Are DAOs a flash in the pan or a serious alternative corporate structure?
“What has been will be again, what has been done will be done again; there is nothing new under the sun.” “Nothing new under the sun” has become a cliché, but did you know it comes from the Book of Ecclesiastes in the Bible? It’s a truism worth remembering in this age of rapid technological change and advancement. How much of what is called “radical change” is really innovative, and how much is just a different way of doing things we have done in the past? The decentralised autonomous organisation – or DAO – is a new type of organisational structure. However, on closer inspection, it is really just an updated version of a cooperative organisation. What makes it different is the technology it leverages. You’ve probably not heard of DAOs (yet). But you will. What exactly is a DAO and why do you need to know about it?
What is a DAO?
A DAO is an organisational structure, in the cryptocurrency space, that is built with blockchain technology. It is – and is often described as – a crypto cooperative (or co-op for short). Members of a cooperative have equal voting rights and participate in decision-making processes. Cooperatives are usually formed to serve the interests of members and improve their economic wellbeing. Examples of co-ops in South Africa include the Mzansi Meat Cooperative Limited and the Thekwini Wire and Fastener Cooperative. KWV, one of the country’s leading wines and spirits producers, is now a public company but started life as a cooperative – the Ko-operatiewe Wijnbouwers Vereniging van Zuid-Afrika.
A DAO is a group formed for a common purpose and run by its members, like a co-op. This modern co-op is based on blockchain and smart contract technology, which allows decision-making and governance to be decentralised. Members no longer have to gather in a room to cast their votes; DAOs automate decision-making through code and protocols. Although in theory a DAO could be formed for any purpose, to date DAOs have been linked with cryptocurrency and associated activities. DAOs have been established to invest in start-ups (usually tech-related), manage a stablecoin or buy non-fungible tokens (NFTs). Once formed, a DAO is run by its members, usually via crypto tokens which come with certain rights attached, such as the right to vote on certain decisions. For example, ConstitutionDAO was a group of thousands of crypto fans who raised more than $45 million in one week to bid on a rare copy of the US Constitution that was being auctioned by Sotheby’s. Unfortunately, not only did the DAO lose out at the auction, it disbanded and chaos ensued when it tried to return the money to investors. Other DAOs have been more successful, but ConstitutionDAO is the best known, probably because of its notoriety.
Both the traditional co-op and modern DAO share the fundamental principle of putting control and decision-making power into the hands of the members involved. Let’s look at some of the benefits and drawbacks of DAOs, and the legal challenges they pose.
Benefits of a DAO
DAOs are in their infancy as a business structure and are largely unproven. Critics liken them to barely disguised pyramid schemes, a fraudulent investment in which investors are promised big profits in exchange for recruiting new participants into the scheme. However, proponents of DAOs are confident that successful examples will emerge in the next few years, and they point to a number of features that make DAOs superior to traditional commercial organisations:
- DAOs are more transparent than traditional organisations, because decisions are made and recorded on the blockchain, which is a permanent ledger
- DAOs are fully democratic, because all participants have the right to vote; voting rights are not limited to boards or excos
- DAOs are agile and can be set up and wound down quickly, making them useful for specific projects
Drawbacks of a DAO
Any innovation is bound to have teething problems. Undoubtedly, they will be resolved eventually, but at this stage there are some concerns about DAOs. Transaction fees are quite high. The ill-fated ConstitutionDAO, mentioned above, paid $1.2 million in fees to the Ethereum network. A crowdfunding platform like Kickstarter might have been just as effective and a lot cheaper for members.
So far, DAOs have been used almost exclusively to allocate cryptocurrency to crypto-related projects. This makes their relevance to a wider set of business applications questionable. And the concept of a decentralised organisation may have a certain anarchic appeal, but it is in fact difficult to govern in the absence of leadership. The first DAO, called simply “The DAO”, floundered because it became paralysed by democracy. Anyone in the community could change the code, if the community agreed. Voting power was determined by the size of a voter’s investment. Ultimately, the community was unable to agree on the project’s direction.
Lastly, there are regulatory and legal ambiguities. If the tokens issued by DAOs are classed as securities, DAOs will have to register with the Securities and Exchange Commission (in the US). There are also concerns that some DAOs are simply fronts for fraud. Let’s look more closely at the legal challenges.
DAOs have no clear means to hold someone responsible when legal disputes or fraudulent activities occur. It may be difficult to identify responsible parties and allocate liability. If assets are lost, determining accountability may be problematic. DAOs operate using smart contracts, built on the blockchain. However, the enforceability of these contracts is still unclear globally. If disputes arise, traditional legal systems may struggle to interpret and enforce these contracts, especially when multiple jurisdictions are involved.
As with all cryptocurrency, financial crime is a worry. DAOs are decentralised and investors are anonymous. DAOs are not registered in any one jurisdiction, so enforcing anti-money laundering, prevention of terrorism, and “know your customer” legislation or protocols is a major challenge.
DAOs operate globally, and tax laws differ across jurisdictions. The lack of harmonised tax laws and the global nature of blockchain technology will inevitably give rise to jurisdictional issues, and tax authorities may struggle to apply existing tax regulations to DAOs. Significant adaptations are likely to be required to address the unique nature of decentralised organisations. Clarity is needed to ensure proper compliance with taxation regulations while avoiding double taxation or undue tax burdens on DAOs and their members.
The future is…?
DAOs offer exciting opportunities for innovation. However, the legal challenges cannot be ignored. Addressing and overcoming them will require a proactive approach from regulators, legal experts and DAO members in order to develop appropriate frameworks that strike a balance between encouraging innovation and operating within the laws of multiple jurisdictions – a tall order.
The nature – indeed definition – of a DAO is decentralisation. Nevertheless, human beings do not live in a virtual environment; they live in nations. So far, no single nation-state is dominant in term of DAO establishment. But popular jurisdictions include Switzerland, Singapore, the Cayman Islands, and the US, particularly the state of Delaware, which has uniquely business-friendly laws. To our knowledge, at this time no DAO has been established by South Africans in South Africa, but we are always willing to be corrected.
For more information
At SD Law, we’re keeping on top of developments in cryptocurrency, decentralised finance (DeFi) and DAOs. When you’re ready to ask questions, we’ll be ready with answers. If you want to know more about DAOs, DeFi or cryptocurrency, contact us. We are a firm of experienced attorneys based in Cape Town, with offices in Johannesburg and Durban. Call Simon on 086 099 5146 or email email@example.com.
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