Smart contracts are software codes that can execute any command that can be digitized. They enable many transactions, from automating supply chains to insurance payments, from NFT sales to syndicated loans, to be carried out quickly, with less expense, and without the necessity of intermediaries.
Smart contracts are also used in the establishment and execution of contracts. Their use cases are not limited to bilateral agreements, but they can also be used in the establishment of multilateral agreements. For example, smart contracts can mediate the establishment of shareholders' agreements; or enable the creation of organizations/partnerships by connecting large numbers of people who have come together for a joint project.
Decentralized autonomous organizations (DAO) use connected technologies such as blockchain, smart contracts, digital assets, and IoT to manage resources, coordinate activities and make decisions. DAOs are digital organizations created with smart contracts on the blockchain. They generally operate on public, permissionless blockchains. Developments in the DAO ecosystem, which has been in our lives since 2016, gained momentum as of 2020, with the rise of decentralized finance (DeFi) platforms and the inclusion of DAOs in this rise.
In DAOs, the organization's logic and operating rules are predetermined, coded by smart contracts, and executed by computers. From this perspective, the backbone of DAOs are smart contracts: smart contracts contain rules that the DAO will follow and parameters for how group-owned assets will be used. With the help of Oracles, data from the external world can be transferred to the DAO smart contract, and the encoded instructions can be executed. In this context, DAO can be described as a complex smart contract or an entirety consisting of the smart contractual network.
The basis of this structure is the following logic: Instead of hoping and trusting that the members of an organization will follow the rules, the rules that the members must follow are placed in the code to ensure that the rules are followed. If participants do not comply with these pre-programmed rules, they will be automatically expelled from the organization or subject to other predetermined sanctions.
All actions and financial status in the DAO are publicly visible. The history of transactions made under a DAO is recorded on the blockchain and is openly visible to everyone. Therefore, the DAO is a more transparent business organization compared to traditional partnerships, and the transaction history of DAOs cannot be changed or manipulated. All DAO participants can real-time view financial and operational information stored on open and permissionless blockchains, and anyone with sufficient expertise can check the smart contract code.
The activities of DAOs are performed algorithmically and are set up and managed entirely by computer code, not by an individual or group. Therefore, there is no need for a separate management team. There is no hierarchical structure in DAOs; no one holds the decision-making power. DAO management is coordinated using tokens or NFTs that grant voting powers. Therefore, all token holders in a DAO, not just administrators, play a role in decision-making. All this reduces operating costs. In addition, since the decision-making activities are based on the code and the most economically efficient decision is made automatically, poor management decisions are avoided.
DAOs, which are a new structure, have the potential to offer more transparent, secure, decentralized, adaptable, and fast solutions than traditional communities thanks to open-source software, blockchain technology, economic incentives, and smart contracts. However, DAOs also have many potential vulnerabilities. DAOs face challenges such as scalability, participation, cybersecurity, privacy, and legal uncertainties.
In the recent past, attacks and exploits against DAOs have resulted in the loss of hundreds of millions of dollars in crypto assets. In 2016, the first decentralized autonomous organization called theDAO, raised nearly $150 million worth of Ether to create a platform for collective investment in blockchain-based projects. A short time later, a bug in the DAO's smart contract code was used to drain (withdraw) a significant amount of digital assets deposited in the DAO. After this incident, security protocols for code auditing and solutions to ease the voting within the DAO were created by DAO creation platforms.
Determining the legal nature of the DAO in terms of private law rules is a separate issue. In particular, the problem of classifying DAOs in terms of corporate law is a recent issue. DAOs without clear legal status do not benefit from the same protections in traditional companies, such as legal entity status, limited liability, and simplified tax regulations. In some countries, such as the USA, legal regulations have begun to emerge regarding the legal nature of DAOs and how they are positioned in terms of corporate law.
A problem that should be given priority regarding DAOs is determining which country courts will be competent in disputes originating from DAO and which law will be applicable in this case. DAOs are based on a pseudonymous structure as well. In this framework, although DAO members can be identified as a digital key, it may not be possible to identify who these people are in the real world.