A DAO (for Decentralized Autonomous Organization)is a new form of business organization that is native to the blockchain. What is it? well, the Ethereum foundation has this handy chart:
But to really understand the nature of a DAO, we need to better understand the “traditional organization”, the corporation. The corporation was a world-changing legal innovation that enabled the separation of two different roles in an organization: ownership and management.
It does this by providing limited liability to owners (so they can invest in the corporation without risking all of their assets) and imposing a fiduciary duty on the managers. Both of these aspects have long and complicated legal histories, but corporations provide a neat package of well-accepted and time-tested legal patterns that make investors willing to put their money in the hands of other managers.
A corporation is all about trust. Specifically, an established legal system can enable the owners of a corporation to trust the managers. This trust led to the development of the kind of organization we know today where a large amount of capital enables the hiring of a large number of laborers that are organized by a hierarchy of managers.
But corporations aren’t the only kind of organization that exists today. There are also all kinds of private companies, clubs, non-profit groups, and cooperatives. Some of these organizations share the democratic ethos of DAOs. For example, a cooperative organization (i.e., a coop) gives voting rights to participants, not to equity owners (although, sometimes it’s a combination of both).
The key thing to understand about all of these corporate alternatives is that they don’t really work at large scale. Large private companies and agricultural cooperatives definitely exist, but the business world is dominated by corporations.
It should be noted that large private corporations and cooperatives also have large managerial hierarchies. The thing that is different is the ownership structure, not the management structure.
It should also be noted that different management structures do exist. For example, the book Reinventing Organizations highlights a few organizations that push decision making power to teams that actually do the work. But as far as I know, this kind of management practice is still pretty rare. It hasn’t really threatened the traditional management hierarchy.
So the corporation emerged due to some legal innovations, and dominates the market for business organization. Enter the blockchain. The blockchain enables people to engage in certain transactions without the need for trusted intermediaries. So, for example, people can send crypto currency across the world without a bank. The cryptography part of cryptocurrencies also enables people to protect their assets without an intermediary.
So the question is: will the emergence of “trustless” transactions will revolutionize corporate structures in the same way it is currently revolutionizing money?
There are three primary ways that blockchain could disrupt corporate organization. Namely, it could change 1) the relationship between the organization and the state, 2) the relationship between capital and management, or 3) the relationships between management and labor.
The first possibility I want to consider is a model where corporations themselves don’t change very much, but the relationship between the corporation and the state is modified.
Currently, corporations depend on the state for their existence. If an entity isn’t granted a legal existence by the state, there is no guarantee of limited liability or fiduciary responsibility. But perhaps this could change. The blockchain does provide new ways for people to engage in and even enforce some agreements.
Thus, a combination or smart contracts and contractual agreements signed via blockchain transactions can take the place of a legal entity granted existence by the state. These contractual agreements may not provide the full extent of limited liability created by statute, but they could provide some of the benefits of corporate structure, and it might be enough for a species of autonomous organizations to emerge.
Of course, just because contracts are signed on the blockchain doesn’t mean they will be enforced there. If a contract is violated, those people involved in autonomous corporations may still want to enforce their rights in a traditional court. The jurisdiction for settling such disputes could be established by the contracts. In other words, a blockchain-based corporation could exist independent of any state charter or registration, but it could still use traditional courts for dispute resolution.
Another alternative is that the blockchain enables a modification in the relationship between capital and management. In it’s simplest form, this could just mean that some corporations prefer to represent ownership using tokens rather than shares that are traded on traditional markets.
In some cases, tokenized corporations might still be chartered by a government entity. For example, the US state of Wyoming has created a ‘DAO LLC’ model to entice blockchain based organizations to register there. The Wyoming model is not without its critics, but the point is that the question of whether a DAO has a legal entity “wrapper” is separate from how it raises capital and how it enforces obligations between the owners and managers.
As with Autonomous corporations, tokenized corporations can still have a centralized management structure. Currently, the kinds of decisions made by corporate managers are too complex to be replaced by an organization type with the feature “Voting required by members for any changes to be implemented.” Avoiding the necessity of ownership in the management decisions is the key feature of corporations, so it is unlikely that an organization type that focuses on getting owners more involved in decision making is likely to spread too widely.
Perhaps the most interesting way that the blockchain could impact business organizations is to change the relationship between management and labor. This is really what decentralization means. If you have a hierarchical management structure, you are not decentralized, regardless of who owns your shares or tokens.
One way that the blockchain could change management structures is that certain management functions could be automated. For example, an automated market maker (AMM) needs to set an exchange price between two tokens. This decision can be made by an algorithm instead of a central planner.
However, the ability to automate relatively simple decisions like price-setting is not really going to change how firms organize. Large corporations involve an incomprehensibly large number of decisions. In many cases, these decisions can’t be easily broken down into discrete automatable pieces. Until we get better and more generalized AI, I find it unlikely that algorithms will replace management hierarchies.
Still, there is another way that firms could be disrupted. In his famous paper The Nature of the Firm, Ronald Coase provided an useful framework for understanding the structure of firms. In his model, firm structure depends on the cost of making contracts. He differentiated between external and internal contracts, and argued that the size and nature of firms will depend on the costs of engaging in these two kinds of contracts. Specifically, firms will expand to the size where the marginal external contract is equally costly as the marginal internal contract for the same thing.
The emergence of the blockchain led to an initial proliferation of large, democratic DAOs where token owners vote on everything. But a DAO like this will never really be able to direct significant amounts of labor. A more disruptive model will look more like a collection of small groups that interact using external contracts. The blockchain has the potential to change how firms organize because it can change how costly it is to engage in these external contracts.
Before fans of decentralization get too excited, however, note that history has shown that improvements in communication technology usually tend to increase the size of firms, not decrease them. Better technology allows managers to collect and analyze more information, which tends reduces the cost of making internal contracts. So it is possible that blockchain technology will result in the creation of even bigger, more centralized firms than before.
At the end of the day, I think the trend toward larger, more centralized firms will continue over the long run, even if there are a few oscillations here and there. But that doesn’t mean there won’t be room for smaller organizations and emergent orders made up of smaller teams.
To the extent that decentralized organizations exist, they will look like networks of small teams and individuals that interact via contractual arrangements. Neither algorithms nor mobs of token owners voting on everything can make the types of decisions necessary to maintain a dynamic organization.