The origin of DAOs

Ethereum, ‘The DAO’, and a cautionary tale

The advent of the Ethereum blockchain and smart contracts, along with the subsequent recognition that the business functions of a company (or almost any other type of organisation) can be replicated by a combination of smart contracts on a blockchain, was what brought the concept of DAOs to life. DAOs have taken many forms since and have been speculated even as alternative mechanisms for governments, but it would be useful at this point to step back in time a few years (a year is a long time in blockchain!) and examine the very first DAO – known simply then as “The DAO”.

In May 2016, the German start-up Slock.it published a white paper scoping their idea for a Decentralized Autonomous Organization (DAO) named “The DAO”, that would essentially work as a pooled investment vehicle to fund other start-ups in the blockchain space. The DAO was designed to be completely open – anyone interested in participating in The DAO could buy in by purchasing ETH tokens, the native cryptocurrency of Ethereum in exchange for DAO tokens. Buying in and committing your ETH to the DAO attracted rights to vote in the investment decisions of the DAO. By design this was intended to democratise the investment decisions of the DAO – all voting members (investors, effectively) would be eligible to participate in all the decisions of the DAO – unlike a ‘traditional’ pooled investment fund where decisions would be made by an investment committee or board.

Source: Deloitte – The DAO | Chronology of a daring heist and its resolution

Unlike other ‘democratic’ systems as we generally understand them, with the principle of ‘one person-one vote’, the DAO operated more like a company with shareholders – where the weight given to one member’s vote depended on the number of tokens (shares, if you will) held by the member. It was even possible for DAO members to propose their own projects and have them voted on. The idea quickly caught fire among blockchain enthusiasts and excited the mainstream media, the DAO pulled in some 12M ETH (then worth around US$150m) within its first month.

The Attack

The scale of The DAO became orders of magnitude bigger than ever expected and with the associated media attention there was much criticism of the governance model. Slock.it CEO Christoph Jentszch said at the time:

“The code of the DAO had been purposely kept very simple…we wanted to keep the DAO’s ‘core’ as simple as possible, and then let it improve organically over time. However, we were also of the opinion that with so many ethers inside of its contract, the DAO’s government model was now too simple”

Among other things the DAO code included an inbuild ‘split’ function that essentially allowed withdrawal of funds from the DAO by transferring ETH to different wallets – this was designed to allow members of the DAO to exit easily. This fuction turned out to be a critical weakness, when in June 2016 a hacker (to this day person or persons unknown) repeatedly exploited this split function to withdraw about a third of The DAO’s treasury, then some $US50m before the theft was discovered, and siphon it off into a ‘darkDAO’. Not only was this catastrophic for The DAO but it was a massive shock to the Ethereum community and precipitated a massive crash in the value of ETH.

As a first defensive move ‘The DAO exploited its own split function to direct its funds into ‘Child DAOs’ to quarantine then form further theft. Several solutions were debated to ‘hack the hacker’ and retrieve the funds but were dismissed as too risky. The ultimate solution was to conduct a ‘hard fork’, assigning all ETH in the Child DAOs and the darkDAO to a new smart contract and allowing original holders to exchange tokens at 100 DAO tokens for 1 ETH. This was done before the hacker could withdraw the stolen ETH from the ‘darkDAO’ (Thanks to a failsafe in the DAO code, the attacker was unable to transfer the funds out of their child DAO until a certain period of time had elapsed). All funds were recovered but the damage was done by then, confidence in The DAO was irretrievably shaken and token holders started to withdraw their ETH.

Since then, many DAOs have emerged but the lesson has been (largely) learned – new DAOs rely on much more sophisticated governance models that are evolving all the time.