While most of us will be familiar with bitcoins, few of us will have heard of blockchains. An essential technology in the world of bitcoin currency, blockchains are the main technological innovation to emerge from the cryptocurrency. At a time when data security and management are important factors, blockchain software has emerged as a way to enable companies to verify transactions on a network without the complexities of central financial authority.
In 2015, an entity known as The DAO was created by a German start-up to operate using blockchain software. The original software, intended to be the basis of a crowdfunding contract, gained the attention of many cryptocurrency enthusiasts and quickly amassed more than $100 million by late April 2016. The DAO has become the largest crowdfunding event in history, having reached more than $150 million from over 11,000 members – numbers that even the creators didn’t expect. To investors and professionals who work with start-ups, such as Henner Diekmann (an experienced lawyer and partner at Diekmann Associates), the DAO’s inception demonstrates the potential of crowdfunding as a means of getting start-ups off the ground.
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DAO stands for Distributed Autonomous Organisation, which until the creation of The DAO, seemed more feasible in theory than reality. By their very nature, DAOs function like companies. But rather than have legal documents to support their existence, the structure of a DAO is coded into a blockchain. In simple terms, a blockchain is a distributed database that stores a growing list of data records. Think of it as a digital ledger that is shared among a distributed computer network and uses cryptography to enable each network participant to revise the ledger without the need for oversight from a central authority.
Changing or removal of data that’s been recorded on a blockchain is touted as quite difficult. Should a participant want to add to the blockchain, the participants in the network have to evaluate the transaction and verify its validity. If a majority of the participants are in agreement, the proposed transaction is approved and a new block is added.
What does the DAO do?
The DAO is a complex smart contract that can be compared to a venture capital fund. It offers its own voting shares (DAO tokens) to members who get Ether, which is a cryptocurrency similar to Bitcoin. Ether is run on a network called Ethereum and is proving to be serious competition to Bitcoin. Members who buy into DAO are basically buying voting rights on how the funds collected are used.
It can be argued that this is a venture capital firm with its investors being the token holders. And while returns could be in the form of ether, the creators of the entity were quick to point out that these tokens don’t represent equity. The DAO’s goal is to support projects delivered by contractors using the ether raised by the crowdfunding exercise. By the time the crowdfunding ended, more than 50 project proposals awaited token holders to vote on.
As impressive as the rise of The DAO, it has not been as successful as creators would have wished. Any networked system is vulnerable to attack, and The DAO system was no exception. In May 2016, an unknown attacker was able to breach the system and drain a significant amount of ether collected from the sale of tokens. Since then, another two attacks have taken place with more funds being taken in the process.
Lessons to learn
While efforts have been made to retrieve the funds that were compromised during the hacks, there are serious questions about the future of the project. Bad coding aside, there are more general lessons that all start-ups can learn from The DAO’s failed project.
For starters, where huge sums of money are involved, it’s important to put security first. The DAO’s creators overlooked a key part of its security infrastructure, and hackers were able to exploit this vulnerability in the system. Some experts argue that the coding that took place was sloppy, leaving The DAO open to attack. All businesses should ensure that they have the right checks in place to ensure that security is as comprehensive as possible.
Secondly, management and operations experience is key to running a successful venture. These aspects cannot be made up on the go, and it falls on start-ups to find the right people with the necessary experience. Seeking second opinions on key areas is always a good idea. Often a different perspective is required to identify pitfalls.
Lastly, learn from your mistakes. The Merkle reported that in all three instances very similar attacks took place. A business will be judged not only on the mistakes that it makes but its ability to rectify them. Failing to address such major issues will have a knock on effect, shaking customer confidence in all areas of the business.
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