In the song Power to the People, John Lennon summed up the concept of freedom and citizens’ ability to decide on political and social circumstances. These ideas are as old as the first theories of societal organization. Kropotkin, a revolutionary and anarchist, points to Zeno’s prediction of a time when people, regardless of borders, will unite and create a “universe” without the need for laws, courts, temples, and money for exchange of mutual services. It seems that with the development of technology, primarily blockchain, we are one step closer to the realization of those ideas. An obvious example are decentralized autonomous organizations (DAO), which are organizations based on rules (smart contracts) recorded on the blockchain and controlled directly by its contributors, without delegating management powers to the central entity (e.g., board of directors or CEO). The conditions for an organization to be considered DAO are not fully defined, and those most often listed are 1) reliance on blockchain, 2) smart contracts, 3) digital assets by which members contribute to the independence and functioning of DAO, and 4) the possibility of scaling globally.
DAO is very similar to existing companies. First, participation in the management of DAO is based on the possession of tokens, which is similar to how shareholders own the appropriate class of shares. Second, DAO has rules according to which it operates, such as the statute of a joint stock company or the founding act of a limited liability company. Third, DAO assets can be invested into various projects or used for the development of its own products; moreover, assets can be increased based on the income DAO generates from successful investments or fees from its products.
However, the use of blockchain and smart contracts for DAO means transparency because rules are known in advance and remain permanently recorded online. In addition, this means security for DAO contributors because the rules cannot be changed unilaterally. The decision-making process is open to all contributors, decision-making is efficient (no sessions, counting of votes, etc.), and decisions are permanently recorded on blockchain. In traditional companies, decisions are often made behind closed doors, without the possibility for minority shareholders or contributors to follow the decision-making process or influence decision-making. Non-transparent management of a company can lead to large losses for investors, but also for the state that is deprived for tax revenues. The most famous case is the Enron case.
Although the possibilities offered by DAO are excellent, and the advantages over traditional companies are indisputable, we must not forget that DAO also has its downsides. In that sense, the problem with direct decision-making comes down to encouraging DAO contributors to vote on a certain proposal, i.e., to be actively involved in the decision-making process. In addition, in order to make a decision, it is necessary for a DAO member to be sufficiently informed about the proposal being voted on. An informed decision can be an unattainable goal because DAO tends to include as many contributors as possible, often tens of thousands, which by its nature means exceptional diversity in terms of education, expertise, and the like. An additional problem is created by tokens, which give contributors certain rights, primarily the right to vote. Namely, the legal nature of a token is not entirely clear, and this causes difficulties. In particular, if a token does not pass the test that determines whether it is considered a security or not (e.g., Howey test in the US, or MiFID II standards, in the European Union), it will be subject to capital market and anti-money laundering (AML) rules, which is not only a huge administrative burden for DAO as a token issuer, but also for contributors themselves.
In addition to the issue of DAO management, currently the biggest challenge DAOs face is that legal systems do not recognize them as a legal form. The absence of regulation means that DAO contributors are exposed to the demands of DAO creditors. In other words, DAO contributors can be liable with personal property for DAO obligations because DAO is not formally an economic entity whose responsibility for business obligations is related only to DAO property, i.e., there is no limited liability. The lack of legal personality makes it difficult to interact with traditional economic entities, but also with individual contractors (e.g., freelancers). So far, only the state of Wyoming in the United States and the Marshall Islands have recognized their limited liability status.
The lack of regulation also carries serious tax and AML risks. These stem from the unclear nature of tokens and projects that DAOs deal with. Specifically, if tokens are considered securities, there will be an obligation to establish the identity of members, i.e., the owner of the token. Failure to comply with AML rules can mean high penalties for members. Regarding the tax aspect, there may be difficulties in determining the taxpayer of the profit tax that a DAO realizes. Specifically, if the profit is attributed to the DAO, there is the question of the jurisdiction in which the profit is reported, i.e., the tax is paid. On the other hand, if the profit is attributed to the members of DAO, they will be obliged to independently report income to tax authorities. In that case, an additional problem will arise: whether the income from DAO is considered income from capital or it will fall under the so-called other income that is generally less taxed.
Back to the future
Having presented the basic philosophical values, potential, and challenges of DAO, it is worth looking at the opportunities in Serbia that may affect the creation and operation of DAOs, especially since there are already a couple of domestic DeFi projects that operate as DAO (Thales) or are on the way to become DAO (Tempus Finance).
As we mentioned, DAO is not regulated in Serbia, i.e., it has no legal personality under domestic law. This involves all the problems that have been discussed. However, the Serbian legal system has two forms into which DAO could fit. These are cooperatives and (civil) partnerships.
A cooperative is a legal entity that represents a special form of organizing natural persons (cooperatives) who, by operating on cooperative principles, realize their economic, social, cultural, and other interests, and who manage and control the business of the cooperative. Cooperative principles are almost identical to those on which DAO is based, and some of them are:
- voluntary and open membership;
- control by cooperatives is exercised through the cooperative as a democratic organization controlled by its members, who actively participate in decision-making and formulation of its business and development policy;
- economic participation of cooperatives is achieved by members contributing to the capital of their cooperatives and democratically controlling it;
- community care.
If we wanted to treat DAO as a cooperative, the main objection would be that our law on cooperatives prescribes the obligation to have management bodies (boards). In other words, this would lead to the centralization of DAO. However, even if this problem is overcome, the question remains whether when fixed as a legal form, DAO remains an organization or becomes just a tool for managing a legal entity.
Alternatively, it seems that the (legal) nature of the partnership is more in line with the need for DAO to remain decentralized. It is interesting that the partnership is regulated by the Civil Code for the Kingdom of Serbia from 1844 (GZ), which is still partially applied. The Civil Code prescribes that a partnership agreement exists when two or more persons agree to invest their labour or things, so that the benefit, if any, is shared. At DAO, developers invest their knowledge while contributors invest their digital assets. No partner can appoint another person other than themselves without the consent of others, they cannot accept anyone into the partnership, nor can they lead any business that would be to the detriment of the partner. DAO members also approve of the accession of new members or a new way of managing DAO projects. The Civil Code further stipulates that “partners will be consulted about the venture, and that the number of votes how to proceed will be decisive.” Furthermore, “every partner can look into the partnership’s accounts at any time and cannot be prohibited from doing so.” These are the principles on which DAO bases its joint management and transparency. An additional advantage of the partnership in relation to the cooperative is that the partnership is not subject to the obligation to register, i.e., partnership is not a legal entity just like DAO.
We can conclude that DAOs as well as digital assets, have a lot of potential for application, but that their regulation is necessary. This means it is necessary to regulate the legal form of this organization, primarily to ensure the legal security of their members.