Exploring Pros and Cons of DAOs vs. Traditional Vertical Structures

With all the talk about DAOs, it may seem that every organization wants to be one. But why exactly? And how is a DAO different from the classical vertical structure (the one with a clear distinction between leadership and the rest of the staff)?

DAO: Pros and Cons

Since DAO is the hot new organizational concept, let’s look at it first.

DAO stands for Decentralized Autonomous Organization, meaning any organization that does not have centralized leadership (or a physical location) and where members can automate governance by a democratic voting mechanism of some sort.

DAO Advantages

One obvious advantage is the inclusivity and engagement within the organization. When everybody can participate in decision-making (including big ones like budget spending, hires, and even the direction of the organization), members can feel more empowered and engaged. This in turn creates more trust for the organization, both internally and externally.

DAOs are also very flexible: any of its laws and settings could be changed by voting and different voting weights can be given to various stakeholders (perhaps giving the teacher in the class veto power over votes to cancel the school year). An organization can easily adapt a DAO structure to any organizational type or need.

For blockchain-based DAOs, the added transparency and accountability of having all governance votes and decisions permanently inscribed on the blockchain and visible to anyone is a major advantage to classical vertical structures where the decision-making process is much more opaque.

The autonomous nature of DAOs, such as using smart contracts for the automatic execution of governance decisions, can tremendously increase the effectiveness of the organization while cutting costs (not to mention the massive savings from not having a central physical location).

DAO Disadvantages

On the other hand, having to go through a proposal and voting process for every decision could create a number of bottlenecks in the DAO’s functioning. Decentralization could also lead to issues arising from a lack of leadership and cohesiveness. It’s also more likely for factions within the organization to block important proposals or use their collective voting power to harm the DAO or take it in a risky direction (i.e., DAOs are a dream for hostile takeovers).

Blockchain DAOs generally require some technical expertise and the implementation could be quite costly.

Plus, new structures (let alone democratic ones) tend to face a barrier in trying to get people to behave in new ways. Just because the DAO’s creator intends for the DAO’s members to take charge and actively govern the DAO to grow and succeed does not mean they will. And it’s hard for leaders/creators to let go of that power, trusting in the process.

Legally, DAOs could have a number of issues with jurisdiction and taxation since members are often all over the world. This is why many DAOs are putting a clearly defined legal layer on top of their DAO structure.

Classical Vertical Structure: Pros and Cons

We’ve all been part of classical vertical structures (CVS) in one way or another, from family (with the parents - usually - in charge) to school, to work.

Advantages of CVS

The obvious advantage of having a classical vertical structure is that the leader can make quick decisions when necessary, which creates efficiency and a clear direction. Whether in your family or a Fortune 500 company, a strong leader can make all the difference between weathering a storm quickly and successfully or not.

There is also a very clear sense of responsibility within CVSs. The one(s) at the top give directions and the ones below follow. Failing in your responsibilities gets you fined, fired, or… well, grounded. Conversely, a leader who doesn’t lead well could be fired too, jailed, or have the kids taken away by social services.

CVSs have clear legal and tax structures, giving stakeholders clear legal recourse when needed. This also allows them to operate in specific national and regional markets without fear of being shut down or prosecuted.

Disadvantages of CVSs

The vertical structure of CVSs makes them less flexible and certainly less democratic. Members in the lower tiers of the hierarchy can feel intimidated to bring up their concerns and ideas to the ones higher up. This can create an echo chamber where the management doesn’t hear or understand the consensus of the entire organization and is basically out of tune with reality.

While some CVSs try to be more transparent, it’s still too easy to conceal the nature of various management decisions. Lower-ranked members cannot have full trust in the management no matter what assurances they get. Membership in a CVS could be terminated abruptly and thus often requires a complex contract to have any measure of security.

Not least of all, CVSs are hard to scale beyond a certain point since the vertical structure puts a lot of administrative barriers and bottlenecks into any such expansion. Physical locations and the requirement of travel add to those barriers. Being centralized and not autonomous, various units or departments of CVSs have a harder time independently pursuing growth activity without constantly checking back with “the home office.”

A Comparison Between DAOs and Classical Vertical Structures

There are, of course, similarities between DAOs and CVSs in that they are both organizations with a clear structure, various stakeholders, and established rules and processes that can be updated. Both can self-organize into smaller organizations, expand into larger ones, form partnerships, and self-dissolve.

Yet, the fundamental difference between the two is in that a CVS is governed by fiat while a DAO is governed by consensus. Plus, DAOs are horizontal in structure while CVSs are obviously vertical.

Which to choose?

The choice of whether to form a DAO or a CVS is not automatic. For example, most families with small kids are probably better suited for the CVS model. Though the ones with adult children or even teenagers may benefit more from a DAO framework (with the parents perhaps having more voting power via special governance NFTs or validator tokens).

For crypto projects, the choice to form a DAO is rather obvious since DAOs embody some of the best and most progressive principles of crypto culture. But even non-crypto ones could benefit from it. A local government can form a DAO to get community members to actively participate in the governance process, including budget collection and distribution. Even the biggest corporation can be a DAO. After all, all public companies allow shareholders to participate in governance, just not in a very effective and interesting way.

On the other hand, a hockey team should not form a DAO to let players vote on each night’s starting lineup — that should be left to the coach. Private companies with secret information (and government agencies for that matter) may want to keep their vertical structure.

Conclusion

All-in-all, most organizations can benefit from implementing some aspects of the DAO structure, especially if they want to increase stakeholder participation and trust. A classical vertical structure can be more advantageous where quick and unquestionable decisions need to be made (such as in the army).

With the world rapidly moving toward more automation and globalization (and with post-COVID remote-first work environments dominating), the DAO structure has more and more appeal. With its flexibility and universality, the DAO form of organizing can certainly overtake the CVS model in most organizational types.

In an ideal merger of the two models, the best of each one would be integrated to balance out the weaker sides. In reality, there will surely be a transition and consolidation period giving birth to a number of hybrid organizational models and various adaptations of the DAO structure to the needs of specific organization types. Prepare for a world of sub-DAOs and DAOs of DAOs.