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Decentralized Autonomous Organization

All that you need to know about the Decentralized Autonomous Organization

May 12, 2022

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This article is written by Mili Kanoujiya pursuing a Diploma in International Business Law. This article has been edited by Ruchika Mohapatra (Associate, Lawsikho).

This article has been published by Sneha Mahawar.

Introduction

DAOs have swept the crypto world; communities are joining together to monetize their efforts while also defining the trajectory of web 3.0. DAOs are a new type of organization that is becoming increasingly popular in the Ethereum blockchain environment. The concept of a decentralized system has made its way into a wide range of fields and domains, ranging from investments to administration. DAOs combine principles from organizational forms, coordinating, distribution channels, ledger, and smart contract innovation to enable a group to organize around a mission or objective and coordinate using smart contracts that are immutably and independently executed on the blockchain.

DAOs reflect a shift in how people collaborate with one another, as the organization is free of the influence and goals of a third-party middleman. As they swiftly evolve into a new form of organization, DAOs offer a distinct potential and risk. Anyone from any jurisdiction can join a DAO, take part in its activities, and be compensated for their efforts. The legal ramifications of a DAO’s actions in each country, however, are still up in the air, and governments have yet to decide whether to follow Wyoming’s lead or set their own rules for how DAOs can operate in their territories.

In this article, the author has tried to analyze the concept of DAO. The article explains the importance, types, advantages, and disadvantages of DAO. Further, the article also highlights the legal issues with this emerging technology and the challenges ahead.

What are DAOs

A Decentralized Autonomous Organisation (hereinafter referred to as DAO) is a non-centralized organization. The community is managed by a system of regulations maintained on a blockchain, and decisions are taken from the bottom up. These are cooperatively owned and governed by their members. They have built-in treasuries that may only be accessed with the members’ permission. Decisions are made by suggestions that the group votes on over a set period of time. It operates without the need for hierarchical supervision and can serve a variety of objectives. These groups can create freelancer connections where contracts combine their resources to pay for technology licenses, philanthropic organizations where members approve payments, and venture capital businesses run by a group.

Related terminologies

Token

A “token” is a term used to describe any cryptocurrency. Tokens can assist decentralized applications in a variety of ways, like automating interest rates and selling virtual real estate. They can, however, be owned or sold in the same way as any other cryptocurrency.

Blockchain

A blockchain is a decentralized database that is maintained among computer network elements. A blockchain acts as a database, storing data in a digitized version. Blockchains are well known for their critical role in keeping a secure and decentralized track of transactions in cryptocurrency systems like Bitcoin. The blockchain’s novelty is that it ensures the reliability and protection of a data record while also generating trust without the requirement for a trusted third party.

Smart Contract

Smart contracts are essentially programmes that run when certain criteria are satisfied and are maintained on a blockchain. They’re usually used to automate the performance of an agreement so that all parties can be assured of the conclusion right away, without the need for any intermediaries or time waste. They also can automate a process, starting the following step when certain circumstances are satisfied.

History of DAOs

The creation of Ethereum, the first blockchain platform to integrate smart contract logic, might be regarded as the beginning for the advent of decentralized autonomous organizations. Smart contracts have enabled the creation of autonomous systems that are managed by a computer rather than a person, removing the potential of data manipulation and eliminating the need for the human aspect. Launched in 2016, the DAO protocol was the first platform to embody the ideals of decentralized autonomous organization.

Importance of DAOs

The DAO’s developers planned to avoid human error and exploitation of investor funds by placing decision-making authority on the shoulders of a computerized method and a crowdsourcing procedure. The ether-based DAO was established to enable investors to transfer funds discreetly from anywhere on the planet. The DAO would then give those owners tokens, allowing them to vote on potential proposals.

Types of DAO membership

There are different models for DAO membership. Membership can determine how voting works and other key parts of the DAO.

Token-based membership

These tokens can primarily be traded for permissionless trade on a decentralized exchange. Members can obtain complete authority for all activities depending on the sort of token they have. Others, on the other hand, must provide financial contributions or other forms of assurance of reliability. In either case, simply owning a token grant you voting privileges. This is widely used to control large-scale decentralized approaches and tokens.

Share-based membership

Share-based membership is more limited but still relatively open. All interested members are welcome to join DAO and contribute useful contributions in the form of tasks or tokens. Members with shares have unrestricted ownership and voting rights. Members of the group are allowed to leave at any moment with their obtained profit share.

How does DAO work

A DAO’s smart contract serves as its spine. The contract establishes the organization’s norms and safeguards the funds of the group. No one can alter the law after the contract is active on Ethereum until a vote is taken. It will fail if someone attempts to do things that aren’t authorized by the code’s principles and rationale. Since the treasury is also established by the smart contract, no one can consume the funds without the agreement of the group. DAOs do not require a central authority as a result of this. Rather, the group takes decisions jointly, and transactions are automatically allowed when votes are passed.

To create and start a DAO, follow these three steps:

Creating the smart contract

The DAO’s developers create the smart contract(s) that will govern the group’s rules and determine its purpose. Since the code can only be altered through a group vote once the DAO is enabled, this step requires intensive testing.

Funding

DAOs rely on a shared cache of currency that must be generated from their members. Individuals who appreciate the group’s mission can buy into it hereby agreeing to invest a particular number of tokens in return for a stake. This is also the time to set governance norms.

Launch

Deployment of the DAO’s code onto the blockchain. From now on, it can only be amended by a majority vote of the stakeholders. The project is no longer under the authority of the founding programmers.

Since smart contracts are tamper-proof after they go online on Ethereum, this is achievable. As everything is open, you can’t unilaterally change the code (the DAOs rules) without others seeing.

Advantages of DAO

A decentralized governance system is often referred to as a DAO. Blockchain technology makes this system transparent. The management team is no longer required after the assistance of DAO is availed. By integrating consensus rules into the native token, blockchains and smart contracts cut administrative transactional costs while increasing transparency and harmonizing the interests of all stakeholders. Project organizers will be likely to save costs on pay rates as a consequence. Due to software technology, work is completed at a high rate. There is no requirement to wait for the official to handle the request and locate the relevant information for the action in DAO.

Due to the lack of the human aspect, there is a minimal probability of inaccuracies. Coming on the board of a DAO is simpler than joining on the panel of a regular corporation. Many perceive the transfer of management of the organization and its assets to the project participants as an advantage that assures that the DAO’s founders do not flee away with investor funds.

Holding a governance token in a DAO is similar to owning stock in a fledgling company – if it succeeds later, that stock will be incredibly valuable. Members of the DAO who also own tokens are given a predetermined percentage of the exchange’s trading volumes. This contributes to the development of a more reliable token user community with a long-term investment mindset.

Disadvantages of DAO

The ambiguity that limits the use of decentralized autonomous groups is one of their key disadvantages. The difficulty is exacerbated by the fact that it will be impossible to maintain access to the system once it has been established in a private or public entity.

Another issue is the ecosystem’s debatable efficiency. On the one hand, if we’re talking about large-scale changes to the DAO, they outperform a massive bureaucratic structure that necessitates significant time and financial inputs. A decentralized strategy, on the other hand, can be not only ineffective but even harmful to the system in the case of minor modifications. Experts believe that a hybrid management style will be the most successful.

Part centralization does have its drawbacks. The protocol’s developers pre-set the original rules in the code, and they can’t usually be modified. However, if the contract allows for the modification of the original rules at the outset, the problem can be handled. Although the blockchain’s enormous potential for system management, it comes with a slew of security problems.

Wyoming law on DAO

The “Wyoming Decentralized Autonomous Organization Supplement” was just passed in Wyoming, the US state. The new legislation is a supplement to Wyoming’s existing Limited Liability Company Act. This is a one-of-a-kind statute that declares DAOs to be limited-liability corporations (LLC). In the past, it has also been claimed that treating DAOs as limited liability businesses had merit. The LLC structure identifies the DAO members’ primary concern of personal accountability for the DAO’s conduct.

Legal Issues

The majority of legal frameworks around the world are mute on how DAOs should be treated. Due to this ambiguity, their rights and obligations, as well as their capacity to sue and be sued, their ability to engage into contracts, and the rights and obligations of individuals associated with the operation and growth of DAOs, are all unclear. A couple of these are discussed further down.

Jurisdiction

DAOs are entities that span many jurisdictions. They do not have a country of incorporation, a seat of governance, or a major office, unlike corporations. The jurisdiction that applies to entities under present legal systems is mainly dependent on the location of the organization’s incorporation or the location of the organization’s important managerial decisions.

Liability

The most pressing concern in a DAO is who would be sued and who would be held accountable for DAO acts. To incorporate any of the fresh concepts or approaches into the traditional structure, the government would have to classify them as one of the current categories of businesses. The most common structure for DAOs is a general partnership (and not a limited liability partnership or LLP). If DAO is treated or recognised as a general partnership, it will be disastrous for DAO’s partners, as general partnerships allow for unlimited liability. Any liability originating from the business and the conduct or omissions of the other partners is shared equally by the partners. This implies that each participant of a DAO is accountable for the actions of all other participants and that even the partners’ personal finances would be used to settle the DAO’s debts.

Challenges ahead

Despite the fact that DAOs are based on the idea of community and social participation, there will come a moment when there are more speculators and investors than contributors. To counter this, a focus on the key contributors and developing value within this tiny fraction should be prioritized in order to lead the path forward.

The majority of decentralized autonomous organizations (DAOs) are not organized around the concept of one vote per member. It’s usually determined by how many tokens a person has. Although it may be argued that this is undemocratic because larger influencers have more clout than smaller ones, these difficulties could be addressed by imposing restrictions. It’s also worth noting that not every DAO works in the same way. There is little legal knowledge regarding what ought to be enforced in terms of laws and legislation. Additionally, state recognition is a subject that requires further investigation. It is very early in the history of DAOs, and given that it is such a unique concept, it is difficult to predict what the future holds.

There are questions that lawmakers all across the world must address in this matter as well. Legislators must consider the prospects of DAOs and create a legislative framework that allows them to operate in accordance with the law. A framework that should account for a DAO’s members’ liabilities, the jurisdiction for managing and controlling DAOs, and a defined taxation system for a DAO’s activity. Legislators must keep in mind that the company, which now appears to be a fairly basic group of people, is actually a legal fiction.

Conclusion

DAOs have ushered in a new era of business structure. Corporations have been constrained to some extent by their jurisdiction and corporate governance standards up to now. DAOs aspire to be the world’s first genuinely global and decentralized organization. In the actual sense, they have a flat hierarchy. Smart contracts are also self-executing, which eliminates much of the human angst and allows for corporate democratization. A decentralized autonomous organization (DAO) can make it exceedingly simple to share resources worldwide and interact without undermining trust.

References

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