Decentralised Autonomous Organisations offer an attractive alternative to traditional corporate structures. At the same time, they are challenging legislators around the world with the design of a suitable regulatory framework.
Decentralised Autonomous Organisations (‘DAOs’) are a new form of digital organisation emerging on the blockchain. As their name suggests, they are decentralised, offering new ways for investors to finance projects, govern businesses, and share value. Their promise is democratisation, making use of Web3 technologies to empower digital communities for collective business participation.
How do DAOs work?
DAOs exist on the blockchain. They are run and maintained entirely across computers on a peer-to-peer network, utilising ‘smart contracts’ to enforce decisions, define rules, and verify transactions. Smart contracts are self-executing, meaning they are stored on the blockchain and only come into effect when predetermined conditions have been met. As such, this removes the need for any centralised management, instead putting an emphasis on governance through computer code, transparency, and collective participation by all ‘token holders’ in the decision-making process.
Token holders buy into a DAO using cryptocurrency. Cryptocurrencies such as Bitcoin or Ethereum are used to purchase tokens (i.e. a crypto asset) and receive voting rights. The more tokens someone holds, the more voting rights they obtain. Generally, token holders will vote on every decision to be made by the DAO, including what projects to invest in, and ensuring that the goals of the DAO are achieved. Once again, rules associated with voting, as well as the outcome of votes, are stored and executed in the form of immutable smart contracts.
The DAO ecosystem
According to a Forbes article from 3 February 2022, there are more than 4,000 DAOs in existence, globally, with over US$8 billion in their treasuries. Ranging from venture capital enterprises to DeFi (decentralised finance) applications, to the coordination of open-source gaming and digital goods projects, DAOs are a growing trend which is unlikely to slow down anytime soon. For those establishing DAOs, doing business through smart contracts has its benefits. DAOs cannot be censored, shut down, nor interfered with by regulatory bodies. The fact they are decentralised and premised on autonomy also mitigates corruption. It is this which allows DAOs to achieve independence, offering new approaches to social and economic interactions, interactions which promise a focus on community rather than just profit.
The legal gap
However, DAOs find themselves in a legal vacuum as the traditional rules of company law do not apply. DAOs have no directors, no board, and are under no requirement to lodge any financial information or pay taxes. Governance relies on their respective blockchain communities. DAOs challenge conventional definitions of what it means to be a corporate entity and are evolving into their own unique class of organisation. As ASIC chair, Joe Longo, observes, DAOs have garnered much fascination from the legal community because they “work on the basis that the ‘rule of code’ replaces ‘the rule of law’”.
This has meant that DAOs are subject to legal uncertainty, particularly in the context of responsibility and liability. DAOs are not recognised as having separate legal personality, meaning they have no ability to own assets, enter into contracts, sue, or be sued. If one was to try and categorise DAOs, they would be most reminiscent of a partnership, unincorporated joint venture, or unincorporated association.
Recognising DAOs as a legal structure
Jurisdictions around the world have begun to explore how to legally recognise DAOs as a form of corporation. For example, in the United States, both Wyoming and Vermont have recently passed legislation that allows DAOs to register as limited liability companies, under their own name, and with their own legal personality.
Under this scheme, DAOs must file a constitution or articles of organisation, classifying the smart contracts that manage the organisation. The DAO can also select whether it is managed by physical members, or whether it is autonomously managed by algorithms and self-executing computer code. However, it is important to note that under both the Wyoming and Vermont laws, regulators and government cannot interfere or alter the internal governance of the DAO. These laws do not radically re-invent already established corporate structures, rather, they tailor traditional regulatory standards and practices to protect DAOs and their operations.
In Europe, Malta has also begun to develop a new DAO-based corporate scheme. The Maltese scheme allows for the registration of ‘Innovative Technology Agreements’, for distributed ledger technologies. Whilst this does not grant DAOs legal personality, it does attempt to provide DAOs with some assurances, particularly in the context of local approval and recognition. The advantage of this approach is that it offers a high level of flexibility to DAOs, providing them with the ability to operate internationally, whilst establishing a foundation to comply with Maltese tax laws.
In Australia, the Senate Select Committee on Australia as a Technology and Financial Centre has recommended that the Australian Government establish a new DAO company structure. In October 2021, the Senate Select Committee’s final report noted that “legal liability for members (i.e. token holders) for these organisations is currently unclear, and this regulatory uncertainty is preventing the establishment of projects of significant scale in Australia”. As the digital economy continues to grow, so too will the number of DAOs. Hence, it is important for Australia to capitalise on this opportunity. The only way this can occur is if new laws give DAOs legal personality and protect token holders through a scheme of limited liability.
However, with no physical place of business, an all-digital treasury, and members dispersed across multiple countries, how is the applicable jurisdiction established? One answer would be to register the DAO in a jurisdiction where DAOs are recognised. For example: a DAO may choose to subscribe to Wyoming’s DAO LLC law. The DAO would then register in Wyoming. It would then have and continuously maintain a registered agent in Wyoming. Subsequently, the DAO would be subject to Wyoming’s DAO LLC law.
Under this approach, DAOs would be able to pick and choose the law which they find most favourable. Competition amongst jurisdictions would increase in the hope of tapping into a new world of economic activity, as too would innovation amongst DAOs in the hope of making use of a regulatory regime that would best recognise their status.
A different approach is taken by The Coalition of Automated and Legal Applications (COALA) which has developed a Model Law for DAOs. The COALA Model Law aims to create consistency and legal certainty when it comes to DAOs, providing national legislators with a uniform set of rules that can be adopted into domestic law. This approach recognises that DAOs are inherently transnational and acts as a best practice guide that can be used to bridge the gap between the multiple existing and potential activities of unregistered DAOs. As the Model Law explains, “in a State that has transposed or adopted the Model Law into their domestic legal system, a DAO that is constituted according to the requirements of the transposed or adopted legal rules will qualify as a legal entity”.
Legislating the way forward
It is important that any attempt to change Australia’s laws, with respect to DAOs, does not inhibit innovation. More specifically, if the legislative change is to be meaningful, DAOs must not be thought of as some form of quasi-company. DAOs are unique in their own way, and so, attempting to fit these organisations into a long-established framework of corporate law may be to the DAO’s detriment. Legislators should ensure DAOs are not forced into compliance with frameworks that were developed for traditional company structures. Instead, they should imagine a new framework of registration and regulation specific to DAOs which recognises their unique features and ambitions.