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DAOs are a type of Ethereum application that represents a virtual entity within Ethereum. When you create a DAO, you can invite others to participate in the governance of the organization. The participants can remain anonymous and never meet, which could trigger Know Your Customer (KYC) rules (the process a business must go through to verify the identity of its clients) and anti-money-laundering (AML; the laws and regulations designed to stop the practice of generating income through illegal means) compliance issues.

DAOs have been created for raising funds for investing, but they could also be designed for civic or nonprofit purposes. Ethereum gives you a basic framework for governance. It’s up to the organizers to determine what’s being governed. Ethereum has created templates for you to help in the creation of DAOs.

Figure 5-2 shows a depiction of the organization of an Ethereum application.

Here’s how DAOs basically work:

1 A group of people write a smart contract to govern the organization.

2 People add funds to the DAO and are given tokens that represent ownership.This structure works kind of like stock in a company, but the members have control of the funds from day one.

3 When the funds have been raised, the DAO begins to operate by having members propose how to spend the money. Voting may be affected by how much Ether the member risks or stakes in the DAO.

4 The members vote on these proposals.

5 When the predetermined time has passed and the predetermined number of votes has accrued, the proposal passes or fails.

6 Individuals act as contractors to service the DAO.

FIGURE 5-2: Ethereum.org blockchain application depiction.

Unlike most traditional investment vehicles, where a central party makes decisions about investments, the members of a DAO control 100 percent of the assets. They vote on new investments and other decisions. This type of structure threatens to displace traditional financial managers.

DAOs are built with code that can’t be changed on the fly. The appeal of this is that malicious hackers can’t monkey with the funds in a traditional sense. However, hackers can still find ways to execute the code in unexpected ways and withdraw funds. Also, the immutable nature of a DAO’s code makes it nearly impossible to fix any bugs once the DAO is live in Ethereum.