The current state of DAOs is problematic.

The DAOs attempt to achieve decentralization by releasing an ERC20 token which is then used as the voting mechanism and the projects funding mechanism is the biggest contributor to its centralization.

ERC20s are great funding mechanisms but releasing an ERC20s as voting mechanism is a horrible idea.

DAOs, understandably so, release a tokens to reward early adopters, users, developers, and investors (if any). In an effort to protect the DAO and secure longevity, the team typically allows most of the supply to be kept by the DAO.

Here is on example:

But by attempting to protect the DAO, the team reduces decentralization as the voting power is centralized within the team. The team, by holding the majority of the tokens, can sway voting as they please. This isn't very decentralized.

This Model of Tokenomics for a DAO is a paradox in which the DAO cannot achieve an economic model and decentralization at the same time.

ERC404 can help achieve true DAO Decentralization.

To explore the idea of using ERC404 to solve the big issues inherited with DAO economy we first need to understand what is an ERC404.

Simply put, the ERC404 protocol combines the features of an NFT and an ERC20 token.

A team can deploy a DAO Token that would generate an ERC20, which will take the role of the financials, and an ERC721, which will be used as the voting mechanism. All within an ERC404 framework.

For more information on how ERC404 work: https://medium.com/aelfblockchain/erc-404-standard-daa69e9399fb

The author shares a few examples:


DEFROGS -> 1.43627 DEFROGS will also hold 1 DEFROGS NFT.


PANDORA -> 3.28708 PANDORA will also hold 3 Pandora NFTS.

And one more example of buying enough ERC20 to complete a whole NFT and "burning" the NFT by selling the ERC20 making the total balance less than 1 Unit NFT.

  1. Buying 0.8 $T results in 0 NFTs.
  2. Purchasing an additional 0.3 $T, making the balance 1.1 $T, triggers NFT minting.
  3. Selling 0.2 $T lowers the balance below 1, leading to NFT burning.
  4. Buying back 0.2 $T results in the minting of another NFT to your wallet

ERC404 as a DAO Token

Step-by-Step Guide for Implementing ERC404 NFTs as a DAO Token for Voting and Financial Use

1. Understand the Concept

The DAO will utilize ERC404 NFTs as the primary governance token, which also has the flexibility to be converted into ERC20 tokens. This setup separates voting power from financial trading capabilities.

2. Define Tokenomics

Decide on the distribution strategy for the ERC404 NFTs. A common allocation is:

  • **50%** retained by the DAO treasury
  • **30%** allocated to key contributors, stakeholders, or early adopters
  • **20%** reserved for public sale or community distribution

Adjust these percentages based on the DAO’s goals and structure.

3. Develop and Deploy the ERC404 Contract

  • **NFT Functionality**: The ERC404 token will represent voting rights within the DAO.
  • **Conversion Mechanism**: Include a mechanism to "burn" the NFT, splitting it into a predefined number of ERC20 tokens.
  • **Governance Logic**: Implement smart contract logic to ensure:
  • Voting power is tied exclusively to the NFT.
  • Burned NFTs reduce voting power proportionally.

4. Determine the Conversion Ratio

Decide how many ERC20 tokens will correspond to one ERC404 NFT. For example:

  • 1 ERC404 NFT = 1,000 ERC20 tokens

This ratio will affect the financial token’s liquidity and trading behavior.

5. Retain DAO Voting Power

To maintain decentralization and governance integrity:

  • Keep a majority of ERC404 NFTs (e.g., 50% or more) in the DAO treasury.
  • Monitor and update smart contract logic to prevent any single entity from acquiring excessive voting rights.

6. Allow for Financial Flexibility

Enable DAO members or the DAO itself to:

  • Burn ERC404 NFTs to split them into ERC20 tokens.
  • Trade ERC20 tokens on decentralized exchanges or use them for funding, investments, or other purposes.
  • Forfeit corresponding voting power with every NFT burned.

7. Establish Governance Processes

Define and document:

  • **Voting Mechanism**: Use ERC404 NFTs as the basis for voting. Voting weight is determined by the number of NFTs held.
  • **Burning Rules**: Set clear rules for burning NFTs and converting them into ERC20 tokens.
  • **Proposals and Quorums**: Determine the minimum number of NFTs required for proposals and quorum thresholds.

8. Educate DAO Members

Provide clear guidance to DAO members on:

  • How ERC404 NFTs and ERC20 tokens function.
  • The trade-offs between retaining voting power and converting NFTs for financial purposes.
  • The importance of maintaining decentralized governance.

9. Launch and Distribute Tokens

  • Mint and distribute ERC404 NFTs according to your tokenomics plan.
  • Release ERC20 tokens to exchanges or as part of the DAO’s funding strategy, as required.

10. Monitor and Optimize

  • Regularly review the DAO’s token distribution and voting dynamics.
  • Update smart contract logic to address any unforeseen issues or security risks.
  • Encourage community feedback to improve governance and financial mechanisms.

By following this guide, your DAO can successfully implement ERC404 NFTs as a dual-purpose token, combining robust governance with financial flexibility.

Conclusion

The current state of DAOs faces a fundamental paradox: their reliance on ERC20 tokens as both funding and governance mechanisms compromises decentralization, the very principle they aim to uphold. The proposed ERC404 framework offers a compelling solution by separating governance from financial mechanisms. By leveraging the dual functionality of ERC404—combining ERC721 (NFTs) for voting and ERC20 for financial transactions—DAOs can achieve both decentralized governance and sustainable economic models.

Through careful implementation, tokenomics design, and education of DAO members, ERC404 has the potential to address the inherent flaws in traditional DAO structures, paving the way for a more equitable, decentralized future.