Decentralised autonomous organisations (DAOs) will proliferate as an organisational model for the non-centralised digital economy, particularly in its focal point – the metaverse.

Of the thousands of DAOs (or entities incorporating DAO concepts) exist today, most are in DeFi,[1] hardly any are in the UK,[2] and enormous value has already flowed through, been created, used and sometimes lost by DAOs as the vehicle of choice for Web3-native proponents. Significant questions arise for the role played by English law and the common law more broadly on shaping the use and recognition of DAOs in furthering the metaverse, which if left unanswered could see the UK left behind as a jurisdiction that encourages blockchain-related investment and innovation.

DAOs are a revolutionary decentralised approach to organisational structure whose establishment, rules and functions (to varying extents) are coded on blockchain systems, smart contract or other software-based protocols.[3] DAO tokenholders may participate in decision-making and gain access to exclusive services or tradable on-chain virtual assets depending on the rights granted by the token.

DAOs are often contrasted with traditional organisations (think private companies, partnerships or co-operatives) that function privately, have less transparency and deliberately centralised governance structures. The following two characteristics distinguish DAOs from traditional organisations:

• Decentralised. A DAO is not controlled by a single individual or group, but instead operates based on the ‘democratic’ collective decisions of its members using a set of rules encoded into smart contracts on the blockchain protocol governing the DAO. A DAO is rarely fully decentralised or autonomous. Rather, DAOs exist on a spectrum, with some decentralising or autonomising only a few components or limiting its application to control a single purpose entity or a single fund. Decision-making within DAOs typically remains highly concentrated amongst governance tokenholders.[4] Completely autonomising a sophisticated entity’s entire operations also dramatically increases the technical complexity required to achieve full decentralisation or automation, as well as opening further the scope for exploits or mischief.
• Autonomous. A DAO’s activities, functions and decisions can operate without needing human intervention; if the predefined conditions are met, the smart contract will immutably execute a particular action deterministically. This is possible because the rules that govern the DAO are encoded into smart contracts on a blockchain, and the DAO can automatically execute these rules without the potential for human error (or, importantly, human discretion).

DAOs are already important in the context of crypto-token (cryptocurrency) and decentralised finance protocols, as crypto project proponents also adopt a decentralised approach to its governance structures. DAOs can also be used to govern many communities that have been and are planned to be set up in the metaverse, including social structures or organisations involving multiple participants set up for investment purposes, such as to invest in or trade crypto-tokens and non-fungible tokens (NFTs), as well as fundraising or charitable purposes. Many widely-used blockchain software protocols also have a DAO structure governing developing, modifying and maintaining open-source software infrastructure for its underlying blockchain systems or decentralised finance applications.

We expect to see these structures used more broadly in the metaverse, and even adopted by particular metaverses as their own governance structure if anything as the ultimate advertisement for being truly Web3-native.

Implementing a DAO in the metaverse presents a number of challenges and uncertainties stemming both from the nature of DAOs themselves and also from the metaverse environment within which they operate. Its revolutionary and nascent nature also present significant challenges and opportunities to regulators seeking to enhance market trust, improve market operation through encouraging innovation, and prevent harm from occurring. Prospective DAO proponents and participants must give consideration to these issues to ensure the success and sustainability of any DAO.

Several key issues to implementing DAO in the metaverse include:

1. Clear and concise governance rules. Due to a DAO being decentralised and autonomous, it is important for the DAO to have transparent rules and guidelines to ensure its proper and efficient function. This critically includes rules for voting on proposals, decision-making, managing the DAO’s assets and resources, complaints handling and dispute resolution procedures. These processes must ensure that all members have the same opportunity to participate. Such rules must be straightforward and concise particularly to the extent that any of them are managed on-chain by smart contracts.

• Effective and efficient communication between members. A centralised entity typically is responsible for messages between the organisation and its members or stakeholders. As a DAO is decentralised, its members must be able to easily communicate and collaborate with each other to make decisions, execute plans and give effect to its governance rules. This often involves specialised communication and collaboration tools, such as dedicated chat rooms, forums, and real time voting platforms. The rules of the particular metaverse within which the DAO operates will also impose requirements on how communication occurs between holders. These platforms are also critical for DAO leaders to communicate effectively with members and work towards its goals and objectives.
• Legal recognition. While the metaverse is, conceptually, a jurisdictionally-agnostic virtual world, the recognition of DAOs and the rights or obligations afforded to its members will still very much be affected by (real world) legal principles. A DAO is not currently recognised as a legal entity in the UK, so it cannot own assets, enter into contracts or provide its members with liability protection.[5] This is a significant impediment to realising the potential of DAO-based organisations.  Some other jurisdictions recognise DAOs structured as limited liability companies (LLCs) as a form of “legal wrapper”, where the LLC is liable for contractual and legal obligations and its members have limited liability protection,[6] while other jurisdictions offer corporate vehicles whose concepts are more aligned with the ethos of a DAO.[7]  While various jurisdictions are considering how laws and regulations treat DAOs,[8] it is also unclear which law would apply to particular metaverses, let alone to DAOs that operate within them.
• Shortcomings with lex cryptographica. There are already examples of DAO code being exploited by adverse actors in a manner arguably permitted by the underlying DLT code.[9]  English common law does not recognise a general fiduciary or tortious duty of care owed by software developers to users,[10] and finding one even where software developers could implement software patches to address an exploit in the blockchain code to enable a cryptoasset owner to retain lost cryptoassets seems unlikely.[11] The rules for participating in a metaverse could also stipulate rules for DAOs to ensure against harms and provide remedies to its communities in a manner that upholds the values of that metaverse, enforced by mechanisms such as requiring the underlying code to be open source, publicly available, subject to audit and meet minimum quality standards, and mitigate the risk to tokenholders of potential harm.[12]

Its increasing use and prominence as metaverse adoption expands will bring forward critical discussions regarding the legal status of DAOs, liability carried by its participants, and the role played by the law to shape the rules and regulations applying to them. Providing legal certainty to DAOs in the UK will support its adoption as a blockchain-driven decentralised approach to organisations and further the UK’s ambition to become a global hub for metaverse-related crypto investment.[13]

References

[1] DeFi accounts for 83% of all DAO treasury value and 33% of all DAOs by count: Forbes, The State of DAOS and what that can mean for Web3, https://www.forbes.com/sites/forbesfinancecouncil/2022/10/14/the-state-of-daos-and-what-that-can-mean-for-web3/?sh=2024b5897f37

[2] Law Commission of England and Wales, Decentralised Autonomous Organisations, https://www.lawcom.gov.uk/project/decentralised-autonomous-organisations-daos/

[3] IBM – Smart contracts (https://www.ibm.com/uk-en/topics/smart-contracts).

[4] This raises questions around whether this contradicts true decentralisation principles.

[5] In the UK, a DAO is likely treated as a general partnership.

[6] Vermont recognises a “Blockchain-based” LLC whose governance may be partially or fully decentralised: Vermont Legislature (https://legislature.vermont.gov/statutes/section/11/025/04173).  Wyoming recognises algorithmically managed DAOs as LLCs, regulating aspects such as majority decision-making, quorum, disclosure requirements, minimum requirements for regulations in bylaws and the appointment of a registered agent: Wyoming Legislature (https://www.wyoleg.gov/Legislation/2021/SF0038).

[7] See, for example, the foundation company structure in the Cayman Islands offering separate legal personhood and limited liability while also retaining features of a trust.

[8] See, for example, the Law Commission of England and Wales public call for evidence on decentralised autonomous organisations: https://www.lawcom.gov.uk/project/decentralised-autonomous-organisations-daos/.

[9] In 2016, over $60m of Ether was siphoned from a DAO called “The DAO” by exploiting the logic of its underlying smart contract.  The “attacker” infamously posted an open letter (albeit its authenticity is disputed) to The DAO’s members and the Ethereum community defending their actions, saying that they legally used a legitimate feature of the smart contract that anyone could have exploited.

[10] Tulip Trading Limited v Bitcoin Association for BSV [2022] EWHC 2 (Ch).

[11] The Tulip case (ibid) is on appeal.

[12] See, for example, Rule 4 of the DAO Model Law: https://coala.global/wp-content/uploads/2021/06/DAO-Model-Law.pdf.

[13] The UK government announced its plans in April 2022 to position the UK as a global hub for cryptoasset technology and investment: Press release (https://www.gov.uk/government/news/government-sets-out-plan-to-make-uk-a-global-cryptoasset-technology-hub).