Digital cooperatives are the future

Decentralised autonomous organisations (DAOs) are being described as the future of the firm. But we think we can do better by combining the benefits of a DAO model with the reassurances of a legal entity. We are linking the two concepts to form a digital cooperative.

A DAO is a way of allowing a group — people, corporations, even machines — to come together for a common purpose without the need for a central administrator (but with full trust in the code). The operations, day to day decisions and rules can be easily handled and enforced by pre-defined code, called smart contracts, running on a blockchain. It’s just as though an old community membership group running a local bake-sale was suddenly able to grow enormously without introducing restrictive coordination costs.

DAO proponents make many broad claims. They argue that this new version of the firm is inevitable and will be unstoppable; that it will shift power to the masses, enable coordination on a scale we haven’t seen yet, and that anyone can be part of it — from the comfort of their home computer. Whether or not these utopian visions prove real, DAOs need a way of interacting efficiently with the regular physical world if they are to have any role at all ‘off chain’.

DAOs replace traditional corporate governance with innovative technology. Rather than relying on human agency and trust, it relies on rules pre-defined in code that cannot be altered. No human interaction is required because the code is the final arbiter. By relying on the immutable blockchain based data model, individuals won’t have to rely on centralized control for rule enforcement. Instead of an institution or even a legal system, pre-determined code executes governance rules automatically.

The mutual and cooperative insurance market has been the fastest-growing part of the global insurance industry in the 10-year period since the global financial crisis, according to theGlobal Mutual Market Share 10 report. This is partly because consumer trust and spending declined. A DAOs main strength is an answer to those issues by reducing or eliminating ‘agency’ or the need to trust someone else with your money or property. Blockchain technology allows money to be held by smart contracts, which are controlled by the DAO, using a pre-defined set of rules. For example, consider an insurance company which holds a pool of funds from customer premiums and shareholder capital. This pool is controlled by the insurance company, with customers and shareholders trusting the managers of the company to use and deploy their funds appropriately. In the DAO context these funds can be held in a collectively owned account with a very specific set of rules — that cannot be changed — ensuring no individual or small group can access the funds in bad faith.

At the same time we have to recognise some of the challenges of the DAO:

· Maintaining ‘mindshare’ of the DAOs members and encouraging active participation in running the organization.

· The underlying blockchain platform may not be sufficiently scalable to handle all the transactions needed to make the DAO run.

· The viability of blockchain based voting systems; the way votes are set-up means the DAO is susceptible to bribing attacks, which could undermine the original purpose of the DAO.

· Legal challenges stem from a focus on technology at the expense of real-world risk. Joint and several liability, a multi-jurisdictional presence and potentially unlimited personal liability are a few issues for distributed organizations that exist globally. DAO’s are unlikely to become successful as corporate governance structures if they don’t account for the tax and liability protection benefits corporations provide.

A corporation’s limited liability for shareholders has been described as the key to industrial capitalism. It facilitates massive reductions in the costs of coordinating capital, has created access to large pools of capital that were previously sitting on the side-lines and meant that economically valuable projects are more likely to get funded. It was an important plank in the exponential growth in global GDP per capita that began in the early 1800s. Without limited liability, corporations are an ironic innovation: technologically forward, legally backwards.

A DAO might access the benefits of limited liability; obtain a defined legal personality and the associated advantages. Membership organizations already exist so it may be as simple as aligning a corporate structure with the smart contract code and effectively placing a ‘legal-wrapper’ around the DAO. Or, from a legal perspective, automate an existing legal entity using blockchain based governance systems. In doing so software can be directly combined with the real world, allowing basics like invoices to be paid. We can create something new, something we are terming a ‘digital cooperative’.

Once a membership corporation or digital cooperative, is established, there is wide scope to define its governance structures. Existing membership companies tend to delegate most control to their board, but this doesn’t have to be the case. Members can remain in control of most decision-making power while leaving only limited responsibilities with the board. Specific details of the governance structures such as day-to-day operations and decision making can be pre-defined in the smart contract code which is referenced in the company’s official documents.

So what would this mean for the digital cooperative? A combination of blockchain software (enabling the scalable coordination of disparate individuals) with a legally defined structure creates a new type of organisation. One that can adequately compete with the shareholder, profit driven organization we currently know. One that is bound by both law and code to further the goals of the community it represents. If the technical barriers can be overcome, we could see a new version, or more accurately, re-ignited a very old version of the firm.

Nexus Mutual operates as a digital cooperative and we would love to discuss our model, or any thoughts you have on it on our discord channel:

With thanks to Stephen Palley for both very helpful, as well as challenging, comments and input.