Explainer: What is a DAO - and how did one of them almost succeed in buying the US Constitution?

Earlier this month, one of the 13 surviving copies of the original United States Constitution sold for $43.2 million in New York. The fact that it was the highest price ever paid for a printed text was not the only reason this auction hit the headlines.

Among the bidders was a digital group who came together, using cryptocurrency, to try to buy the historic document with the intention of putting it on public display. Even though they lost out in the auction, the nature of their organization is still attracting attention.

ConstitutionDAO is, as the name suggests, a DAO - decentralized autonomous organization - a digital hub where individuals can combine to make purchases and share ownership, using cryptocurrencies like Bitcoin and Ethereum.

All the transactions in a DAO are recorded on a blockchain, a distributed database that uses multiple computers in a network to store data about purchases and ownership in a format known as a “block”. This can be viewed, but cannot be altered.

Each block contains a finite amount of data and once full, it is locked and cannot be reopened. A new block is then opened which links back to the now closed block in a chain - hence the name given to the technology.

It’s the security aspects of blockchain that have enabled the growth of cryptocurrencies. Blockchain fulfils the same role as banks do in a traditional currency, providing proof that an individual possesses the funds to make a purchase through its transparent digital records.

DAOs are not widely recognized as legal entities, although change is coming. In order to qualify as a bidder for the US Constitution, the DAO had to set up a limited liability company. Wyoming recently became the first state to define the legal status of a DAO.

Having been outbid in its attempt to buy the Constitution, the DAO - which was reported to have raised over $40 million - has announced that it will refund investors, minus a “gas fee” or handling charge.

DAOs are founded on what is known as a smart contract which defines the rules under which they operate. The rules can then only be changed by a vote of the members. The founders of ConstitutionDAO say they decided to offer refunds rather than try to change their smart contract.

Ethereum describes a DAO as like an online business that’s owned and managed by its members. “There’s no CEO who can authorize spending based on their own whims and no chance of a dodgy CFO manipulating the books. Everything is out in the open,” says the site.

But despite their transparency, two principal criticisms have been levelled at DAOs. Firstly, their smart contracts do not always allow every member an equal say. Secondly, there are concerns about their security which, in one notorious case, cost investors dear when it was hacked.

Members of a DAO typically receive a “non-fungible token” or NFT in return for their investment. Put simply, non-fungible means that it can’t be exchanged for anything else, unlike cryptocurrencies, which like traditional currencies are designed to be exchanged for something.

Holding an NFT means you are recognized as a member of a DAO and therefore eligible to vote on how it should be managed. But, as writer Geoffrey Mak found when he investigated several DAOs for The Guardian, not all tokens are equal when it comes to voting rights.

One DAO he investigated allowed one vote per token. But, as tokens were also allocated based on the number of likes given to a member’s posts in its chatroom, it was possible for one individual to accumulate a larger number of tokens than other members.

The vulnerability of DAOs to hackers was spectacularly demonstrated in 2016 when a pioneering investment DAO, known simply as The DAO, was hacked. A flaw in the DAO’s code allowed a hacker to extract $50 million in the cryptocurrency Ethereum.

DAOs are part of the emerging world of Decentralized Finance or DeFi. The World Economic Forum’s 2021 DeFi Policy-Maker Toolkit, noted a sudden upsurge in the sector in 2020 with the value of assets held in DeFi smart contracts growing 18-fold to $13 billion by year end.

“What is clear is that DeFi represents a distinct and potentially significant development, both within the landscape of blockchain and of financial services more generally,” the report concluded, going on to warn regulators there were “no clear answers” about its future.