for themselves. This pure capitalistic organization leads to the exploitation of team members, who might get a salary but compared to the value they are creating for the capitalist are underpaid and do not have the freedom to decide the way they work. Instead, the contributors want to be organized as a true DAO: all team members control their work and get the surplus from the success of the organization.
In concrete terms, that means:
- Every team member has the SAME rights, defined in this agreement.
- Every team member co-owns the organization.
- Every team member is involved in the decision making.
- Every team member has maximum freedom:Decides where to work
- Decides how much to work
- Decides when to work
Distribution of Ownership
- Ownership determines voting rights and future share in profits and proceeds from a sale or the IPO of the company.
- Every team member gets ownership. The share of ownership depends on how much contribution has been given compared to the total contribution.
Explanation of the Ownership Model
A traditional startup is organized as follows:
The two main founders hold around 85% of the shares and only the remaining 15% are distributed among the less important team members. It might be that one of the minor team members in terms of shares turns out to be most important to the company but still does not get more shares, as they were not the one that came up with the original idea of the startup.
Traditional startups thus have a clear distinction between founders on the one hand and other team members (co-founders, freelancers, or employees) on the other.
We believe there is no clear separation between founders and team members working for shares or at least partly for shares.
We can illustrate this as follows:
The above illustrates that in our company, the distinction between founders and normal freelancers is on a continuum, where the more the person works and the less remuneration the person receives in cash, the more the person is like a founder and the more the person gets in ownership.
On the other hand, people who contribute only a few hours per month, and receive a normal payment in cash contribute very little and thus are more of normal freelancers or part-time employees and less of founders.
This leads to the following share distribution, which is much more equal:
Moreover, the big difference between our model and the traditional model is that every person participating in the company has the same agreement (except for differences in the hourly rate, as discussed below), and therefore everyone is able to get more shares by contributing more. In fact, everyone can become the largest equity holder simply by contributing more than anyone else.
Principles of the true DAO
Decision making by the whole founding community
One of the most fundamental principles is that everyone who contributes to the success of the company, be it by investing money or by investing work, should have the power to participate in important decisions
Financial rewards distributed to the whole founding community
Just like control, financial rewards should also be distributed to all people that contributed to the success.
Ownership depends on contribution
Both voting rights and financial rights depend on ownership. The ownership should be held by everyone. However, there are some people who contribute a lot and others who contribute only a little. For example, there will be some team members that work 70 hours per week, receiving no cash and contributing money, while other team members work only a few hours and in addition receive cash. The members who contribute the most should also get the most ownership.
Everybody gets the same deal
Everybody who is somehow contributing to the success of the company should get the same deal.
This is very different from traditional companies, where the founders often only come up with the idea and then acquire funding. Once they get money from investors, they let others work to implement their idea. The workers do the bulk of the work, but only get a low salary while the founders pay themselves a high salary and in the future get 100% of the sale value.
At the True DAO, we want everyone to get the same deal no matter when they join the organization. So even if they join when the company is already one year old, they could become the biggest owner of the company if they make the biggest contribution to the company.
Small differences in hourly rates
There is one caveat to the fact that every team member gets that same contract. There need to be some differences in the hourly rates. People with high experience and valuable skills need to get more remuneration for every hour of work.
Is that fair?
We think it is! Some team members spend many years of their lives to build their skills. It would not be fair if they got the same hourly wage as, for example, a newly graduated intern.
Also, if everyone worked for the same rate, we would only attract workers without highly marketable skills.
Highly skilled people would not have an incentive to work in the organization, as they wouldn’t want to receive the same rate as less skilled members.
Maximum freedom for every team member
We want maximum freedom for everyone in the organization. That means every team members gets:
- The freedom to choose what to contribute – money or work.
- The freedom to decide how much work they put in.
- The freedom to select their work hours and their workplace.
- The freedom to select how they are compensated: in cash or in shares, or a combination of the two.
Free to choose compensation
There is one caveat to being free to choose the compensation mix of cash and shares. If the company does not have enough money to pay everyone 100% in cash, it is not feasible to allow everyone to take 100% in cash.
Also, if a team member asked for 100% cash compensation, then in fact the member would not bring any contribution. Yes, they would contribute their work, but this work would have already been compensated 100% in cash.
For that reason, we can only allow compensation of up to 90% in cash.
Also, in order to incentivize every team member to choose shares rather than cash, we apply a sub-1 factor to the cash to be taken out, so it becomes less, and we apply a factor higher than 1 to the shares to be taken out, so they become proportionally more valuable than cash.
Decision-making power to those with the most expertise
Decision making power should go to those people that are able to make the best decisions.
So decisions are only up for vote in case they affect the whole company. The vast majority of decisions are taken by the person directly involved with the decision at hand. Furthermore, if a company-wide vote is held for decisions that are related to someone’s area of expertise, that person gets their voting power multiplied by 3.
General voting power is not only dependent on the number of shares held; rather, it is the average of the amount of shares held and the amount of responsibility held. We recognize that a person could have a lot of responsibility but due to the fact that they just started working with the organization, their past contribution and therefore the amount of their ownership is still limited. Nonetheless, the high level of responsibility in general means that the person would have a high level of expertise and high stakes in the company too.
Speed of decision making
For a startup to be successful, it has to make decisions quickly. However, making decisions by involving all team members from the whole company is often slow and leads to bottle necks.
For that reason, we have to provide additional measures for fast decision making.
First, as mentioned above, the whole company makes decisions only in rare cases. In general, decisions are made by each individual confronted with a certain decision in their area. Only when a decision affects many areas or the whole company do we vote as a company.
Also, we use voting shortcuts. A shortcut means that before involving all team members, we have a vote among the core team members: those with the highest amount of responsibility. These team members have more than 50% of the voting rights, so if these members come to a decision, we do not have to involve more team members.
Even with the objective of decentralization and with the governance set up as described above, it is easily possible to become too centralized. For example, imagine one founder with a high hourly rate that works full time and does not take any cash compensation. If the other founders are working part time, at a lower hourly rate or are requesting a high cash compensation, the net contribution of the single founder could easily become over 50%.
That means this founder could change the governance structure alone or with the help of one or two other founders.
To avoid this, we created a founder council. The founder council is an institution composed of three founders who each hold less than 15% of the shares in the company. The founder council gets elected not by the normal voting procedure, but by a special procedure in which each founder, even minor founders, have one single vote.
The founder council then is solely responsible for dealing with founder grievances, resolving founder conflict and making proposals related to team issues. It also gets 33% of all the voting rights, so to avoid that a single founder has too much voting power.
The above are the foundational principles of the True DAO. As we are gaining more experience, the governance protocol is constantly improving and becoming more detailed.
Legality of the true DAO
Recently, there have been calls all over the world for regulation of the DAO. In fact, the state of Wyoming recently passed legislation to establish a DAO in the form of an LLC. We do not see why specialized legislation is required. In fact, we have a legal form of Delaware C-Corp but are still organized as a DAO. This is possible as the legal form is important for the relationship to the outside world, such as the government, contractual partners or public investors. But for the inside relations between contributors to the company, we are able to freely choose how to manage ourselves.
How does it work in practice?
Our core principle is that ownership, and thereby financial and control rights, depend on contribution to the company. But contributions are made daily and thus, the shareholding would vary daily. For that reason the shares are not held as actual legal shares but as what we call ownership shares. Ownership shares are a contractual right to receive the shares and their associated benefits, both financial and control-related, in the future. This is done by a continuous SAFE agreement. SAFE stands for Simple Agreement for Future Equity. Normally, a SAFE is given to investors and is valid until the company raises Series A funding. In our case every founder holds a SAFE, a contractual right to get their ownership shares and all the benefits of being an owner when the company gets sold or IPO-ed.
It provides the same benefits as legal ownership in the book, but it avoids the prohibitive legal costs of having to change ownership every time ownership changes, which in our case literally happens daily.
This model has worked so well that we believe there is no need for specialized legislation for DAOs. Delaware C-Corps, using our true DAO model, can become DAOs without having specialized legislation.
The promise of the True DAO
We started developing our DAO structure 16 years ago, although at the time we did not call it DAO. The model became more and more mature over time as we built into it our learnings from using it in different startups.
We now believe that, even though it is not perfect, the True DAO is the best model to organize companies, especially startups with the aim of
- right incentives, and
The model works particularly well in situations where many founders come together and want to start a company working remotely and part time.
We have used the model over the last year for this particular circumstance and have been able to create a founding team that is very productive and satisfied with the company environment.