Posted: 09/03/2023
The decentralised autonomous organisation (DAO) is a relatively new form of organisational structure, which offers an alternative to traditional corporate structures. This article provides an overview of DAOs and consider whether they really are the future of corporates.
A DAO is a digitally native organisation that allows its members to govern themselves through smart contracts coded onto a public blockchain.
The critical difference between a DAO and a limited company is its horizontal structure, where there is little formal hierarchy and no bosses (ie no managers, executives etc). Every member of a DAO is at the same time a co-owner, co-manager, and potential co-worker. The membership governs a DAO as a mini democracy where everyone’s vote counts. Members collectively decide on every matter and rules are executed according to the nexus of smart contracts that constitute the DAO.
While DAOs will not be replacing the majority of traditional corporate structures in the short term, they can serve to operate more like general partnerships, unincorporated associations or cooperatives and may be an attractive solution for project work, limited investment structures and charitable collections. However, as outlined below, DAOs are not without their problems.
Each DAO is generally framed by a particular purpose, which can be far ranging. Individuals can become a member of a DAO by acquiring a token. That token gives that individual the right to vote on initiatives and decisions of that DAO. Membership is also entirely anonymised through the blockchain.
Some examples of DAOs are:
To properly understand how DAOs work in practice, we must first look at how they are formed.
A DAO is formed through the creation of a smart contract on the blockchain. Put simply, a smart contract is a set of terms and conditions (or rules), written into code that exists on a blockchain. Once the terms of the smart contract are met, it will automatically self-execute.
Blockchain as a distributed ledger technology provides a coordination mechanism for distributed governance. By providing a shared record of history to geographically dispersed participants, blockchain technology enables the possibility to create new economies, markets, and governance institutions. The rules of blockchain-based governance are scripts, embedded in the software code of the protocol itself. The innovation of public, decentralised blockchains is that these rules leverage digital assets (known as cryptocurrency) to align incentives and behaviour as a coordination system.
A real-world example of a smart contract can be found in e-commerce, where a buyer makes a payment for goods directly into the smart contract. The smart contract tracks the delivery of the goods and on confirmation of delivery automatically releases the payment to the seller.
So how are smart contracts relevant to DAOs? A DAO is essentially an organisation, which is built upon an interconnected web of smart contracts. These contracts simplify and automate all of its processes and decisions. Once the smart contracts of a DAO are set up, the rules governing DAOs can then only be changed by member consensus.
As we have explained above, unlike traditional corporate structures, DAOs are non-hierarchical (ie decentralised). They have no governance structure and instead have a network of stakeholders who make decisions as a collective. In essence, they work more like general partnerships or collective investment schemes.
Also, there are differences in terms of how voting is operated. Traditional corporates generally operate on a ‘one share, one vote’ basis, which is all conducted manually. DAOs conduct voting without the need for any trusted intermediary. Control is not necessarily on a ‘one token, one vote’ basis. Some DAOs distribute power to its members in accordance with community contribution and engagement.
Other differences are in terms of finances, with traditional corporates requiring human handling of monies, which can be subject to manipulation. DAOs handle funds on an automatic basis, without any risk of human malfeasance (unless the coding has been manipulated before it is published onto the blockchain).
Finally, activity conducted by DAOs is fully transparent and public (much like a listed company, save that the public blockchain is accessible to all to review 24/7). Activity of traditional organisations is typically private, with limited information needing to be disclosed to the public.
While DAOs offer many advantages to corporate structures, like many blockchain solutions, they should still be treated with caution and legal advice ought to be obtained before it is decided which form of corporate structure ought to be created.
A primary issue is that they are not yet considered a legal entity. This means they are precluded from doing a number of things, such as opening a bank account, entering into contracts with third parties, holding non-blockchain assets and limiting liability of its members. This limits them to the digital world only.
Another is security. The nature of the blockchain means that all of its source code is public information and can be accessed by anyone. Hackers can therefore exploit any vulnerabilities there may be in the underlying code of a DAO. An example of this would be an investment DAO called ‘The D.A.O.’, which was hacked in 2016. The hacker managed to siphon off more than $50 million of digital money from The D.A.O. As security issues cannot be remedied without a vote, DAOs are not very reactive which can leave them exposed.
Other issues revolve around:
‘Metaverse’ has become a buzz word amongst businesses in recent years, with companies deploying extraordinary amounts of time and resources to develop the technology in this sector.
A metaverse is a virtual world where you can socialise, play games or even buy virtual land. There are two main types of metaverse: (1) centralised and (2) decentralised. Why is this relevant for DAOs?
For (1), these metaverses are governed by a single entity. This entity will set the policies that regulate the virtual world. Users’ freedom is restricted, and they cannot own any of the digital environment. A key example of this is the game Fortnite and it is the basis on which Meta (Facebook) is creating its metaverse.
However, for (2), these metaverses operate through a DAO, each with their own fully autonomous virtual economy controlled by its users. These metaverses initially start out as investment and creator DAOs, which fund and construct the virtual world. But, unlike for centralised metaverses, governance and control are operated by the users, meaning they can set the rules, control assets and engage in transactions. Real world examples of this would be Decentraland or The Sandbox.
In a nutshell, not yet. But as we move closer to everyday business being operated in virtual worlds, DAOs will certainly become more prominent and more readily used.
With certain organisations, such as investment cooperatives, they definitely offer an attractive option for investors and could provide much needed competition to venture capital firms. However, the limitations of DAOs for traditional businesses will mean that the traditional corporate structures will likely be the blueprint for many years to come.
© 2024 Penningtons Manches Cooper LLP.
All rights reserved.
Website design by Frontmedia / Dynamic Pear
Penningtons Manches Cooper LLP is a limited liability partnership registered in England and Wales with registered number OC311575 and is authorised and regulated by the Solicitors Regulation Authority under number 419867.
Return to news headlines 