Explain Like They’re 5 — How TheDAO Was Misunderstood by TheSEC
While the SEC investigation and report on the DAO has made a lot of headlines, it shows the SEC’s naivete and lack of understanding regarding blockchain technology and subsequently DAOs. Below are some examples from #theDAOReport. I’m not licensed as a lawyer in US. The article expresses my personal views.
“Although The DAO has been described as a “crowdfunding contract,” The DAO would not have met the requirements of Regulation Crowdfunding, adopted under Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012 (providing an exemption from registration for certain crowdfunding), because, among other things, it was not a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority (“FINRA”)”
Literally it was a crowdfunding contract. Just a crowdfunding contract. No Broker Dealers which are expensive intermediaries, sometimes even corrupted. Also, it took 4 years for theSEC to implement regulation crowdfunding, and eventually it proved to be a failure.
The world would have been still waiting for a global scale crowdfunding, if not for blockchain technology. Using blockchain technology allow any person in the world can easily raise capital from other persons who hold digital currencies. This mechanism allows a freer movement of capital globally and removes gatekeepers. With it’s inclusiveness it gives a better chance to a fairer wealth distribution.
“On or about April 29, 2016, Slock.it deployed The DAO code on the Ethereum Blockchain, as a set of pre-programmed instructions.”
“Slock.it also created and maintained other online forums that it used to provide information to DAO Token holders about how to vote and perform other tasks related to their investment. “
SEC conclusion here seems (again) to be misleading: daohub.org started by community members (Auryn Macmillan), another major site to evaluate proposals was dao.consider.it, an independent online tool. Also the slack channel for TheDAO was eventually donated to the community.
“At the time of the offering, The DAO’s protocols had already been pre-determined by Slock.it and its co-founders“
That SEC record of events does not correspond the project’s github account, where we can find 21 contributors, while slock.it employed only 3 people. And this is a relative large amount of contributors to a new open source project.
“There were no limitations placed (…) on the number of purchasers of DAO Tokens, or the level of sophistication of such purchasers”
The SEC really correlates sophistication with wealth, by an arbitrary label called Accreditation. The standard for accreditation is whether one has $1m USD in assets excluding his primary residence. The SEC discussed changing this discriminating limitation on investing capital once, but it turned out for the worse. Of course, as it took 4 years for Regulation Crowdfunding and 1 year and two months for the SEC to decide on theDAO legal status, it can be years until we see any progress here.
“Curators could impose their own subjective criteria for whether the proposal should be whitelisted for a vote by DAO Token holders. (…) that (Curators) clearance process did not include any mechanism to provide DAO Token holders with sufficient information to permit them to make informed voting decisions.”
It doesn’t seem like the SEC understood the role of the curators at all. It was just “trivial and entirely algorithmic , no judgement whatsoever is required” as co-author of Ethereum Gav Would himself have put it. They were acting as “identity oracles”, and you can think of a scenario in the future that a non human version of such oracles would replace them, bringing back the A into theDAO.
Curators were volunteers, they did it through their own free will. Any attempt to see them otherwise or attaching attributes to their role can be harmful Although larger groups of curators or independent oracle services (variations of Oraclize, The uPort Project), might have been better, theDAO Curators were still monitored very closely by a large community, and could have been fired through a proposal. It would have been extremely hard for them the act on foreign interests.
“The DAO’s investors relied on the managerial and entrepreneurial efforts of Slock.it and its co-founders, and The DAO’s Curators, to manage The DAO and put forth project proposals that could generate profits for The DAO’s investors (…) Their efforts, not those of DAO Token holders, were the “undeniably significant” ones, essential to the overall success and profitability of any investment into The DAO “
The whole point of theDAO was to allow anyone to participate and suggest proposals. You didn’t have to be one of slock.it guys or a Curator to submit a proposal, on the contrary, check the community strong refusal for the slock.it security proposal.
Also slock.it “essential managerial efforts which affect the success of the enterprise” might have been less relevant on the long run if indeed the Community would govern the organization mostly through software.
Finally it is not clear that “managerial and entrepreneurial efforts” can easily fit open sourced development. Howey test is from 1946, long before the concept of open source software was even born. Any user could contribute to theDAO code, and if slock.it disappeared theDAO would still run, thus it is harder to determine that slock.it, or anyone, were essentially the managers of this open sourced project.
“That the “projects” could encompass services and the creation of goods for use by DAO Token holders does not change the core analysis that investors purchased DAO Tokens with the expectation of earning profits from the efforts of others.”
Enter the unfulfilled vision of Universal Sharing Network. That is the essence of blockchain, it promises to scale and coordinate human activity to provide profit and utility. Token can represent both usage rights in a network as well as the opportunity to profit from the popularity of that network. O n the other hand public company usually distribute profit as dividend in fiat (or sometimes as dividend in kind, mainly for tax considerations). Little do we know where this will go and we’re only starting to scratch the surface of it’s potential in the token economy.
In theDAO example holders could collectively fund Airbnb-Decentralized project and the collected fees that would be then redistributed to DAO holders either with ETH, a crypto currency or a usage rights of Ethereum blockchain, or with the Decentralized Airbnb Tokens themselves, granting direct access to bed and breakfasts all over the the Decentralized Airbnb’s listings. Accordingly, DAO holders could also be seen as expecting goods in return for their participation.
“The voting rights afforded DAO Token holders did not provide them with meaningful control over the enterprise, because (1) DAO Token holders’ ability to vote for contracts was a largely perfunctory one; and (2) DAO Token holders were widely dispersed and limited in their ability to communicate with one another”
The opposite, theDAO was a self-executing program! Although perfunctory is a nice word I had to google translate, the voting right granted could not been anymore efficient: the user held it’s own voting rights, not an intermediary that collects fees using proxy schemes. Users interacted directly with the software. Couldn’t get more attentive than that.
As for the ability to communicate, well it’s the internet era. People and companies now days are using Slack, forums and instant massaging apps. The whole point of the internet is to allow people to share information and collaborate on it (anyone remember the Arab Spring?). Wall St. is still using snail mail and fax, while online communities and team members can give 24/7 online support. It’s an online companionship, or a partnership. And this phrase holds a crucial legal implication.
Courts found that general partnership is not a security because partners have significant control over the enterprise. But according to the SEC, theDAO holders had limited control, and their voting rights resembled more those of a corporate shareholder.
Indeed in Williamson Case it was found, that a general partnership or joint venture can be a security if: (1) there is little power in the hands of the partner or venture;(2) or the partner is so inexperienced that he is incapable of intelligently exercising his partnership powers;(3) or the partner is dependent on unique entrepreneurial ability of the manager that he cannot replace him.
This is not the case with blockchains.
Williamson case is from May 21st 1981, long before the internet, even longer before bitcoin. Satoshi proved us otherwise, he left bitcoin and yet it still goes on. Power is inherently decentralized on the blockchain, it’s an open sourced collaborative project that anyone can contribute to. Users benefit from it even if they are not knowledgeable about SHA256. Partnerships can and should occur online with large amount of people, it’s the only path forward to human coordination. Bitcoin appeared out of nowhere and the internet won a new and independent currency.
The SEC’s current regulation doesn’t allow for the public at large to form an organization together. The SEC is actually saying that online networks are incapable to collaborate and make decisions on their own budget. Unless, of course, they go through the SEC non practical registration process. The SEC conclusion endanger the future of crypto currency based social networks.
Unfortunately, the SEC didn’t even bother to deep dive into the meanings of forks and theDAO’s split function. These are innovative decentralized mechanisms which allow groups to maintain independence from larger groups, and effectively have their own course of action in cases of dis-agreements.
Now Andreas M. Antonopoulos is already publicly saying that not every security should be registered with the SEC. Bity furthermore argues that theDAO creation was similar to a creation event of a big organization from the first place, and that doesn’t necessarily needs an approval. Bitcoin was created without any permission, and yet is integrated to our legal system.
It’s also important to emphasis that most ICO’s are distributing consumable tokens, not a partnership units. This could be another discussion, but in short consumable tokens are spendable on a certain platform to access it. These are different than securities, where one holds them and expects solely a dividend or some kind of return on investment.
Eventually, enforcement will get harder in the new world we are building. Lawmakers are still scratching their heads. Nevertheless, innovation will not stand still. It used to be a world with no shareholders, monarchs used to have all the rights. Then limited liability companies appeared with restrictions on registration (and securities regulations after the great depression). But now a virtual organizations world is forming. It will be different than anything we’ve ever know. As we’re moving forward to more automatic, information based approaches to finance, it only make sense to create such environment more decentralized and open sourced.
Just like theDAO.
And one more thing…
“During the period from May 28, 2016 through September 6, 2016, one such Platform executed more than 557,378 buy and sell transactions in DAO Tokens by more than 15,000 of its U.S. and foreign customers. During the period from May 28, 2016 through August 1, 2016, another such Platform executed more than 22,207 buy and sell transactions in DAO Tokens by more than 700 of its U.S. customers.” — Where is the source SEC? #ELI5