Serious questions for DAO founders

Rage Review : This is an article that needs to be taken seriously. It delves into multiple issues that need to be addressed in Distributed Autonomous Organizations (DAOs). Most people don't quite understand the concept of DAO, but perhaps in ten years a considerable number of organizations and companies will be transformed into DAOs. If such a scenario is really realized, it means that it must be able to fit within the framework of our current laws and regulations. This article explores many possible scenarios and the problems that will be faced in the future. Perhaps, DAO is the biggest change to the human organizational framework since the invention of the limited liability company.

Translation: Annie Xu

Piers R is an early Ethereum adopter, blockchain enthusiast and co-founder of the startup BXD.io.

In it, he responded to comments from Washington lawyer Stephen D Palley and listed some legal issues that creators of distributed autonomous organizations should consider.

The Ethereum-based Distributed Autonomous Organization (DAO) is a blockchain organization that operates according to preset rules. Its members work together to maintain these rules and use them to make group decisions.

A DAO is formed for a common goal and it transfers funds (usually in the form of digital currency or other tokens) to control the planning of DAO activities to achieve its goals.

From a practical perspective, the lack of a legal identity makes it particularly difficult to own physical assets, sign contracts with non-blockchain technology companies (real-world suppliers, contractors, etc.), and deal with tax issues.

For example, at least the following questions are still unclear:

1. Whether DAO members can apply for expense reimbursement;

2. If the DAO purchases physical assets, what name should be used on the relevant documents;

3. If the DAO applies for intellectual property, who is the registered owner;

4. Since domain names need to be registered with personal or company names, how can DAO obtain domain names?

5. If the DAO or its members make a profit, how will the tax be handled?

6. When signing a traditional contract, who will testify for the DAO and how to prove its legitimacy.

Since there is no corresponding activity plan for the realization of DAO goals, it is natural to expect service providers to fill the reality gap (for example, providing one-time hardware design services).

If there is any central point to the purpose of the DAO (e.g. ownership of IP in the case of design fees), you would really want the DAO to have more smart contracts; especially if the DAO can actually be separated from the service provider (e.g. you don't want the DAO's assets to be held by the service provider after the separation).

What is more worrying is whether the decisions or actions made by DAO, which has no legal identity, should result in corresponding losses; the most desirable legal option is to sue all shareholders and let all individuals involved in the decision-making bear the consequences of the decision together.

In the UK and in ordinary judicial interpretation, this practice is called "joint liability", which means that you can choose to sue everyone; even if you can identify a single plaintiff, you can also choose to sue as a group.

It was then up to the DAO members to find the party responsible.

Scenarios where the above applies

For example, if a DAO conducts a plan or activity that causes one or more members to suffer losses.

Here’s a simple example, peer-to-peer insurance: DAOs should be thought of as joint insurance organizations.

After collecting the insurance premium, the DAO can hire a service agency to assist in investigating the claim. A DAO member attempted to make a claim, but was rejected by other members. The claimant believed that the rejection was unfounded. The DAO can choose not to pay the service agency if DAO members believe that their work is not up to standard.

Who should the claimant sue, and who should the service provider sue?

Even if a DAO’s bylaws are perfect, if they don’t adapt to changing local laws (such as consumer protection legislation, rules for the sale of goods and services), it doesn’t matter how perfect the DAO definition is or what waivers people sign, the DAO will still be sued.

Different corporate structures

The limited liability company (LLC) was created to solve these problems. It gives a group of individuals a legal identity that they can use to enter into contracts and be legally responsible; however, this form limits the liability of individuals to the amount of their investment.

There are many forms of limited liability companies in the UK, this article only lists a few:

1. A limited liability company (LBS);

2. A company limited by guarantee (LBG);

Generally, a company limited by shares is established with the express purpose of making profits for shareholders. This is the most common type, and the total amount of company assets that can be obtained is the total investment of shareholders (after calculating net assets).

The organizational structure of a DAO with a purely profit-oriented purpose can be as follows:

DAO members are shareholders and need to purchase DAO’s shares (as company founding capital) when it issues shares or is established.

If members want to join the DAO later, they need to buy shares at the market price, whether from existing shareholders or by increasing capital. As the market value of the DAO increases, the value of the stock will naturally increase (provided that the dilution of the stock price is less than the increase in value).

Shareholders appoint the chairman of the board, and generally speaking, the person with the most shares is entitled to make the appointment.

The main flaw of the DAO corporation form is that control of the DAO can easily change hands simply by purchasing the largest number of shares.

This possibility puts all of The DAO’s blockchain-based assets under the control of the company’s majority shareholder, despite the DAO’s rules’ best efforts to prevent centralization.

Company Limited by Guarantee

LBG is not explicitly for-profit in nature and currently is mostly in the form of community organizations or social enterprises.

Unlike buying shares and waiting for a return, LBGs are subject to member guarantees.

Therefore, if the company fails, members are only liable for their guaranteed share. Usually, this amount is fixed.

This format is attractive to DAOs.

This form of enterprise is not for profit, but for the execution of a certain goal. No one can purchase control over corporate decision-making, but any new member of the DAO can become a member of the LBG and have a say in both institutions.

This form separates legal control of the enterprise from ownership profits.

For example, a DAO could be structured as a LBG, which could then issue and sell tokens to members as a means of profit (much like the crypto shares that startups like Slock.it plan to issue).

Such a DAO is a for-profit organization, and most ownership-type attacks cannot undermine this purpose.

In a for-profit DAO, the size of the membership or LBG voting rights and the number of DAO shares are all tied to the initial investors. However, even if these shares are resold, it will not bring additional value to the DAO.

Some DAOs therefore impose a payback period on ownership to reduce the incentive for speculative and malicious third parties to purchase shares and control the DAO, as well as to protect the institution's purpose and long-term members.

DAO construction and relationship determination

To obtain the LBG structure and give the DAO legal identity, you can consider the following additional clauses and amendments to the standard Articles of Association (AoA).

In the event of liquidation or winding up, members can jointly obtain the guarantee funds in advance, which are stored in independent blockchain-based wallets and can only be transferred to LBG’s bank account.

When a member joins, this asset exists in the form of one pound, and once the membership is terminated, the funds can be regained (for example, when leaving the DAO).

That is, if LBG needed to be liquidated, all members would be obliged to pay the guaranteed amount (although enforcement would also be necessary if the value of the raised funds fell below a multiple of £1 of the value of all members).

LBG membership and voting rights need to be directly tied to DAO membership, potentially including a minimum DAO membership period (to prevent fake DAO members from controlling the LBG).

That is, to become a LBG member, one needs to be a member or owner of the DAO for at least one year. The chairman of the committee cannot directly appoint another chairman, but should be elected by the committee or at least 5% of the members.

This recommended chairperson would then need to go through a confirmation vote by the DAO. Any positive vote would have issues with scale (e.g. 5% of 1 million members vs. 50,000 votes). Instead, I recommend forgoing negative votes: after at least 10 business days, the candidate chairperson is automatically confirmed unless 5% or more of the members vote against the appointment.

There needs to be an upper limit on the number of chairpersons (the recommended number is 9) to prevent too many people from exercising power on behalf of the LBG. The reason for the even number is to prevent the chairpersons from getting stuck in decision-making disagreements.

The chairman’s personal ability to discipline the company must also be limited. Any action, divestment, or asset purchase decision worth 10% of DAO+LBG assets requires a committee vote and the signatures of at least two chairmen.

The Chair is elected based on his or her relevant skills and experience for a maximum term of four years, with appointments staggered to prevent the easy replacement of the entire committee.

The above structure may seem complex and bureaucratic. It is important to note that most of the liquid assets and work of DAO+LBG should be managed and controlled by the DAO (such as smart contracts and digital currencies).

The DAO does not need to follow any rules for handling assets, except its own internal logic and rules. Only when the DAO enters into contracts, purchases and sales in reality (service providers should not be involved), the LBG and its chairman need to exercise power on behalf of the DAO.