The Wisdom (Or Lack Thereof) of The DAO

If there is a problem in the world today, you can bet someone is trying to solve it with blockchain technology. However, it's unclear how many of these projects will still be around in a few years.

The concept of decentralized autonomous organizations has been discussed in the bitcoin community for years. In short, a DAO is an organization (for profit or not) whose mission statement is implemented by computer code, specifically self-executing smart contracts. It would not be a stretch to say that bitcoin was the first DAO.

Recently, a new DAO, called "The DAO," raised more than $150 million worth of ether (the cryptocurrency of the Ethereum network) in a crowd sale. More than 14% of all the ether in circulation is now tied up in The DAO, which was programmed by coders at a German company called Slock.it.

The idea behind The DAO is to act as a sort of decentralized investment fund. Supporters of the concept say the wisdom of the crowd will lead to sound investment decisions that provide dividends (or other benefits) for the organization (and thus its users). The DAO also has the goal of supporting "the decentralized ecosystem as a whole.”

"I think the DAO's large crowdsale just ensures we've a large enough financial incentive to get these sort of autonomous projects going and lay the groundwork for perfecting the DAO model over time," said Steven McKie, an Ethereum developer who is not involved in Slock.it.

To critics, the DAO appears to be yet another example of decentralization for its own sake. While bitcoin's leaderless structure has made permissionless, censorship-resistant payments possible, it's unclear what benefits are brought about by many other projects in the blockchain ecosystem. Setting aside the possible legal and security issues that observers have raised, it's unclear what problem The DAO is supposed to solve.

Just read about #TheDAO & had to update the graph. Almost there!!! #bitcoin #blockchain #ethereum $BTCUSD $ETH #btc pic.twitter.com/1cIHH96MRX

— Tone (@Tone_LLT) May 20, 2016

"It looks to be a typical case where people have taken some academic idea and just applied it to suit their purposes, without taking any due care to discover all the nuance behind it," said Jan-Willem Burgers, an expert on democratic theory and institutional design at VU University Amsterdam.

"The DAO is likely to be dead-on-arrival (DOA)," Burgers said, echoing a crack made by Daniel Larimer, founder of Bitshares, one of the earliest companies to experiment with decentralized organizations.

Burgers said he believes The DAO was created in good faith. However, he said, "this idea is poorly thought out from an institutional design perspective."

While there is nothing inherently wrong with testing out new ideas, there is a need to have logical reasoning behind an idea before testing it in the real world.

"Any kind of experimentation needs to meet minimal standards of evidence and rationale," Burgers said. "And I am not convinced these minimal standards have been met here to justify pooling together $150 million of people's money."

It should be noted that DAO token holders have not yet risked any of their ether on the project. Participants are still able to withdraw their ether from The DAO before the first project is funded.

And to their credit, nearly all of The DAO's vocal supporters are quick to admit that this is an experiment and not a sure thing.

Been many scams in #Bitcoin, but The DAO appears to be the first decentralized autonomous scam where the participants scam themselves.

— Kyle Torpey (@kyletorpey) May 11, 2016

One of the key elements of The DAO is its reliance on the wisdom of crowds. This is the idea that, in specific situations, a group can provide a more accurate answer to a question than a single expert. While a superficial understanding of this concept may indicate that it applies to The DAO, Burgers (who studied the wisdom of the crowd as part of his Ph.D. research) does not find that to be the case.

Neither the white paper nor the website for the DAO explains how the wisdom of the crowd applies to the project.

"Most importantly for this wisdom-of-the-crowds idea," Burgers said, "it has been shown to work in contexts where people have knowledge of the question they are trying to answer."

Francis Galton asking a crowd to guess the weight of a bull in the 1800s is an often-cited example of the wisdom of the crowd. "Galton's participants in the game were generally people who had experience in holding cattle and thus would have had experience weighing bulls," Burgers said.

Two other examples of situations where the crowd is often wise, political elections and counting jellybeans in a jar, also involve some base knowledge from the participants.

"But now suppose that we need to build a bridge over a river," Burgers went on. "Rather than hiring a bunch of people who know about this stuff, we just let anyone come up with proposals and then conduct a poll in the Sunday Times. Here's the snag. Most people don't know anything about building bridges. How on Earth could a crowd of people make a better decision here than a group of experts, both in terms of making proposals and then voting on it? They can't because they don't know what the hell they're doing."

I can't help but think of old episodes of "Who Wants to Be a Millionaire?" If the audience did not know much about a particular question, the "ask the audience" lifeline was not very helpful.

McKie disagrees that a crowd would be useless in Burgers' bridge scenario. He points out that the division of labor could be handled by anyone who makes a proposal to The DAO.

"I think most issues with the DAOs will be handled by how flexible proposals can be," McKie said.

Burgers pointed out that, in many situations, it's useful to have a diversity of experts rather than any old "crowd."

"In the context of building a bridge, it might be useful to have a geologist, an expert on the local climate, a civil engineer, an architect and so on, rather than just a group of engineers," he said. "This idea often gets confused with the wisdom of the crowds, but it is a very different idea."

But in the case of The DAO, Burgers doubted that this particular crowd has some knowledge related to the questions it will be asked to answer.

"Well, they're a bunch of amateurs, for one," he said. "Perhaps they could be taught some of this expertise, but it is a real question to what extent, especially given that, for most of these people, this is hardly their full-time job. People can also move in and out of the organization, so there is just no stability or consistency in composition that is required for educating the group."

On a recent episode of the Epicenter Bitcoin podcast, Stephan Tual, CEO of Slock.it, disputed the notion that the organization's funders were amateurs.

"These guys that are in The DAO ... they're the early adopters of bitcoin," Tual said. "They understand this space. They know what's good; they know what's bad. ... They're very astute – let's put it that way."

Of course, there have been plenty of altcoins and appcoins in the cryptocurrency space that failed – none of them have been able to gain any real traction. Some point to Ethereum as the first alternative to bitcoin to succeed (partly due to its $1 billion market cap), but Litecoin also reached that milestone in late 2013 (it's often referred to as the "silver to bitcoin's gold").

Litecoin is currently worth roughly 15% of its all-time-high market cap. More time is needed to determine whether Ethereum will turn out to be more than hype.

Another issue is that The DAO could run more like an oligarchy than a democracy, since some participants have invested much more ether than others and votes are weighted by one's share of DAO tokens. A two-part series of blog posts (one and two) by The Bitcoin Podcast's Corey Petty included statistics showing some DAO members have many more tokens than others.

McKie disagreed with this characterization of The DAO's governance model.

"The core basis of the DAO is to use decentralized and distributed decision-making to appeal to the needs of those with vested interest, and since anyone can join with no barriers," he said. "It's far more fair than any oligarchy. Luckily, the token distribution is fair and will only become more so as the tokens are traded."

When Burgers brought his criticisms to Slock.it's Griff Green on a recent episode of reinvent.money, Green responded:

"I think you have a valid point: Wisdom of the crowds does not always work. It works in very specific situations. We believe this is one of those [situations]. It is still an experiment."

Green also argued that the fact that DAO users are making a financial investment in the system will incentivize this "crowd" to make the right choices. Of course, having a financial incentive to be right is not the same as being right; otherwise, picking winners and losers in the market would be much easier for everyone.

Even McKie has some misgivings about the applicability of the wisdom of crowds to The DAO.

"One aspect of good crowd judgment is that people's decisions are independent of one another," he said. "If everyone was influenced by each other, there's more chance that the guesses will drift toward a misplaced bias."

The DAO could hire financial advisers or a due-diligence team to make investment recommendations. But if that's the case, then what's the point of having The DAO in the first place?

"Do we have huge problems with trustees of VC funds absconding with the money or purposely wasting it? I doubt it," Burgers said. "We may have problems with large fees, and certainly, the average person currently does not have access to these kinds of investment opportunities, but The DAO only solves that problem by sacrificing competence, hardly a solution."

Kyle Torpey, a freelance writer and researcher, has followed bitcoin since 2011. His work has been featured on VICE Motherboard, Business Insider, Nasdaq, RT's Keiser Report and many other media outlets. Follow him on Twitter: @kyletorpey.