DAOs Are Gaining Traction and Here’s Why It’s a Big Deal

Author: Christina Comben Date: 03 Jun 2019

It’s not only New York that’s been at the leading edge of the cryptocurrency industry lately. The tiny Mediterranean island of Malta has been drawing crowds once again. Last year, the Blockchain Island made headlines as the first jurisdiction to create a new regulatory framework for blockchain companies and DLT. Now, it’s preparing to draft a fourth law to give a legal personality to DAOs. Why is this important?

Malta the Blockchain Island

At the latest Malta Blockchain and AI Summit, Maltese Prime Minister Joseph Muscat gave a keynote speech. He recapped the ambitious and innovative steps that Malta took last year (that attracted the likes of Binance and OKEx to its shores). The country enacted three new laws to approve virtual financial assets and provide legal certainty to the industry.

Six months later, Malta is continuing to be a blockchain and emerging technology-friendly place to be. Its government is showing the world that people should embrace technology rather than fear it and harness it to solve many of the world’s problems.

Malta’s first three blockchain-related laws established a Digital Innovation Authority to focus on governance, an act to deal with DLT arrangements--cryptocurrency exchanges in particular--and the Virtual Financial Assets act to regulate ICOs, wallet providers, and exchanges.

The country recognizes the unstoppable march of technology and understands that no adequate regulation exists to deal with it. That’s why Malta is busy preparing its fourth law to give a DAO (Decentralized Autonomous Organization) a legal personality. But what’s the significance of this?

What Is a DAO (Decentralized Autonomous Organization) Anyway?

Those of you familiar with Ethereum will know what a DAO is already, but let’s back up a couple of steps. A Decentralized Autonomous Organization (DAO) is an organization that is preprogrammed through smart contracts to carry out the functions of a regular company.

As cryptocurrencies remove the middlemen from the financial equation, the thinking behind a DAO is that they can also do the same for companies, particularly where any kind of decision-making needs to be taken regularly. As Coindesk explained here:

“In short, DAOs aim to hard-code certain rules that a company would from the get-go. This could be setting aside a certain percentage of earnings for a cause or determining a process by which such a rule could be changed.”

A DAO runs very similarly to a regular organization with the exception that the rules are digitally enforced. The first experiment to run on the Ethereum blockchain was simply called The DAO. Unfortunately, the project failed soon after creation. However, it was a huge step forward in innovation and corporate governance.

Participants received DAO tokens to incentivize voting on important decisions such as which projects to fund, and smart contracts fulfilled prearranged obligations like paying salaries and awarding bonuses.

The concept of a DAO not only reduces many inefficiencies in businesses today but it also cryptographically guarantees a merit-based democracy. A DAO removes the typical pyramid structure or hierarchy of a business. It is run in a fair way in which all members vote on the company’s future and can transparently see the flow of funds.

The Problem with The DAO in 2016

In 2016 when The DAO was launched, it collapsed a few months later leading to a hard fork in the Ethereum blockchain that saw the birth of Ethereum Classic from the fallout. Smart contracts were still in their infancy and problems were being detected. As the above-mentioned Coindesk article points out:

“It’s easy to see why “unstoppable code” could pose a security problem.”

The great thing about preprogrammed smart contracts is that they cannot be tampered with. No one can make changes to them once they have been deployed. However, that also means that if a bug appears in the code of a smart contract, developers also can’t change the code.

This was the case with The DAO, one of the largest and most publicized hacks in the cryptocurrency space. Thanks to a bug in a smart contract, a hacker was able to drain funds equivalent to around $60 million ETH. And no one could stop it happening.

This lead the Ethereum developers to reverse the transaction history to return funds to their owners. It created a hard fork between those who were not in agreement believing that “code is law” and the majority of the community who went on to become Ethereum as we know it today.

The Importance of Giving a DAO a Legal Personality

As technology improves and smart contracts become ultimately unhackable, more and more organizations will use this organizational structure. Smart contracts can improve efficiencies across the board. Just look at JPMorgan planning to preprogram a multitude of back-office tasks through them.

Using a DAO structure, businesses can automate mundane tasks such as budget preparation, and paying out salaries and suppliers. They can also run as a merit-based company with all information transparent stakeholders being able to vote.

But while the emergence of more decentralized autonomous entities is surely a positive thing, there’s still the question of legal liability. After all, in order for a DAO to be truly decentralized, no one can own it. But what if something goes wrong?

Under current law in most jurisdictions, they would apply the “nearest person” principle. You can see how this may be applicable in the case of an autonomous vehicle causing an accident. No one was driving the car, but the company who made it would be responsible in the eyes of the law.

A DAO is different because this type of organization can truly run with no one at its helm. Using the nearest person principle would not be correct in the case of a smart contract going wrong--after all, would a developer be liable for an honest mistake in a line of code?

In a previous interview with Steve Tendon, a key member of the Malta Blockchain Task Force and the country’s blockchain strategy, he told me:

“We all know about the Internet of Things, it’s going to be enormous in the next 5-10 years. But when we have all these things, many of which are going to be autonomous, going about in the physical world, at a certain point there must be some way to identify them.”

Malta giving a DAO a legal personality limits the liability of its creators. Just as a person sets up a company to limit his or her personal liability in the case of legal action.

The Takeaway

As technology improves and becomes increasingly robust, more and more DAOs will appear. They’ll be used for everything from replacing mundane tasks to automating greater decisions in a truly democratic way. And as they gain more traction as entire organizations or as part of larger ones like JPMorgan, the world of decentralized work is ever more a reality.

Governments starting to recognize the potential of DAOs and proving regulatory certainty for them is a major step forward as the way we work and live continues to evolve.