One night over sushi your friend just throws it out there: “you know, we should set up our business as a DAO”.
You choke up, not sure if it’s on your beer or the DAO idea.
In the last couple of months both of you have been testing the market for a new social app that will revolutionize how people interact with each other. Your girlfriend called it the Insta killer - and she lives on Instagram.
The initial results have been promising but it has been a tough going. You and your co-founder have been clashing on almost everything - your customer focus, the unique value proposition and even whether the primary colour should be blue or purple. You love his commitment but you often wonder if his mind lives in an alternative reality.
Now, out of nowhere he drops this on you: let’s build a DAO. How can he even fathom this? If the two of you can’t agree on the fundamentals, how would you get a whole group of people to do it?
True, DAOs are the future. Building a community and empowering its members to self-govern could be a powerful competitive advantage. Yet, doing it too early can spell a disaster.
The question comes down to this: do you set up a DAO before you have even launched or do you do it later?
from a16z has an answer that sidesteps this conundrum:
Walden argues that to maximize their chances of success, crypto startups should follow a path of gradual decentralization:
“... Much of what it takes to build a successful product at the outset — product leadership, rapid iteration, a managed go-to-market — complicates the path to community ownership and regulatory compliance, which guarantee long-term health.”
Building a community and issuing a token before validating any demand for your product is doing things backwards. Instead of focusing on the critical task validating your idea, you dilute your attention on the less prescient tasks of building a community and issuing a token.
To avoid such missteps, Walden recommends progressive decentralization at three stages:
Think of these stages as a quest where the successful completion of one level opens up the gate to the next one.
This is the stage where things move fast and direction changes frequently. You come up with an idea, develop it in a rough value proposition and test with your market. Depending on the results, you tweak it and test it again or pivot to another idea.
Focus and rapid iteration are critical to success at this stage. The best way to achieve them is through a small team of founders working in concert. Walden says that at this stage decentralization should be non-existent.
Once you have validated a product-market fit, you shift focus to refining your offering. While at the previous stage you were winging it with rough drafts, at this stage you add the finer details - the features and functionality that turn your product from a good fit to the perfect fit for your target customer.
Building a community of early users is the best way to achieve such fine-tuning. This is the approach Coda has taken. At any time its product team can plug into the community conversation and discover pain points and wish list items.
In Web 2, community-building stops at the stage of a fan club. The community is a tool the core team uses to gain customer insights and increase product stickiness. By design, the participation of community members is limited to providing feedback and in some cases to building ancillary products on top of the core product.
In Web 3, we do things differently. At this stage, the core team encourages community members to actively participate in building the product and supporting the community. They do this by creating bounties, launching grants and appointing community leaders.
Gradually, the founders can start introducing polling mechanisms and encourage discussions about product development and community governance. Some decision-making can be deferred to the community. Enabling members to make formal proposals on product features and community governance will further push decentralization.
At this stage, the core team can start testing a native token. Initially, it can be used to compensate members for their contributions and incentivize them to do so. The token can also have a governance function - it can give its holders voting power on decisions and proposals.
All the efforts in the previous stages culminate here - the founding team gives full control to the community to run the show. Token holders make all decisions about the future of the company no matter how big or small. It’s a case of direct democracy not that different than the version the ancient Athenians practiced.
Getting to this point, however, requires us to get a significant amount of work done:
Determine what problem we are solving (after all, even the hippiest of communities gather around an unmet need); Validate that this is indeed a problem people care to have solved; Come up with a solution enough people are willing to pay for; Prove that enough people are willing to pay for it; Build an engaged community around our product and mission to solve the problem; Build the structures to support community decision-making. In the least, this includes setting up a Discord server but almost always it means designing the fundamentals of a governance structure. Develop and test incentive mechanisms - usually a token that gives its holders certain rights and behaves in a certain way.
We don’t have an exact formula how to turn a startup into a DAO. They are too new for that. We can, however, look at the path successful DAOs have taken and learn from their experience:
How Others Have Gone Full DAO
In 2017, Scott Moore and Kevin Owocki launched - a platform that funds the development of open source public goods for Web 3. Owocki that many interesting projects never get built for one simple reason: lack of funding to sustain developers during the initial years of building. Many founders have to hold regular jobs to sustain themselves and moonlight building the next Ethereum. Gitcoin didn’t becomes a DAO until when it launched its governance token (GTC). In the four years before then Owocki and Moore were busy validating the problem they wanted to solve, design a solution, find funding, build a community and develop the structures paving the way to full DAO. The launch of GTC was the culmination of all these efforts.
started . It was a decentralized peer-to-peer lending platform built on the Ethereum blockchain. A year later, however, Kulechov and his team changed their business model to a liquidity pool platform. They also to AAVE - the Finnish word for “ghost”. AAVE didn’t start functioning as a DAO until 2020 when its got to vote on its first proposal.
What did Kulechov and his team do in the gap of three years? They refined their business model, rebranded and validated their product-market fit. Once AAVE had some market traction and significant user base, did the founding team decide to go DAO.
MakerDAO started as the Maker Foundation in 2015. Rune Christensen, the man behind Maker, a vision of building a stable token (e-Dollar) that would support exchange on value on the Ethereum network. The problem Christensen was trying to solve is the one we still face today - the major cryptocurrencies were too volatile be effective tools for daily transactions. Crypto needed a token that remains stable with respect to a major fiat currency (e.g. US Dollar). In the years to follow Christensen scrapped the Maker Foundation, released a limited edition of a stablecoin, dropped its current stablecoin DAI, survived a tumultuous 2020 and cleared the path to going full DAO. You can read the full version of Maker’s tribulations .
When Progressive Decentralization Doesn’t Make Sense
Walden explains that progressive decentralization works best only for one type of companies - Layer 2 applications built on a decentralized platform using smart contracts. AAVE, MakerDAO and many ways Gitcoin are such a type of applications. So is most of DeFi and Web 3.
There are some business models, however, that call for decentralization from day one.
Layer 1 Protocols
By design projects like Ethereum, Solana and Polkadot need a community of participants from the very beginning. Their raison d’etre is a decentralized blockchain that solves a specific problem.
History tells us that none of these protocols started as DAOs. But then, DAOs with tokens and solid governance were not a thing before 2016. Today, Ethereum, Solana and many other L1 protocols are DAOs or DAO-like because their existence relies on it.
Ethereum would have never worked if its founders held all decision-making power. It would have been just another Amazon or AirBnB - a platform where people do certain things following the rules set by a central ruler. The hidden revolution that Ethereum brought to the world is in the thinking how people can organize themselves as co-owners, not merely techno peasants.
Social Clubs and Investment Funds
would have been a traditional VC fund if it weren’t for Web 3. would have not existed.
The LAO’s success lies in the community of participants jointly investing in crypto projects. In the traditional VC world, The LAO would have had a general partner (GPs) who would have pooled money from limited partners (LPs) into a fund. The GP would have been responsible for investing the money and delivering a return.
This model works in a world where the LPs have little interest in where the fund invests their money (as long as the return and risk profile is as promised). Active LPs who want to be more than just bank accounts are looking elsewhere. Decentralized organizations like The LAO and Meta Cartel are made for them.
You can’t pull off The LAO without a DAO. By design it relies on a network of people who play different roles - investors, scouts, mentors and founders. The work together to build projects that build the future.
The same is true for PleasrDAO. Its premise is collectively owning digital art. By design, it calls for a group of people coming together to behind a common goal. Collectors’ clubs do exist in the real world, however, they tend to be over-reliant on a central authority and be small in size.
So, maybe your friend’s idea of starting a DAO from day one is not that crazy. If you’re building the next Index Coop or Forefront, starting as a DAO is the only way to go. You don’t have to have a token and a full-blown governance structure from day one, but you can scaffold the framework to help you get there.
If you’re in the shoes of Coda, however, it may be smart to wait. Keep the team small, validate your value proposition and slowly sail to a full DAO when the time is right.