One of the major features of digital currencies is that they are decentralized. This means they are not controlled by a single institution like a government or central bank, but instead are divided among a variety of computers, networks, and nodes. In many cases, virtual currencies make use of this decentralized status in order to attain levels of privacy and security that are typically unavailable to standard currencies and their transactions.

Inspired by the decentralization of cryptocurrencies, a group of developers came up with the idea for a decentralized autonomous organization, or DAO, in 2016.

What Is the DAO?

The DAO was an organization that was designed to be automated and decentralized. It acted as a form of venture capital fund, based on open-source code and without a typical management structure or board of directors. In order to be fully decentralized, the DAO was unaffiliated with any particular nation state, although it made use of the ethereum network.  (See also: How Do You Invest in the DAO?)

Why make an organization like the DAO? The developers of the DAO believed they could eliminate human error or manipulation of investor funds by placing decision-making power into the hands of an automated system and a crowdsourced process. Fueled by ether, the DAO was designed to allow investors to send money from anywhere in the world anonymously. The DAO would then provide those owners tokens, allowing them voting rights on possible projects.

The DAO launched in late April 2016 thanks to a month-long crowdsale of tokens which raised more than $150 million in funds. At the time, the launch was the largest crowdfunding fundraising campaign of all time.

Risks and Downfall of the DAO

By May 2016, the DAO held a massive percentage of all ether tokens that had been issued up to that point (up to 14%, according to reporting by The Economist). At roughly the same time, however, a paper was published which addressed several potential security vulnerabilities, cautioning investors from voting on future investment projects until those issues had been resolved.

Later, in June 2016, hackers attacked the DAO based on these vulnerabilities. The hackers gained access to 3.6 million ETH, worth about $50 million at the time. This prompted a massive and contentious argument among DAO investors, with some individuals suggesting various ways of addressing the hack and others calling for the DAO to be permanently disbanded. This incident also figured prominently in the hard forking of ethereum that took place shortly thereafter. (See also: Why Are There Now Two Ethereums?)

According to IEEE Spectrum, the DAO was vulnerable to programming errors and attack vectors. The fact that the organization was charting new territory in terms of regulation and corporate law likely did not make the process any easier. The ramifications of the structure of the organization were potentially numerous: investors were concerned that they would be held liable for actions taken by the DAO as a broader organization.

The DAO operated in murky territory with regard to whether or not it was selling securities, as well. Further, there were longstanding issues regarding the way that the DAO would function in the real world. It was necessary for investors and contractors alike to convert ETH into fiat currencies, and this could have impacted the value of ether.

Following the contentious argument over the DAO's future and the massive hacking incident of earlier in the summer, in September 2016, a number of prominent digital currency exchanges de-listed the DAO token, marking the effective end for the DAO as it was initially envisioned.

SEC Response

In July 2017, long after the DAO had ceased to function, the U.S. Securities and Exchange Commission issued a report on initial coin offerings and on the DAO. The report determined that the DAO had sold securities in the form of tokens on the ethereum blockchain, meaning it had potentially violated portions of U.S. securities law.

Future of the DAO

What does the future hold for the DAO? As of early 2018, there are no clear signs that the DAO as it initially existed will be resurrected. Nonetheless, interest in decentralized autonomous organizations as a broader group continues to grow.

While there are many lingering concerns and potential issues regarding legality, security, and structure, some analysts and investors believe that this type of organization will eventually come to prominence, perhaps even replacing traditionally-structured businesses.

The popular digital currency Dash is an example of a decentralized autonomous organization because of the way it is governed and the way its budgeting system is structured. It may only be a matter of time before additional DAOs enter the field.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns cryptocurrencies.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.