Decentralized autonomous organizations are disrupting existing industry sectors and challenging current governance systems. In collaboration with the Wharton Blockchain and Digital Asset Project, the World Economic Forum has published a white paper on decentralized autonomous organizations to serve as a foundation for policy makers and senior business leaders to understand the DAO ecosystem.
The CAD market
The first working DAO, known as “The DAO”, was created in 2016. In its first few weeks, it raised US$150 million in ether to create organizational investment in blockchain projects. However, this success was short-lived as the DAO collapsed after a bug in its code was exploited to take a large chunk of the pledged assets.
Despite the initial setback, DAOs grew in popularity. According to the analysis service DeepDAO, in 2021, the total value of DAO treasuries has increased from $400 million to $16 billion. The number of DAO participants also increased 130 times, from 13,000 to 1.6 million. This growth has allowed DAOs to make investments, network around common interests, and even advance the ESG agenda. The increasing prevalence and versatility of DAOs means that developing an understanding of the ecosystem is crucial for policy makers.
What are DAOs?
DAO is a general term for a group that uses blockchains, digital assets, and related technologies to direct resources, coordinate activities, and make decisions.
DAOs can best be understood as opposed to traditional hierarchically managed entities such as governments, religious institutions, and corporations. These entities are centrally managed and often opaque, with decisions being made from above. In contrast, DAOs allow token holders to propose ideas, vote on them, and adopt them, thereby encouraging token holders to work collaboratively towards their common goals. Votes from token holders can then be automatically executed on the blockchain.
DAOs are often started by peers who coordinate on communication platforms like Discord, Telegram and Twitter. The creators work together to determine the purpose, governance structure, and deployment plan. Once these questions are settled, creators can encode their rules into smart contracts, which ultimately bind the group to its decisions before issuing tokens to the market.
While many were established as investment vehicles, a large number were also established for other purposes. For example, DAOs such as GitcoinDAO and EduDAO were created for philanthropic purposes, and Yacht Club and Bored Ape were created as networking platforms for token holders.
With the adoption of DAOs, a host of vendors have emerged to offer token services, vote management, cash monitoring, risk management, growth products, community platforms, and legal services to help DAO management after launch.
Evaluation of the DAO structure
Although DAOs are nascent, the benefits of establishing a DAO are clear:
- the decentralized voting system responds to the limitations of centralized governance and democratizes the management of the DAO unlike traditionally managed institutions;
- the use of blockchain technology allows the DAO to execute actions quickly and seamlessly while allowing endless customization of the DAO according to its objectives;
- DAOs can be directed towards a wide variety of goals such as investment and networking as well as pro-social goals such as ESG; and
- By virtue of their token holder voting system and use of the blockchain ledger, DAOs provide participants with confidence in the decision-making mechanism.
Yet, despite market growth and considerable benefits, DAOs remain subject to a number of risks:
- DAOs receive inconsistent regulatory treatment across jurisdictions, particularly regarding legal personality, making the taxation and liability of DAOs uncertain;
- the voting mechanism – which relies on the participation of token holders – carries the risk of low turnout, and voter fatigue can block decision-making;
- an information asymmetry may exist between the creators of a DAO and the token holders, and makes the token holders vulnerable to fraud;
- the anonymity of participants can be an obstacle to the fight against financial crime and legal recourse;
- as DAOs are hosted on the blockchain, they are vulnerable to the same cybersecurity threats and therefore carry a risk of financial loss; and
- lack of DAO contributor information or reliable channel credentials can create liability issues.
What does it mean?
In the Australian context, the legal status and laws applicable to DAOs are still untested. Given the growing participation and capital invested in DAOs, as well as the risk of allowing DAOs to operate without regulation, this white paper should inform policy makers in their possible consideration of DAOs in the national legal context.
This article was written with the help of Adam Nguyen Mahoney, seasonal clerk.