Author: Felix Fuith

The Decentralized Autonomous Organization

Country Analysis & Reports,   | November 16, 2018

Since the establishment of the DAO, a venture capital fund that launched with USD 150m in cryptocurrency, the concept of a decentralized autonomous organization (“DAO”) has received significant attention. The DAO attempted to be a decentralized autonomous investment fund without any fund managers. Software and a consensus-based governance system replaced the board and CEO1. The fund’s purpose was to invest in projects, companies, and ideas that would yield returns (in the form of dividends or other benefits) for its participants. The DAO was the first of its kind to aim to achieve a democratized ownership structure (with no singular leader), as opposed to only serving as a digital currency or asset system. Thus, ownership of The DAO was distributed among its tokenholders (similar to shareholders)2. However, at the very beginning, a hacker discovered a potential weakness (i.e. a loophole in the code) in this system. Still, recent examples of decentralized autonomous organizations like Dash and Storj show the enormous potential of the concept. In practice, a DAO may provide a vehicle for business models that were previously unfeasible or too costly to pursue. Consider an ordinary crowdfunding project where investors provide funding and wait for the product to be delivered and profit to be realized. In the DAO model, an individual or a group proposes a general, abstract product description, and investors can contribute financially. Their contributions are then automatically transferred into tokens (similar to shares). Through their tokens (which translate into voting power), investors select which company with whom to engage in the project in order to transform the idea into reality. Thus, investors may shape and influence every aspect of the product at a very early creation stage (if the DAO main code gives them the power to do so). In the case that investors are not satisfied with the selected company, they may replace it, given that they reach a predetermined amount of majority support for a new proposal.3

To assess the legal classification of such an organization, one must first analyze what a DAO actually is and how it works. A DAO can be defined as a permanent organization consisting of a program code that is kept decentralized in the digital world4. It is further described as “the most complex form of a smart contract, where the bylaws of the decentralized organization are embedded into the code of the smart contract, using complex token governance rules.”5 It is critical to understand a DAO’s broad scope of application and its potential to enhance business activities. In general, a DAO is feasible in sectors and industries subject to moral hazard and behavioral uncertainty. These businesses depend heavily on intermediaries who provide trust to the parties involved. A DAO may replace such intermediaries and provide competitive alternatives in structuring those sectors. New approaches could be developed in areas such as the payments sector (the most prominent example being replacing intermediary financial institutions in cross-border money remittance), supply chain management in the luxury goods industry, recordkeeping in trade finance, patient-history management in the healthcare sector6, and the hospitality industry (e.g. replacing online travel agents).

Still, there is no universal definition of a DAO, and its legal status is subject to dynamic and intense discussion. A DAO could be considered an autonomous code which functions separately from any legal system. In contrast, it could be argued that humans or entities created by humans must own or execute a DAO. Many factors will determine a DAO’s legal status, including how its code is applied, where it is used, and which parties use it.7

In assessing the legal recognition of a DAO, the context on which it is based is crucial. A DAO consists of smart contracts, which are characterized as computerized transaction protocols that implement contract terms.8 The well-known blockchain technology is suited for executing such transaction protocols. Blockchain is a public register where transactions between two users subject to the same network are stored in a verifiable, secure, and permanent manner. Within the cryptographic blocks, data concerning the exchanges are saved and connected hierarchically.

Consequently, this creates an endless chain of data blocks that enables you to trace and verify any and all past transactions. Thus, the main function of blockchain is verifying transactions between parties. In terms of smart contracts, one could classify the blockchain technology as a notary that “certifies” the contract.9 A smart contract may be further characterized with an “if-then” rule whereas the occurrence of the condition (“if”) will fulfill the contract without further action (“then”).  More benefits are given in those situations where standardized provisions are applicable.10

During the creation phase of a DAO, at least one founder may determine a main contract (i.e. a smart contract; comparable to articles of association) establishing the DAO. This smart contract can run, for example, on the Ethereum network. Ethereum is a blockchain technology created with the purpose of allowing smart contracts to be coded directly into it, permitting the execution of trusted transactions and agreements.11 In order to engage in transactions on the Ethereum network, the code of a DAO needs “ether”. Ether constitutes the currency of transaction fees. These fees compensate the computers engaged on the network for providing computing power that validates processes executed on the Ethereum blockchain.12 Hence, ether is a form of payment made by the members of the platform.13 A DAO’s code generates tokens (in exchange for ether) that are transferred to the account of the person who sent the ether. The tokenholder receives voting and ownership rights akin to a shareholder.

As soon as the creation phase has ended, tokens are freely transferable on the Ethereum blockchain (similar to shares in an Austrian joint-stock company or a US LLC or corporation). A DAO’s main function is to store ether and tokens and transfer them based on the code of the DAO. Therefore, in order to achieve a DAO’s goal (e.g. creating a certain product; similar to the “objects of the company’s business” defined in the articles of association), the participants need to select a “Contractor” by accepting a Contractor’s proposal. The code specifies the minimum quorum of all tokens needed to pass a proposal.14 These smart contracts may be referred to as the founding documents (similar to articles of association) and as a series of by-laws that determine how the participants vote on proposals, allocate resources, and distribute profit.15 Furthermore, on the top of the structure of the DAO, an individual “Curator” is nominated by the tokenholders (and can be replaced anytime). The Curator controls the list of addresses that receive ether (i.e. the compensation) from the DAO, across all proposals.16 This provides a failsafe mechanism to avoid dangerous proposals.17

Once one understands the possible structure of a DAO, an assessment of its legal status proves crucial. DAOs are not recognized as legal entities in the US nor in Austria. In the US, a DAO could be characterized as a general partnership18 or a joint venture agreement19 between its members. Members of a DAO act as co-owners of a for-profit business and undertake a particular business transaction or project for a limited period of time. Considering these kinds of actions, the members are personally liable for the obligations of the DAO. However, seeking the liability of members would necessitate connecting physical people, across jurisdictions, to their Ethereum addresses. This may be legally and practically problematic20.

The members of a DAO likely do not intend to assume unlimited liability. However, under Austrian law, , they might be required to do so. The tokenholders of a DAO could be classified as members of a civil law partnership21 without legal capacity under Austrian law. Nevertheless, there are arguments that a DAO tends to have more characteristics similar to that of a corporation or limited liability company (Kapitalgesellschaft). These include a prevailing “majority principle” (or even less than the majority, e.g. The DOA required a quorum of just 20% of all tokens for any proposal to pass22) for decision making and a creation goal linked to a certain amount of ether received by the DAO (akin to a minimum required nominal capital)23 . In light of its uncertain legal status, it is necessary to assess how a DAO could engage in business activities, namely contracting with subcompanies to implement resolutions agreed upon by the tokenholders. In Switzerland, the founders of The DAO incorporated “DAO.Link S.à r.l.”, a company in the corporate form of a GmbH/S.à r.l. (a limited liability company, similar to an LLC in the US). DAO.Link Sarl was intended to serve as a bridge between The DAO and the real world. It is necessary because individuals and businesses (who act as Contractors) who wish to send corporate invoices and purchase orders (issue VAT) still don’t feel perfectly comfortable doing business exclusively in digital currencies. A Contractor using the DAO.Link S.à r.l. services receives an Ethereum address (which is needed to send and receive tokens), which it then provides to The DOA in place of its own. DAO.Link S.à r.l. then contracts with The DOA directly24. This kind of service company structure, which provides a connection for an entity associated with it, may not be acknowledged in all jurisdictions25.

A DOA has certain advantages over a traditional corporate governance structure. The decision-making process – through a proposal and the respective voting system – is faster than passing a resolution in a corporation (where one must adhere to legal formalities relating to convocation of shareholder meeting, for example). Overall, the flexibility of the corporate governance structure gives the DAO the power to react quickly and efficiently. Further, a DOA vehicle allows knowledgeable investors to support and influence an individual’s idea at a very early stage. Right now, regulators need to catch up with organizations based in the digital world in order to make their full potential available.

  1. Roussel, The DAO, the Curators: Evaluating and mitigating the legal risks, online available under : https://blog.bity.com/2016/05/14/the-dao-the-curators-evaluating-and-mitigating-the-legal-risks/
  2. Hayes, Why the DAO Ethereum is Revolutionary, online available under https://www.investopedia.com/articles/insights/051616/why-dao-ethereum-revolutionary.asp
  3. Bordet, Decentralized Autonomous Organizations: Ethereum Sparks Up Googles of Tomorrow, online available under https://cointelegraph.com/news/decentralized-autonomous-organizations-ethereum-sparks-up-googles-of-tomorrow
  4. Mann, Die Decentralized Autonomous Organization – ein neuer Gesellschaftstyp? NZG 2017, 1016
  5. The BlockchainHub, online available under https://blockchainhub.net/dao-decentralized-autonomous-organization/
  6. Hsieh, The Rise of Decentralized Autonomous Organizations: Coordination and Growth within Cryptocurrencies, 107
  7. Jentzsch, Decentralized Autonomous Organization to Automate Governance, 1
  8. Norta, Creation of Smart-Contracting Collaborations for Decentralized Autonomous Organizations, 1
  9. Blockchain – What Is It And What Is It For? Online available under: https://www.forbes.com/sites/forbestechcouncil/2018/03/28/blockchain-what-is-it-and-what-is-it-for/#2e4b7f0e1a16
  10. Ehrke-Rabel/Eisberger et al., Kryptowährungen, Blockchain und Smart Contracts: Risiken und Chancen für den Staat (Teil 1), jusIT 2017/41, 4
  11. Hayes, Why the DAO Ethereum is Revolutionary, Online available under: https://www.investopedia.com/articles/insights/051616/why-dao-ethereum-revolutionary.asp
  12. Allen&Overy, Decentralized Autonomous Organizations, 2
  13. Ether: The Crypto-Fuel for the Ethereum network, online available under https://www.ethereum.org/ether
  14. Jentzsch, Decentralized Autonomous Organization to Automate Governance, 2
  15. Castillo, The DAO: Or How a Leaderless Ethereum Project Raised $50 Million, online available under https://www.coindesk.com/the-dao-just-raised-50-million-but-what-is-it/
  16. Jentzsch, Decentralized Autonomous Organization to Automate Governance, 2
  17. See for further details: Tual, on DOA Contractors and Curators, online available under:
    https://blog.slock.it/on-contractors-and-curators-2fb9238b2553
  18. A general partnership can be defined as an association of two or more persons to carry on as co-owners a business for profit; See New York Consolidated Laws, Partnership Law – PTR § 10
  19. A joint venture may be defined as a general partnership typically formed to undertake a particular business transaction or a project and is intended to exist for a limited time period. See https://definitions.uslegal.com/j/joint-venture/
  20. Jentzsch, Decentralized Autonomous Organization to Automate Governance, 2
  21. A civil law partnership may be defined as a contractual coalition of at least two persons to achieve a common goal.
  22. Jentzsch, Decentralized Autonomous Organization to Automate Governance, 2
  23. Hanzl/Rubey, Blockchain – frischer Wind im Gesellschaftsrecht?, 104
  24. Tual, Announcing DOA.Link, the bridge between blockchain and brick-and-mortar companies, online available under https://blog.slock.it/announcing-dao-link-the-bridge-between-blockchain-and-brick-and-mortar-companies-9510ba04d236
  25. Allen&Overy, Decentralized Autonomous Organizations, 6

Felix Fuith

Felix Fuith is a Class of 2017 LLM graduate of New York University School of Law and holds aprofessional certificate in Law & Business from NYU Stern School of Business. In addition, he recently completed the New York State Bar Exam in 2017. Prior to his studies in the US, Felix graduated in law from the University of Vienna (Austria) in 2015 and worked for international law firms in Prague (CZ) and Shanghai (PRC). He is currently working in Vienna as an associate for Binder-Groesswang as part of their corporate/M&A team.

@LLMLawReview Felix Fuith
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