Removing the legal ambiguities around blockchain technology to weed out dodgy operators is the task facing the Treasurer’s payment system shake-up.
In December, as part of a package on “transforming Australia’s payments system”, the federal government announced it will examine how to regulate organisations established on blockchains. The announcement came in response to October’s final report of the Senate Select Committee on Australia as a Technology and Financial Centre.
New Australian companies could soon be created directly on blockchains – the digital, distributed ledgers that enable cryptocurrencies such as bitcoin and collectible non-fungible tokens.
This technology is increasingly being used for crowdfunding for purchases or initiatives, by setting up a decentralised autonomous organisation, or DAO, on a blockchain.
DAOs are a legally ambiguous form of online co-operation. Proponents present DAOs as alternatives to traditional corporations, which have a well-known principal-agent problem.
Directors are obliged to make decisions for the benefit of a company’s shareholders (and can consider broader “stakeholder” interests in some jurisdictions).
Human nature being what it is, directors sometimes make decisions for their own benefit that harm shareholder interests.
As with much of blockchain infrastructure, the DAO attempts to deal with principal-agent problems by creating trustless relationships among participants. “Trustless” means not having to trust an actual human. Instead, DAOs operate through pre-programmed, automated smart contracts on a blockchain.
Human decisions intrude
Investors opt in by transferring cryptocurrency to the DAO and receive DAO tokens. The investor’s crypto is held by the DAO itself. Decisions (for example, to modify the DAO or make an investment) are made by a vote of all token-holders.
There are no directors to vote themselves extravagant bonuses and no managers to abscond with company funds. DAOs instead are billed to operate “solely with the steadfast iron will of unstoppable code”.
That’s the theory, anyway. Experience suggests there are key, human decision-makers in the DAO, just as in any corporation.
In a 2017 investigation, the US Securities and Exchange Commission found that, contrary to claims of decentralised governance, the voting rights of DAO token holders “did not provide them with meaningful control over the enterprise” and they were “substantially reliant on the managerial efforts” of the DAO founders and individuals nominated by them.
With billions of dollars in digital assets reported to be invested in DAOs, the purposes of which range from buying collectibles to dealing in carbon markets, question marks over the legal status of DAOs are a growing concern.
The Senate committee found that “legal liability for members (i.e. token holders) for these organisations is currently unclear, and this regulatory uncertainty is preventing the establishment of projects of significant scale in Australia”. It therefore recommended that the government “establish a new Decentralised Autonomous Organisation company structure”.
In its response last month, the government agreed in principle with this recommendation. It flagged plans for Treasury to consult industry in the second half of 2022 on “an appropriate regulatory structure for innovative new corporate structures” such as DAOs.
Opportunities and challenges
Such an inquiry would have to grapple with a broad set of questions, including: Should DAOs be recognised as separate legal persons, as corporations are? Should DAO participants be protected by limited liability? For what purposes may a DAO be established? How should a DAO be taxed?
There is also the practical issue of how Australian law could be enforced on a DAO with anonymous (more accurately, pseudonymous) participants who might be located largely (or entirely) overseas.
DAOs and related blockchain technology may have the potential to disintermediate corporations, just as social media has disintermediated media.
But just as mainstream media has survived, adapted and integrated social media, blockchain does not necessarily herald the end of the traditional corporation. Also, as with social media, crypto companies bring opportunities and challenges – commercial and social.
Crypto scams
One such challenge of DAOs is thoroughly old-fashioned: to minimise the risks of retail investors getting taken to the cleaners by dodgy operators. In their additional comments to the Senate report, the participating Labor senators were “concerned to note the prevalence of scams based on crypto asset product offerings”.
In 2016, soon after an early DAO was set up, a hacker managed to transfer about one-third of its cryptocurrency holdings (then worth more than $US50 million). This “exploit” was reversed by the extreme solution of essentially resetting the blockchain to before the hack had happened.
More recently, all the $US60 million ($83 million) invested in “dog-inspired” AnubisDAO was siphoned off to parts unknown. Last month, $US130 million was stolen from (badger-inspired?) BadgerDAO.
Controversy over finance and corporate forms is, putting it mildly, nothing new. Just over 300 years ago, the bursting of the South Sea Bubble led to a ban on new joint stock companies without royal charter, under the Bubble Act 1720. (The ban was eventually lifted through the Bubble Companies, etc Act 1825.)
Today, corporate fraud is lamentably common but no one would suggest abolishing corporations as a solution. The consideration of a new corporate form is, however, an opportunity to get the design right to minimise risk.
The warning of the 1984 Gower report on investor protection in the UK, that it would be “detrimental to the national interest and reputation if regulation is so lax that we become a haven for crooks”, is every bit as relevant to current times and technologies.
Stephen Minas is associate professor at the Peking University School of Transnational Law.
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