DAOs have become so big in the crypto world that there’s a belief we are all going to be working for one in the not too distant future. With more than 4,000 decentralized autonomous organizations already in existence – holding more than $8 billion in their treasuries – they represent a new wave of corporate organization that cannot be ignored.
Some might call DAOs anarchistic given that they have no real hierarchy, no CEO, no supervisors, no board of directors and no boss. Instead, DAOs operate as collectives on blockchain technology where traditional employer administrative functions, such as recording hours, issuing payments, approving and executing contracts, are all done by computer. Despite inflammatory stories in mainstream media about their origins, methods, and occasional stumbles, DAOs have become popular structures for contractors, investment clubs, charities, freelance networks, venture funds and philanthropies.
Still, there’s a lingering question about DAOs that no one seems able to completely answer: Who inside the DAO is accountable if something goes wrong? Or, more bluntly, who you gonna sue?
An unsettled area of law
Attorneys just now beginning to specialize in the burgeoning field agree it’s an interesting question, and one which engenders serious debate. But it’s far from settled.
“Because they’re decentralized, all the proposals and decisions are made by the members, who may or may not be considered partners in the traditional legal sense,” said Andrew Lee, an attorney with Foley & Lardner LLP. “Typically, if you got a judgment against a company you could notify their bank, freeze their accounts and assets. But most DAOs have assets in crypto wallets, or on exchanges and not in a centralized banking institution, which would be antithetical to the whole concept.”
Lee points out there are existing procedures for determining accountability for unincorporated businesses, which most DAOs are, but even then the issue can get murky and hasn’t been tested with these kinds of structures.
Still, it’s worth noting that if a DAO is treated in court as a general partnership, the most likely corporate analog, then each member of the DAO would be treated as 100% responsible for any judgment against it, with all of their personal assets on the line.
The question of responsibility also works in reverse, Lee noted, as it is uncertain who signs off on a suit if the DAO wanted to engage an attorney to bring a legal action against someone or something.
“It would be interesting if a DAO could authorize one of its members to sign documents on its behalf, which at some point would have to happen,” Lee said. "But unless it's on an approved-proposal specific basis, this would lean toward centralization rather than decentralization."
Lee suggested a hypothetical example of a junior lawyer at a law firm trying to explain to a senior partner that a DAO wanted to hire the firm for legal work.
“They’d be like ’What is it? Where is it? Who’s going to sign the engagement letter?’” he said. “And the answer might be ‘well, nobody, because it only exists on the blockchain.’”
So far, one state, Wyoming, has passed legislation allowing DAOs to incorporate as Limited Liability Companies. In that case, there would be a designated agent, approved by the Secretary of State, and the structure for legal accountability is more easily determined (and individuals participating in the DAO have much more protection from liability).
But Wyoming is the exception, and legal accountability in all other states at the moment will probably have to be determined through common law and court determinations.
“A true DAO has no actual legal entity or organization,“ said Daniel L. McAvoy, a shareholder at Polsinelli PC, who has worked with several DAOs. “But then there are others that have a real foundation like an LLC or Trust that makes it a real legal entity.“
But, McAvoy notes, one of the reasons for forming or joining a DAO is to avoid liability.
Regulators will find ways to hold DAOs accountable
The attorneys agree there is potential not only for civil and criminal liability but also regulatory liability, in which the U.S. Securities and Exchange Commission could get involved. Already there have been a few cases in which DAOs have issued “tokens,” that the SEC ruled were actually securities and thus subject to regulation.
“I don’t think they were trying to be fraudulent,” said Stephen L. Rutenberg, another shareholder at Polsinelli. “I think that they thought that by being a DAO they just wouldn’t be subject to securities laws. And the SEC said no.”
One emerging area for DAOs, the Polsinelli attorneys said, is predictive analysis, adhering to the wisdom of crowds or distributed algorithms. These DAOs are used to predict everything from elections to the price of digital currency, stock markets, and even the weather. But even these benign sounding functions can rub up against the law, as the SEC might consider some to fall under the rubric of securities regulation or state authorities could see their actions as gambling.
Another thing that could bring more regulation to DAOs, attorneys say, is the likely event that a big scandal could erupt inside some DAOs that will put them on the front pages and bring attention from regulators and even Congress. Already there have been a few cases where DAOs have made headlines after being hacked or having funds stolen like The DAO or BadgerDAO.
Of course, as purely digital organizations that only exist online with members spread around the world, there might be international differences in how DAOs will be regulated or what enforcement will look like.
For now, until real cases start cropping up, it’s mostly theoretical, but one scenario that attorneys play with is what would happen if a DAO, through its collective decision-making apparatus, votes to do something illegal.
“For the industry as a whole, I would worry about some massive fraud,” said Rutenberg. “You know, someone raising $30 million and just walking away with it and regulators taking the position that they are criminal enterprises. As an individual client involved with a DAO, I worry about them getting in trouble for an action that was really voted on by the DAO for which they really had no responsibility. So I worry about how to protect them.”