The Formation of The DAO
The entire ecosystem of Ethereum works on the basis of smart contracts. For the uninitiated, smart contracts are basically how things get done in the Ethereum ecosystem. To put it in layman terms, smart contracts are automated contracts that enforce and facilitate the terms of the contract itself.
The DAO aka the Decentralized Autonomous Organization was a complex smart contract that was going to revolutionize Ethereum forever. It was basically going to be a decentralized venture capital fund that was going to fund all future DAPPS made in the eco-system.
The way it worked was pretty straightforward. If you wanted to have any say in the direction DAPPS that would get funded, then you would have to buy “DAO Tokens” for a certain amount of Ether. The DAO tokens were indicators that you are now officially part of the DAO system.
So, how was DAPPS going to get approved and built? Well, firstly they need to get whitelisted by the curators, who have basically known figureheads in the Ethereum world. After getting their stamp of approval, they will get voted on by the DAO token holders. If the proposal gets a 20% approval in the vote, then they will get the required funds to get started.
The potential of the DAO and the flexibility, control and complete transparency that it offered was unprecedented; people leaped in to get their share of the pie. Within 28 days of its formation, it accumulated over $150 million worth of ether in a crowdsale. At that time, it had 14% of all ether tokens issued to date.
You might be wondering, that’s all good but how does one go out of the DAO? What if some DAPP gets approved that you are not a huge fan of, how do you opt-out of the DAO then? To enable this, an exit door was created called the “Split Function.” Using this function, you would get back the ether you have invested and, if you so desired, you could even create your own “Child DAO.” In fact, you could split off with multiple DAO token holders and create your own Child DAO and start accepting proposals.
There was one condition in the contract, however, after splitting off from the DAO you would have to hold on to your ether for 28 days before you could spend them. So everything looks nice and spiffy for now….except, there was one little problem. A lot of people saw this possible loophole and pointed it out. The DAO creators assured that this was not going to be a big issue. The only thing is, it was, and that created the entire storm that split Ethereum into Ethereum and Ethereum Classic.
The DAO Attack
On 17th June 2016, someone exploited this very loophole in the DAO and siphoned away one-third of the DAO’s funds. That’s around $50 million dollars. The loophole that the hacker(s) discovered was pretty straightforward in hindsight.