The Legal Design Puzzle of Decentralized Autonomous Organizations

Wulf A. Kaal, University of St. Thomas School of Law

-- Blockchain-based businesses are a natural global extension of platform businesses. Blockchain-based smart contracts can standardize business processes and enable autonomous organizations. Decentralized autonomous organizations (DAOs) instantiate the need for truly global borderless entities that coordinate agency relationships and limit liabilities via smart contracts. Given the global nature of commerce through internet-based platform businesses and borderless payment systems, among many others, the global promise of the concept of a DAO as a business vehicle is only truly fulfilled if DAOs can be set up via the internet and are jurisdictionally recognized. I address this problem in my recent article, "Decentralized Autonomous Organizations – Internal Governance and External Legal Design."

DAOs have the potential to upgrade business and society on multiple levels. The business applications of DAOs are near limitless. For example, most of the applications and uses of digital currencies are improved and expanded with well-functioning and well-governed DAOs. DAOs help upgrade digital assets across the spectrum of applications and uses. This includes digital assets that can be used as mediums of exchange, speculation, payment rail for non-expensive cross-borders money transfer, and non-monetary uses such as time stamping. Additional use cases of DAOs include financial transactions, secure voting, autonomous organizations, company management, freedom of speech networks, online games, crowdfunding, and speculation, among many other possible applications that cannot be foreseen at the time of publication of this article.

DAOs are organizations that run through rules encoded in smart contracts. DAO smart contracts are executed when the conditions embedded in them are recognized as math by the network. DAOs can be built on any smart contracting platform. In the 2020s, was still the leading smart contracting platform for DAO creation. Ethereum’s programming language, Solidity, enables the development of smart contracts in conjunction with Ethereum’s Virtual Machine (EVM), upon which every Ethereum node runs to maintain consensus. EVM is Turing-complete, meaning that it can perform calculations that any other programmable computer is capable of, enabling execution of code exactly as intended. This is the unique feature of the Ethereum network that enables smart contracts and a high level of flexibility in digital innovation, which makes the platform attractive to developers. Other networks are developing upgrades to blockchains that enhance smart contracting and associated DAO features.

A core problem in the evolution of DAOs is the applicable legal framework. The concept of a DAO fails if it becomes centralized. Tying the legal existence of a DAO to any form of existing legal and jurisdictional frameworks typically results in the need for a representative in the chosen legal framework and jurisdiction, which, in turn, centralizes the DAO and results in the failure of the DAO concept. From the perspective of regulatory competition, one jurisdiction may at some point offer a DAO legal framework that removes the need for a representative in that jurisdiction. However, even if this should exist one day, a significant risk remains that such DAO entity could be labeled a partnership with joint and several liability for its members in a given jurisdiction.

Only a jurisdiction that gives the DAO limited liability as an entity and accepts its independent status without the need for representation may truly be favorable for DAO concepts. Such jurisdiction would have to accept that the DAO is a virtual organization based on code that is accessible from any computer with an internet connection and cannot be jurisdictionally captured. The implication is that such DAO on each computer in any country is effective if another computer in a given country connects with and interacts with the code.

DAO structures are evolving in lockstep with applicable legal solutions. On the operational side, overcoming bugs that lead to security flaws is a crucial part of the DAO technology evolution. On the legal side, experimentation with different legal arrangements in disparate jurisdictions helps DAO communities innovate for the creation of consumer-facing applications in different settings around the globe.

My article examines the existing attempts to establish DAO concepts and legal frameworks. I evaluate the technical solutions and internal governance solutions promulgated by DAO projects. Particular emphasis is placed on the duality and feedback effects between internal DAO governance and external legal design. The article concludes with an examination of legal DAO frameworks and their existing limitations and potential for future development.

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