Decentralized Autonomous Organizations (DAOs) are smart contracts with pre-defined terms and actions which are triggered as per the situation. All transactions and rules/ terms are encoded in the blockchain, thus removing the need for a central authority. This was the technical aspect of DAO but in simple terms, it is a pool of money created by crypto or issuing tokens to the members of DAO and decisions taken by the members on what to do with the pool of money by casting votes. The greater number of tokens a person has the more their votes will be. This is a new form of organization or company which will be seen in the future, but this kind of organization differs from traditional companies, LLP, proprietorship or Partnership, etc. As it is based on smart contracts which run on blockchains, DAOs are unregulated as of now. Till the time cryptocurrencies are not legalized properly and given a particular status as an asset or commodity or currency whichever it may be, regulating DAOs will be a tough task for government bodies.
THE FIRST DAO AND ITS INTERESTING HISTORY
The first DAO was introduced in the year 2016 on the Ethereum blockchain. The DAO was an unexpected genius that accumulated 12.7 million ETH (roughly 150 million Dollars) at that point in time. In a DAO anyone is allowed to pitch an idea or project or suggestion which is then voted on and a decision is taken based on votes in favour or against it, there may be a bar for pitching projects in some cases, (example – minimum 2000 tokens required to pitch an idea or project).
The success was short-lived as it was the first DAO, it was not properly written and hackers found bugs/loopholes to exploit and siphon millions of dollars worth of ETH. Now there were only two options left, First, developers could reboot the DAO before the money was siphoned and reverse the theft, or second, not to tamper with the smart contract and the blockchain and let that be. The only problem here was that choosing the first option would mean defeating the purpose of the smart contract being immutable and the solid structure of blockchain being irreversible.
This problem led to a split in the system creating a fork and the creation of a new blockchain network that would reverse the transaction to the previous day and fetch the money back to its owners. Today as we know it as Ethereum and the original/ older version is known as Ethereum classic.
LEGAL ASPECT OF DAOs
As it is an uncharted area for the law there will be many new pathways for both technology and law. Starting with the most basic and essential, company law – company law would be the foremost applicable law as the name suggest ‘organization’ needs to be defined under company law. Currently, the state of Wyoming has given the option of DAOs being registered as LLCs. The major benefit of being registered would be obtaining the legal status and protection as a legal entity that comes with it. Traditional companies need to procure documents like MOA, and AOA and go through the process of registration and getting a TIN no. but with DAO everything will be there in the code/ smart contract itself. A well-written DAO would consist of the purpose of DAO, decisions of DAO, prospects, voting rights, and dispute situations, etc., it would cover every aspect of what a company should be doing, and the difference left would be the hierarchy of a traditional company in comparison to vote based decision of the company (In a traditional company the top management decides the vision & mission of the company and the middle and lower follow but in DAO the decision would be in the hands of the token holders only and they would decide what is going to be the path for the organization).
Legal problems will start to arise not for DAOs but for the purpose for which the DAO is being created or using the funds. If the funds are being used for an unregulated area like NFT’s, which in itself is a grey area in law then there might be fewer legal obstacles but as soon as the funds are being used for regulated areas like buying real estate or stocks, many government entities would cause hindrances to the organization. Taxation on lands or stocks, the legal status of the company to be able to buy land or stocks, the credibility of the organization, etc. would all come into question. The problem will lie in compliance with the regulatory bodies and existing statutes as the DAO would be required to comply with RBI Act, 1934, Securities contract Act, 1956, SEBI guidelines, Companies Act, 2013, etc. There is a certain upside also.
The benefits would include –
- There is no central legal entity
- self-enforcing contracts (smart contracts)
- Tokenisation which will act as an incentive for the holders.
- Could attain legal status if they want as an LLC.
Another big concern that arises is the liability. If DAOs are registered as LLCs (Limited Liability companies) then it would ease the pressure on the members. If the DAOs are not registered then that would mean unlimited liability for the token holders or members. Let’s say the organization currently has assets of 120 million dollars but has incurred a debt of 150 million dollars, then the remaining 30 million would be collected from the members being their personal liability. This scenario can create a hindrance as it would mean the organization may refrain from heading into riskier and innovative projects which may be beneficial to members in the long run. Secondly, liability on DAOs if the money is used for illegal or illicit activity, then the question arises as to who all shall be liable for the activity, would all members of an organization be liable? Or only those who voted in favor of that idea or the members holding majority stakes? These kinds of questions will be answered as legal advancements also take place and precedents are made by courts.
There is no doubt that DAOs will be the future of companies and will open the door for many new opportunities for investors and businesses but Indian laws are in dire need to be reformed and restructured according to emerging technologies as outdated laws will only provide loopholes and law evasion. “They have a flat hierarchy in the true sense. And since smart contracts are self-executing, it eliminates human malaise to a great extent and enables the democratization of the corporation”, this would encourage more and more organizations to focus on different areas of the world. As of now Bulgaria, Wyoming, Hong Kong, Switzerland, and Cayman Island are the ones with some sort of governance & policy relating to DAOs and we can hope to see the same initiative from Indian policymakers to boost and encourage these kinds of advancements.
Author(s) Name: Rishabh Sharma (Centre for Legal Studies, GIBS, IP University)