Understanding the financial aspects of DAOs

DAOs, and importantly DAO treasuries have seen staggering expansion over the last couple of years.

The World Economic Forum in 2021 released a white paper exploring the topic of and growing prevalence of DAOs, and at the time of its release reported that DAO treasuries had ballooned to $16 billion, and that DAO membership had topped 1.6 million people around the globe. The number and scale of active DAOs waxes and wanes constantly. At the time of writing this piece in early 2023 aggregate DAO treasuries had slipped back to $9.9bn – still a staggering sum. At January 2023 the biggest DAO is Uniswap with $2.4bn in its pot. (for a quick look at the current treasury values (in USD) of top-ranked DAOs take a look at DAO analytics site DeepDAO).

So…where does all that money come from? And what are some of the risks and considerations we need to be mindful of when we are considering investing our money in a DAO?

Sources of financing

Here are a couple of ways that DAOs typically finance their treasuries:

Seed funding from an initial group of founders, investors, or donors

Just like any other organization, a DAO can be funded by a group of founders or investors who believe in the mission of the DAO and are willing to provide capital to get it off the ground. Funds could be raised through conventional investing channels such as Venture Capital (VC) firms, Private Equity or through private funds contributes by the founders. Some DAOs rely on donations from individuals or other organizations to fund their operations – this might be especially true if the DAO has a mission for social or environmental good.

Token sales

You can think of a DAO as like any other blockchain or crypto-based project. Like new coin issues or NFT programs, DAOs can raise their initial and ongoing funding by selling tokens to the public through an initial coin offering (ICO) or initial exchange offering (IEO). These tokens can represent ownership in the DAO or can be used to access certain services or features within the DAO. A feature that is unique to DAOs compared to other crypto projects is that some DAOs issue tokens that give holders the right to participate in the governance of the DAO. These ‘governance tokens’ may have value based on the perceived value of the decision-making power they confer and can be bought and sold on exchanges.

Ongoing revenue streams:

Some DAOs generate ongoing revenue through the sale of products or services, or by collecting fees for the use of certain resources or facilities. For example, a DAO might operate a decentralised marketplace or charging a fee for the use of computing resources.

Financial governance in a DAO

It’s worth noting that the financial as well as operational success of a DAO can depend on the specific market or industry in which it operates, as well as external factors such as regulatory environment and overall market conditions. Good financial governance in a decentralised autonomous organization (DAO) should include the following characteristics:

Clear financial policies

A DAO should have clear policies in place for financial management, including budgeting, spending, and reporting. These policies should be transparent and easily accessible to all members.

Diversified funding sources

Having multiple sources of funding can help to stabilise the financial health of a DAO and reduce risk.

Effective financial controls

A DAO should have robust financial controls in place to ensure that funds are being used appropriately and in line with the organization’s goals.

Responsiveness to market conditions

Like any organisation, a DAO should be able to adapt to changing market conditions in its underlying business in order to remain competitive.

Strong cybersecurity measures

Strong security measures are important to protect the assets of a DAO and maintain trust among members.

Alignment of incentives

To avoid or prevent agency problems, the incentives of the members of a DAO should be aligned in order to ensure that everyone is working towards the same financial goals.

Transparent financial reporting

A DAO should provide regular and transparent financial reports to its members, allowing them to track the organization’s financial performance and make informed decisions.

When Financing a DAO involves the use of cryptocurrency or tokens, we need to be mindful of the concomitant risks – in the next step (4.6) we will look at some of the risks that you should be aware of when financing a DAO.