Decentralised autonomous organisations

By Andrew Godwin

Previous columns have discussed the impact of technology on law and regulation. For example, one column discussed financial technology, or fintech, and the concept of smart contracts (China Business Law Journal volume 7, issue 8: Fintech and smart contracts). Another discussed cryptocurrencies and the use of distributed ledger technology (China Business Law Journal volume 8, issue 9: Cryptocurrencies). A third discussed artificial intelligence and machine learning in the context of regulatory technology, or regtech, and corporate disclosure (China Business Law Journal volume 10, issue 7: Regtech and corporate disclosure).

This column continues the theme of technology and the law by examining an emerging form of business organisation called decentralised autonomous organisations. In English, these organisations are often referred to by the acronym DAO, which is the pinyin for the Chinese character dao [道], which means the “path” or the “way”, and represents the philosophy of Daoism [道教].

An interesting coincidence can be suggested between this new form of business organisation and the derivation of the character dao [道]. The character dao [道] is a combination of two elements: the character shou [首], which means “head” and the Chinese radical for foot [辶]. Together these elements symbolise the notion that the head and the feet are advancing along the same path.

Lexicon-CBLJ2110-2Similarly, decentralised autonomous organisations can be described as the combination of artificial intelligence, which takes the place of human intelligence (in human heads), and blockchain technology, which records the pathway of transactions and interactions between different parties. Of course, time will tell whether decentralised autonomous organisations end up being the “way” or the “path” for business organisations of the future.

The column commences with a discussion of how decentralised autonomous organisations work. It then introduces a new book on technology and corporate law.

How do DAOs work?

Put simply, DAOs are organisations that are governed by artificial intelligence in the form of smart contracts, and which use blockchain technology to record transactions and interactions with and between their members and third parties.

Under a smart contract, the terms of a transaction are encoded as part of a computer program or algorithm, and are self-executing. In other words, the transactions are executed automatically without the need for human judgment or action. An early example of a smart contract is a vending machine that dispenses drink products. With a vending machine, the terms of a written contract for the purchase of a drink product between the customer and the vendor are replaced by an automatic process. Under this process, the customer’s act of inserting coins and selecting a particular drink product is converted into a product that is delivered to the customer by the vending machine dropping the drink product into the bottom compartment.

The blockchain is a type of distributed ledger technology, under which a chain of transactions is recorded on a ledger that is distributed across a network of computer systems. Because all of the parties have access to a single database (or ledger), and because the data are held by (or distributed to) each party, the accuracy and the security of the transaction data can be guaranteed. All the transactions on the ledger form a chain of blocks, and a new block is added to the chain each time a new transaction is verified. An important application of blockchain technology is the creation of “cryptocurrencies” such as Bitcoin.

DAOs are described as “decentralised” because they remove the need for centralised governance by humans in the form of boards of directors and managers. Accordingly, trust in humans is replaced with trust in technology. They are described as “autonomous” because they operate in accordance with rules that are encoded in smart contracts, rather than in accordance with articles of association, shareholders agreements and written law. To a large extent, the “rule of code” replaces the “rule of law”.

Two questions that are currently being debated in many jurisdictions is how DAOs should be characterised from a legal perspective, and how they should be regulated by the written law. These are important questions as the emergence of DAOs has created several challenges.

One challenge arises out of the fact that a DAO is decentralised, and is therefore unlikely to have a board of directors or human managers. The challenge is how to ensure that the members can exercise appropriate governance over the DAO in areas such as the operation of the DAO, or the way in which its resources are distributed. If decisions are made through a process of voting by members (known as participatory DAOs), how should this process be designed to enable members to participate in a meaningful way? On the other hand, if decisions are made not by members but entirely by algorithms (known as algorithmic DAOs), what should happen if unforeseen circumstances arise that require a revision to the smart contract code?

A second challenge relates to the question of the legal status of a DAO, and who is liable for its acts or omissions. With the traditional form of a company, the shareholders have the benefit of limited liability and are not liable to the creditors of the company except in a very narrow range of circumstances (for a discussion about limited liability, see China Business Law Journal volume 3, issue 9: Company or enterprise?).

A third challenge relates to the nature of the interest that members have in the DAO. The interests of members are often represented by tokens that are issued in initial coin offerings (for a discussion of initial coin offerings, see China Business Law Journal volume 8, issue 9: Cryptocurrencies). Are the interests of members proprietary in nature? Are the interests analogous to a share in a company or to some other interest such as a unit in a managed investment fund? If so, should the interests be regulated in the same way, and should the holders be able to deal with the interests in the same way?

Technology and Corporate Law – How Innovation Shapes Corporate Activity

In the US, some states have taken steps to adapt the conventional regulatory framework to DAOs. For example, on 1 July 2021, Wyoming became the first state to recognise DAOs as a form of limited liability company, and to confer legal company status on DAOs.

Many of the above-mentioned legal and regulatory challenges are discussed in a new book called Technology and Corporate Law – How Innovation Shapes Corporate Activity, which was published by Edward Elgar Publishing in August 2021. I co-edited this book with Pey Woan Lee and Rosemary Teele Langford. It contains chapters written by legal experts on the interaction of innovation, technology and corporate law.

A broad range of areas are covered, including new corporate forms, the impact of artificial intelligence on corporate governance, novel fundraising activities, and regulatory challenges in areas such as corporate disclosure and decentralised autonomous business networks.

In his Foreword to the book, Justice Andrew Phang of the Supreme Court of Singapore, noted the following:

The authors not only deal with the impact of technology on law but also raise questions as to the ultimate role of technology (here, in the corporate context). A recurrent theme of the first importance centres on whether technology will become the ‘master’ or whether it will be the ‘servant’ of the law – or whether technology and the law will, instead, form part of a complementary and interactive enterprise. Whilst, for example, there is no doubt that technology contains enormous promise in, for example, facilitating risk management, the fulfilment of corporate disclosure requirements and corporate fundraising (in this last-mentioned regard, both generally as well as more specifically in relation to Initial Coin Offerings) as well as facilitating greater transparency and shareholder empowerment, various questions arise vis-à-vis the ultimate role that technology will play in the longer term. These include the question whether boards of directors as we have hitherto known them will ultimately be replaced, whether the balance of power between the board of directors and shareholders as a collective group will be altered (and if so, how), and whether (and if so, how) technology will transform corporate disclosure (including the liability of individual directors for breaches of disclosure laws by companies) as we have hitherto known it.

I am pleased to recommend this book to readers.