Why ‘the DAO’ Debacle Solidified My Faith in Ethereum

How ‘the DAO’ Heist Compares to Legacy Failures

Written by Zach LeBeau, contribution by Mark D’agostino

Since ETH started trading on Poloniex in 2015 I’ve recruited several new etherlings to join the cause. Most are forever grateful — they started buying in at around a dollar. My more recent recruits are not so happy. Let’s just say I feel obliged to buy them drinks whenever we go out. My friends and associates who’ve been on the fence are greater in number than those who took the plunge, so ever since the DAO debacle I’ve fielded my share of, “See! Knew it was a scam! Knew it wouldn’t work! So glad I didn’t buy Ether!”

Amidst all the “I told you so’s” what critics don’t realize is that the Ethereum community has already performed better than any legacy regulatory or enforcement agency could ever hope to under similar circumstances. How? The sheer fact that the heisted DAO funds were immediately traceable and measures were in place to both freeze and retrieve those funds is an accomplishment to be lauded. A regulatory or enforcement agency would need to monitor the entire centralized legacy world in real-time with the ability to detect fraud in order to match Ethereum’s detection of the heisted funds. The legacy banking system’s siloed and obfuscated infrastructure makes this virtually impossible. When corporate fraud, theft and impropriety do occur in the legacy world, more often than not the money is untraceable or spent by the time the authorities find out.

Let’s take a quick look at some of the biggest legacy failures in history and see if they could have been preventable — or even possible — on Ethereum.

ENRON — Massive accounting fraud wiped out $78 billion in stock market value and led to the collapse of Arthur Andersen and the passage of the Sarbanes-Oxley Act of 2002. A class action settlement of $7.185 billion was the largest of all time.

Had Enron been running Balanc3 — ConsenSys’ triple-entry accounting application for the Ethereum blockchain — or had Enron’s financial network been running on the blockchain, or even on its own private blockchain, their fraud and improprieties — particularly increasing their earnings numbers — would have been detected long before billions disintegrated.

BERNIE MADOFF — The New York money manager’s $65 billion Ponzi scheme, the largest fraud ever by an individual, was exposed in December 2008. It is well documented that the SEC missed several opportunities to stop the fraud.

As it has been explained to me by various programmers, a Ponzi scheme like Madoff’s could not have occurred secretively on the blockchain. If someone wanted to code a clear Ponzi scheme it would be apparent to everyone in the ecosystem. Attempting to hide this nefarious behavior would be impossible. The blockchain’s transparent processes would have revealed the applications true purpose, allowing investors to choose if they wanted to participate in a Ponzi scheme or not. Madoff couldn’t have unknowingly bilked investors for billions on Ethereum.

LEHMAN BROTHERS — with $600 billion in assets, Lehman failed in September 2008. It was the largest bankruptcy in history and sparked the worldwide financial crisis. A bankruptcy examiner’s report concluded there were “colorable” claims against its top executives and its auditor, Ernst & Young, for fraud. Neither the SEC nor the DOJ have so far filed charges.

The sheer amount of leverage and non-performing assets would have been indicators to prevent continuous risky behavior from happening. This situation could have been avoided if all logic existed on the Ethereum blockchain. Continuous funds pouring into highly complex financial derivatives such as CDOs would again have been much more apparent if these transactions existed on an open blockchain ledger. Further, the rising cost of capital Lehman faced in the weeks leading up to bankruptcy would have been yet another example of a red flag investors could have used to heed warning; however these details were kept private behind the guise of a walled off financial system which helped lead to massive investor and pension fund losses.

MF GLOBAL — the brokerage firm had $41 billion in assets before failing in October 2011. That put MF Global at #8 on the list of ten largest bankruptcies. A year later, $1.6 billion in customer assets were still missing and no SEC or DOJ charges had been filed.

On the Ethereum blockchain… wouldn’t have happened.

The examples go on and on from Worldcom to Fannie Mae to Healthsouth and Tyco. The SEC, the FBI, the DOJ were all late to the party. Investors lost money, and more importantly not only did ordinary people lose money, but they also felt the ramifications of these failures in their daily lives due to the systemic risk introduced to our society. The legacy enforcement and regulatory structure’s only effectiveness seems to be the establishment of systems and regulations after-the-fact, in hopes to detect massive fraud before it happens. More often than not, it isn’t preventative, but reactive. Even the newest example of bureaucratic regulation, Dodd-Frank, has done nothing to prevent additional systemic risk. It has merely transferred money out from banks’ coffers and into consulting firms in order to put together 10,000+ page documents meant to be a playbook if another disaster were to happen. These stress testing scenarios and resolution planning have no real effect on system risk of the financial ecosystem, and merely serve as a form of optics to try and quell the unrest and untrust pervasive in the investing public. Similar to the TSA — they make us no more safe.

And while Enron and Worldcom couldn’t have happened on Ethereum, “The DAO” did. How? Why? Lack of foresight, naivete. “The DAO” had holes in it, everyone agrees to that, which a shrewd operator took advantage of.

The difference between the fraud in the legacy examples above has less to do with incompetence and more to do with a mixed bag of greed and negligence. The blockchain — as Gavin Wood first put into my head — is incorruptible. Ethereum takes corruption out of the process. Something the SEC and DOJ should take lessons from. But what Ethereum can’t take out of the process is ignorance and shoddy coding… Human error. The DAO debacle challenges us — all of those people building on top of Ethereum — to be more careful, more anticipatory. It challenges us to be smarter, wiser. It pushes us to create processes to find and correct human error. But human error is something we probably won’t be able to get rid of until AI starts programming the blockchain for us. Until that time — or until the arrival of the Singularity — we need to utilize best practices to ensure the code we use to entrust our values on the Ethereum blockchain is secure.