The Principal-Agent Problem

Let’s say Jon’s car is making a strange noise while starting up, so he takes it to the local garage to get it checked out, where the mechanic immediately identifies the issue as something small.

Unbeknownst to Jon, the mechanic earns a commission on all repairs and sales at the shop. Rather than performing the easy fix and sending Jon on his way, the mechanic tells Jon that his car has some serious damage that will require several new parts to be installed so that he earns a greater commission. Jon isn't an expert, so he takes the mechanic's word and agrees to pay for the "necessary" repairs.

This is an example of a principal-agent problem, where the incentives of two parties involved in some business transaction aren’t properly aligned. In this scenario, Jon is the principal, and he’s incentivized to get his car fixed as quickly and cheaply as possible. The mechanic is the agent, and he’s incentivized to get Jon to spend as much money at his shop as possible - regardless of Jon’s specific needs.

What is a DAO?

A Decentralized Autonomous Organization, or DAO, is a new type of organizational model commonly used by crypto projects to help solve the principal-agent problem by aligning incentives and distributing decision making power to all stakeholders.

DAOs often issue governance tokens in order to enable the decentralized governance of the organization. Usually a specific amount of governance tokens must be deposited in order to submit a governance proposal, and all governance token holders are able to vote on the proposal (1 token typically equals 1 vote). Governance tokens are usually distributed between all stakeholders in an attempt to properly balance the decision making powers and to help align their interests by incentivizing them all to bring more value to the protocol.


Off-Chain vs On-Chain

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