Decentralised Autonomous Organisations (DAOs): The case for regulation

It has been suggested that Decentralised Autonomous Organisations (DAOs) have the potential to revolutionise the business landscape, transforming the way we conduct business.

Whether this statement holds true will mainly depend on how jurisdictions regulate them. Before delving into this critical discussion, it is essential to set the scene.

If you are familiar with decentralised finance (DeFi), you likely know about DAOs and their integral role in many DeFi projects. Even if DeFi is not your area of expertise, you have probably heard of blockchain—the technology behind cryptocurrencies like Bitcoin.

Blockchain not only enables cryptocurrencies but also forms the foundation of DAOs. Until recently, anyone looking to start a business would usually think of traditional structures—such as a sole trader, partnership, or company.

Blockchain technology has introduced a new, arguably more efficient, way to conduct business: DAOs. In technical terms, DAOs are a collection of interacting smart contracts. Conceptually, they are organisations that enable individuals with shared economic or social goals to collaborate effectively.

Simply put, DAOs are organisational structures that function through smart contracts. By now, you might be wondering: What makes DAOs so unique that they could transform business as we know it? The answer lies in their defining features: Decentralisation and Autonomy.

These characteristics align with the growing global demand for more democratic and inclusive structures. From citizens advocating for participatory governance to shareholders seeking greater transparency and employees desiring equity in workplace decisions, decentralisation resonates broadly.

Generally, decentralisation refers to the absence of centralised control, empowering all participants in a given endeavour to have a say in decision-making. Meanwhile, autonomy refers to the ability of DAOs to operate independently, without external influences, and automatically through predefined rules embedded in smart contracts. Imagine a world where businesses operate on these principles.

Particularly, decentralised governance could address a handful of existing corporate governance issues. For instance, it provides a potential solution to the principal-agent dilemma by aligning the interests of decision-makers with those of DAO owners. Furthermore, involving diverse stakeholders in decision-making can harness a broader pool of knowledge and expertise, leading to more informed and effective outcomes.

The autonomy of DAOs introduces additional advantages, such as eliminating costs related to the verification and exercise of rights, enhancing corporate governance transparency through blockchain's inherent openness, and ensuring decisions are executed impartially via pre-defined rules. However, these features operate on a spectrum, with most DAOs falling short of complete decentralisation and autonomy at this stage of technology.

This raises important questions about the optimal level at which these features should be present and, in turn, the regulatory boundaries that must be imposed to achieve them. Without regulation, there is no guarantee that DAOs will adhere to their defining principles to a degree that makes them a viable alternative to traditional business models. Evidently, this is one of the ways in which regulation will contribute to realising DAOs’ potential in transforming the corporate landscape.

Additionally, regulation will ensure legal certainty, a crucial element for the longevity of DAOs. Without regulation, DAOs operating within a jurisdiction risk being classified under existing business structures, such as partnerships or unincorporated associations. This could result in unlimited liability to DAO members and no legal personality for the DAO itself.

The lack of legal recognition for DAOs presents a considerable obstacle to their effective operation in the offline world. Individuals and entities may hesitate to engage with DAOs due to the uncertainty surrounding accountability and enforceability. For instance, when a party seeks to enforce their legal rights, it may be challenging to determine who is legally bound by a contract entered by the DAO. This ambiguity undermines trust and limits the ability of DAOs to function as a credible counterpart in legal and commercial dealings.

Moreover, DAO constituencies, including validators, developers, and token holders, may face personal liability for actions associated with the DAO. This uncertainty discourages participation, as it is doubtful whether anyone would be willing to risk endangering their personal assets in the absence of regulatory safeguards. To date, only a few jurisdictions have sought to regulate DAOs. In the United States, Vermont, Wyoming, and Tennessee have introduced amendments to their Limited Liability Company (LLC) statutes to accommodate DAOs. Utah has taken a step further by creating a distinct legal regime for DAOs, closely aligned with the Coalition of Automated Legal Applications (COALA) Model Law.

In the absence of regulation, DAOs often utilise existing legal structures to perform tasks they cannot do themselves, such as entering contracts or holding the DAO treasury. A few of the most popular legal frameworks that DAO chose to wrap themselves with include the Swiss Foundation, Swiss Association, and Cayman Foundation Company.

In the UK, the Law Commission has recently published a scoping paper for DAOs where, inter alia, it concluded that there is no immediate need to develop a bespoke DAO legal entity under the law of England and Wales. Yet, it left the door open to revisit the matter upon the maturity of market practices. This cautious stance reflects the difficulty of reaching a consensus on the appropriate parameters for such a legal entity, as well as a prevailing preference for maintaining a technology-neutral organisational law.

However, this position may inadvertently discourage DAOs from establishing themselves in the UK, particularly as other jurisdictions adopt more supportive regimes. A coherent legal framework for DAOs should address four key objectives.

First, it must promote legitimacy to the outside world, ensuring DAOs are credible, trustworthy, and capable of engaging with traditional systems. Second, it must provide legal certainty to DAO constituencies, particularly regarding liability. Third, flexibility should be maintained, enabling DAOs to develop without being stifled by unnecessary constraints. Finally, it should preserve the definitional features of DAOs to the necessary extent.

In conclusion, it is evident that some form of regulation should be afforded to DAOs. As a common law jurisdiction, Cyprus has the essential flexibility to adapt its legal framework to accommodate new technologies. By developing a bespoke regulatory framework for DAOs, Cyprus will establish itself as a leader in the field and enhance its reputation as a technology hub within the European Union.

*Ioanna Patsalidou, PhD at King’s College London, Lawyer at Christos Patsalides LLC