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Introduction to Decentralized Autonomous Organizations Ever wondered if an entire corporation can be run on the blockchain without human intervention?

By Prashant Shah

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A decentralized autonomous organization (DAO), also known as a decentralized autonomous corporation (DAC), is such an organization that is run through rules encoded as smart contracts. The idea behind a DAO is similar to that of a virtual entity that has a certain set of members or shareholders (having majority) having the ability to use the funds of such an entity or modify the code on which it has been built. This concept is unique- imagine a framework which essentially replicates the legal trappings of a traditional company or nonprofit but uses only cryptographic blockchain technology for enforcement. Sounds wonderful, isn't it?

So much has been talked about the functioning of DAOs that it's difficult for us to understand what does it really mean and whether it's viable in future. In this post, let's delve deeper into some of these perplexing issues.

DAOs: Are There any Legal Challenges?

Like all new technologies, using blockchain, smart contracts in order to run a DAO could be a subject of significant legal inconsistencies. As these blockchain-based technologies become widely used, there is definitely a need for laws and regulations to provide a legal framework within which blockchain can be utilized. At the same time, while the developers envisage in this new model, it is important to understand these issues so as to build compliant blockchain applications.

Some developing legal issues are as follows:

  • When servers are decentralized and located around the globe, it will be necessary to consider the jurisdiction where a breach or failure occurred for applicability of cross-border laws, which may result in expensive resolutions that undermine the benefits of blockchain.

  • Though the entity is a self-governing software that facilitates commerce, how do we determine the legal status that will attach to DAOs? Are they mere corporations or something else?

  • To what extent can the liability of DAOs extend and whether the corporate veil can be pierced to hold the creators liable?

Additionally, DAOs also render traditional concepts of ownership and liability obsolete. Hence, additional questions may arise, such as those relating to impacts of fraud at any point in the DAO's creation or operation, problems concerning the courts and regulators ability to allow the wholesale adoption of technology that bypasses established oversight etc.

A DAO can also extend beyond jurisdictional boundaries since the nodes on a blockchain can be located in any country in the world. This results in complex jurisdictional issues which will require specialized consideration by lawyers versed in each country's law and the relevant contractual relationships. The principles of contract and title differ across jurisdictions and therefore identifying the appropriate governing law will be a first step in designing and implementing a DAO.

What Can be Done?

Though most of the issues that DAO raises have evolved primarily to exploit legal inconsistencies, various preventive techniques can be adopted to address them. For starters, the inclusion of an exclusive governing law and jurisdiction clause is essential to ensure that a DAO member has legal certainty as to the law that must be applied to regulate the obligations of the parties to the contract and also to consider the jurisdiction of the courts that will handle the disputes. Some other aspects that must be crucially addressed include:

  • Liability for Breach of Contract – Sometimes, the risk to customers of a systemic issue with trading related infrastructure such as blockchain could be significant if trades are not settled or worse if they are settled incorrectly. Likewise, similar issues with respect to the risk of security and confidentiality may also arise for any prospective customer. Hence, the attribution and allocation of liability and risk with respect to a malfunctioning blockchain service must be considered, not only at the consumer level but between all relevant participants, particularly the parties affected by the issues.

  • Service-Level Liability – A crucial aspect of adopting a DAO is the inclination of sellers to commit to performance assurances. This means the vendor prefers to offer the technology and service on "as is" basis, with limited service availability and excluding warranties with respect to the performance of the services. This will leave customers without any assurance that the technology will function as described or the service be reliable and available. For users who are utilizing the service as part of their business, this is unlikely to be an acceptable proposal.

  • Intellectual Property Concerns – Considering the amount of investment and the potential financial returns of blockchain technology, it will be necessary for vendors to determine their IP policy. They will ideally want to capitalize on any commercial benefits generated from the blockchain, including commercialization of the underlying dataset. These IP options are likely to depend on whether such requirements would give a customer an edge or whether it can be used by the blockchain vendor with another customer or vice versa.

  • Exiting a Contract with DAO: Exiting a contract with DAO is very crucial as well. The need for exit assistance will be determined by the extent to which the blockchain vendor holds the customer's data. This will be subject to data privacy norms of each jurisdiction.

  • DAO Data- Is There Property Ownership? In common law countries like India, as a general principle, there is no property right in the information itself. But while individual items of information do not attract property rights, compilations of data may be protected by intellectual property rights. When a database of personal information is sold, if a buyer wants to use the personal information for a new purpose, to comply with data protection legislation (such as the EU's GDPR) they will have to get consent from the individuals concerned.

Who is Responsible?

DAOs are essentially online, digital entities that operate through the implementation of precoded rules. These entities often need minimal to zero input into their operation, and they are used to executing smart contracts and recording activity on the blockchain.

Modern legal systems are designed to allow organizations, as well as actual people, to participate. Most legal systems do this by giving organizations the power to enter into legal contracts, to sue, and to be sued, also called as the concept of "separate legal entity'. However, in determining the legal status to be attached to DAOs (such as simple corporations, partnerships or other legal entities), legal systems will have to evolve to focus on who is responsible in case of the violation of laws. In the absence of such norms, courts will be unlikely to adopt the technology without established control mechanisms.

Given these considerations, we need to tread with due care and caution, while at the same time, be aware of new possibilities for enhanced efficiency and information exchange.

Prashant Shah

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