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Classifying DAOs as companies

Classifying DAOs as companies

The term “Decentralised Autonomous Organisation” (DAO) from the world of DeFi (Decentralised Financial Markets) is on everyone’s lips. For newcomers to this field, it can be frustrating to deal with a multitude of abstract terms. Below is an overview of the latest developments in the digital economy. 

DeFi is a blockchain-based financial system that is openly accessible to all members. The aim is to offer services similar to those of the traditional financial system, but in an open and transparent way. To achieve this, DeFi uses smart contracts, decentralised applications and the blockchain. As a result, contracts can now be processed automatically, transactions can be carried out transparently and all members can be granted the same rights. The DAO plays an important role in this regard but what is a DAO and how is it regulated? The DAO in simple terms is a permanent, virtual organisation without central management, in which decisions are made by its members, who come together to pursue a specific common goal. The concept of the DAO is gaining ground due to the possibility of efficient fundraising, the granting of codetermination and initiative rights to members, and decentralisation. Because of these characteristics, the DAO is often portrayed as a chat group with a joint bank account. The advantages of a DAO compared to the traditional models are obvious: openness for all as well as transparency and democratisation of administration in which all members can participate. 

In this sense, all members are owners of the respective DAO. As in the world of DeFi, there is no hierarchy or central structure in the DAO in which decisions have to be made “from above” and accepted by the other members. Participation in DAOs takes place through the acquisition of tokens, which are issued within the framework of Initial Coin Offerings (ICO) or Initial Token Offerings (ITO) carried out to raise capital. These tokens usually provide participants with rights in the DAO comparable to shareholder rights (e.g. voting rights). 

So how does it all work? Simply put, the DAO is a code-based organisation. The code is programmed either by one or more founders or, in the interest of transparency, by an external agent chosen by the group. The code contains the essential rules of the DAO (e.g. exercising of voting rights, changes to the DAO decided by the members, etc.). Changes to the rules of the DAO as well as decisions on capital appropriation are made via a vote of the members, which is then virtualised in a smart contract and corresponding changes are then made to the DAO’s code. Precise coding is the decisive factor for the subsequent success or failure of the DAO. The task of the programmer is therefore to programme all member rights and to provide for all possibilities necessary for the smooth functioning of the system. 

A function comparable to a normal CEO thus does not exist; this task is taken over by the aforementioned smart contracts. This is not an obstacle in the virtual space. However, in the real world without smart contracts it would be necessary to commission a third party (e.g. a trustee) to execute the contracts, which would, however, undermine the decentralised system of the DAO. The DAO concept has already established itself in various areas. The Ukraine DAO, for example, has raised funds by selling NFTs. Another current example would be “gitcoin”. Here, participants’ capital is used to finance and coordinate open source development projects. In the sports industry, fans have formed DAOs to set up investment groups in which they are given significant voting and initiative opportunities for sums of money. “Krause House”, for example, named after the late Chicago Bulls manager Jerry Krause, is a DAO set up with the aim of raising enough funds to buy an NBA team. However, the extent to which the DAO can actually incur liabilities towards its business partners depends primarily on whether a DAO can be classified under company law, i.e., whether it can be regarded as having a corporate form. 

The introduction of a new type of company (sui generis), which the law does not yet recognise, is limited in Austrian law by the constraint of company form. According to this, an Austrian company must in principle be assigned to a specific legally provided form of company (e.g. GmbH, AG, OG etc.). At first glance, the DAO is comparable with an Austrian corporation or partnership such as a GmbH or OG, which can also itself be the bearer of rights and obligations and thus have legal capacity. The concept of the DAO as laid down in code does have some similarities with a partnership agreement. However, most Austrian company forms require a company register entry for their effective establishment. DAOs fail at this first regulatory hurdle of mandatory disclosure of the company’s registered office in a real political municipality, as the registered office of the DAO is the blockchain. Moreover, such a registration would hardly be practicable due to the DAOs’ virtuality and worldwide reach. 

As DAOs cannot be assigned to any other legal form, the law provides for the “Gesellschaft bürgerlichen Rechts” (GesbR) as a rescue company. It does not need to be registered in the commercial register, but it does not have legal capacity either, so all rights and obligations are directly attributable to the partners. This means that the DAO as a GesbR cannot enter into any legal relationships itself. Even if obligations and thus also liabilities of the participants are not the aim of the DAO, its classification as a GesbR appears necessary in the absence of other options. A legislative response is urgently required and awaited. This is because the DAO’s resulting lack of legal capacity has the consequence that participants in the DAO act jointly as debtors vis-à-vis business partners and are liable. 

However, there has been some initial progress at the international level: the US State of Wyoming has passed a law that recognises the legal status of the DAO and equates it to the American LLC (limited liability company). This would be the equivalent of the Austrian “Gesellschaft mit beschränkter Haftung” (GmbH). The expected international development of the DAO makes the future of this concept promising and raises questions about potential resulting legal regulation. Until an explicit classification is made by the legislator, care should therefore be taken to ensure that concrete regulations concerning participants’ limitation of liability are stated in the code of the DAO as well as in the relationship with the business partners in order to limit shareholders’ associated risk. It is therefore advisable to check the contractual conditions in detail along with other market participants in order to create legal certainty for all parties involved. 


AUTHOR:

Mag. Ronald Frankl, Attorney-at-Law and Managing Partner at LGP

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