A "Decentralized autonomous organization ('DAO')" white paper has been published by German blockchain company Slock.it UG. This white paper is part of a larger conversation that's been going on for a few years in the Bitcoin/blockchain world. The basic idea is to build a software program that runs like a company, but on a decentralized software platform (e.g. Ethereum). Slock.it's paper is one of the longer contributions to this effort (31 pages, including code examples).

This blog post details a few thoughts on the Slock.it proposal, from a lawyer's point of view.

The paper starts by identifying a few problems that traditional businesses suffer from: a) fraud/mismanagement, b) perceived mismanagement, and c) investors not being able to withdraw their money.

The basic solution to the problems identified is to give the shareholders direct control of the company, using a software program that controls the business's funds. Control is exercised by a series of votes that the shareholders make in response to proposals.

As a preface to my comments: I'm not positive that the author of the white paper intends for their proposal to be widely adopted. It seems like more of an experiment but they have already attempted to implement this model under the name “The DAO”. The DAO website states that it's attracted $35 million USD worth of ether investment (some or all of which is likely to end up with Slock.it UG). A bit more context can be found in a May 3rd article by CoinJournal.net.

The author assumes that shareholders want control and would be able to evaluate the options available. I think for the vast majority of corporations, this assumption is not correct - shareholders don't want control. They want to participate in the profits in exchange for their capital. (And in a real corporation, exercising direct control could make the shareholder a de facto director, which creates potential liability.) We have the means right now to have frequent shareholder votes using web platforms (or even simpler solutions like text messaging) but this approach is seldom if ever used (I've never heard of a case but I'm sure there's something like this out there). I'll give the author the benefit of the doubt and assume that shareholders want control.

Using a DAO, as the author proposes, means contributing money to a pool that is then spent on things that the "shareholders" vote on (managed through a software program). Besides the risk of being considered a partnership, this structure means that the principals wouldn't be taking advantage of the limited liability offered by corporate statutes (e.g. the CBCA). This is one of the key advantages of actual corporations (although a DAO might have practical limited liability if the investors are impossible to find). Switching to a DAO would mean definitely losing this advantage to gain the hypothetical advantages the author proposes.

Another downside to the proposed DAO structure is not taking advantage of the investor protections created by corporate law statutes (and possibly not securities laws either). These investor protections have been created through many years of trial-and-error and offer a flexible framework for operating a business with due respect paid to shareholders. Using a small set of coded rules means missing out on some of these protections. Another strike for the rigid DAO program, although this could be mitigated by extending the DAO principle of the white paper with many more coded rules.

The author proposes a means for investors to withdraw their money if they don't like the direction the company (DAO) is headed. But for many businesses this would be a huge disadvantage. The idea of equity funding (or product crowdfunding) is that the money is available for the use of the business and won't be withdrawn on a moment's notice. Most businesses require a long time frame to deploy their capital appropriately. The author considers withdrawing funds a feature but most businesses would consider that a major downside (and risk).

The author's DAO is one in which anyone can make a “proposal” that the investors then vote on (e.g. Slock.it's proposal). If the proposal is accepted then the money (digital currency) is sent to someone (a digital currency address linked to someone's private key). But what if the person promising to carry out the proposal fails to do so? Many contractor disputes are over whether the person did a good job, so even partial completion could be an issue. How will the completion be evaluated? What if the contractor steals the money after making wonderful promises? If the money isn't paid upfront, then what about products and services that have to be purchased upfront? Or will there never be upfront cash with every purchase relying on a third party to assure the sale? That will increase costs or limit the types of businesses that can be engaged in.

As a final criticism, the author states that his solution will "for the first time" offer "governance rules [that] are formalized, automated and enforced using software". But the primary governance means offered in the proposed DAO business is voting by the shareholders. That is hardly a formalized software mechanism of governance. The author actually puts forward a very limited governance model that is encoded into the software DAO system.

Corporate governance is a huge topic that has spawned thousands of academic papers over the centuries. The Canadian business corporation governance rules are found in many thousands of pages of corporate statutes and corporate law decisions made by courts. There are many rules. The DAO proposal has a few rules but they don't come close to being as comprehensive as that offered by the laws of Canada (or any other developed country). The author's rules may be more automated and enforced using software but they cannot be considered a substitute for modern corporate governance.

Despite the criticism above, I would encourage anyone interested in this topic to carefully consider this white paper, if only to get a glimpse of one possible future of business. I don't expect this white paper to be the basis of future corporations but I do expect to see these ideas in a tangible form in the future.