TheDAO — The End of the Corporation?
It’s bold, risky and it could change the world. Or it could fizzle out completely. It’s called TheDAO (for now), and it is a groundbreaking attempt at using the blockchain to change what a company is in the digital age.
Let’s start at the beginning
First, what is a DAO?
DAO stands for decentralised autonomous organisation. A DAO is a self-organizing entity in which software acts according to a set of rules encoded on a blockchain. The rules are immutable and transparent for everybody to see. DAOs are the zenith of digital business. A real digital business does not have a ‘chief digital officer’, or undergoing a ‘digital transformation’. It is an attempt to rethink the very fundamentals of what a business can be with today’s technology, unencumbered by legacy systems, legacy legal structures and most profoundly, legacy thinking.
So, what is TheDAO?
TheDAO is an open source computer programme that works like an investment club. It exists on Ethereum, a decentralised computation platform with a built-in cryptocurrency called Ether. Ether has a real-world value in currencies like US Dollars or Pound Sterling because it can be traded on exchanges. Being an Ethereum programme, TheDAO can be the sovereign controller of an amount of Ether, and send this to others according to its hardcoded rules. TheDAO has semi-anonymous members, no board, no physical presence, no website, not even a legal entity.
TheDAO is not the first attempt at launching a DAO, nor the first attempt to launch a decentralised funding platform. It is however by far the most successful attempt up to now. At time of writing, it has raised $127 million making it the highest funded crowdfunding project of all time.
One theory to explain how one initiative could suddenly raise such a large sum of funds is that holders of Ether saw their crypto-assets sharply appreciate in value since the Ethereum crowdsale, but didn’t have many options to further invest their wealth. Founder and COO of Slock.it and prominent contributor to TheDAO, Stephan Tual, states that giving focus to “sleeping ether” is indeed one possible use of TheDAO:
How does it work?
Investment by TheDAO is structured through Proposals. Real-world businesses or persons called Contractors present an investment Proposal to TheDAO in the form of an Ethereum programme and a description in plain English. A Proposal can describe anything from a lemonade store to a space tourism operator. Anything goes as long as there’s a projected return on investment for TheDAO. Backers of TheDAO vote on Proposals through the Ethereum network, and votes are fully traceable and transparent.
Now, if a Proposal, say for a lemonade store, is accepted by vote, the requested amount of Ether is released. Ideally, the Contractor builds the lemonade store, sells a lot of tasty lemonade, makes a healthy profit and returns the agreed percentage of profit to TheDAO. In a less successful outcome, the project might run a loss and no profits returned to TheDAO.
What can be funded?
Considering the background of the project and the size of the fund, Proposals will likely not be lemonade stores but decentralised applications. From its creation, TheDAO already has enough credibility to become a serious alternative for other forms of early stage startup funding. There are no limitations for any backer of TheDAO to submit a Proposal, have it voted upon and possibly funded. Confusingly, TheDAO does have Curators, whose job is to validate the identity of the Contractors, but they do not provide curation per se, and certainly do not make a judgment on the Proposal. Gavin Wood, one of the original Curators resigned from his role as Curator emphasizing that he felt the communication had been misleading. Curation and due diligence are not modeled as a core part of TheDAO itself. Instead, TheDAO is supposed to hire experts to provide these services with its funds. All of this means there are little safeguards for investors.
The lack of limitations raises questions of illegality. What happens if a crime is committed using funds from a DAO? TheDAO is not a legal entity. Its funders are legal entities, but they are semi-anonymous, not directly connected to the decision, and possibly in many different jurisdictions. Should they all be prosecuted? The legal industry needs to start thinking about these questions.
Why does it matter?
It matters because TheDAO, and DAOs more broadly, is the first serious attempt at rethinking what a company should look like in a digital and globalised world. Existing governance and business processes were designed to work with employees in factories and offices locally. Board meetings, contracts, financing and investment, certificates of equity, and legal contracts are all processes designed with the assumption that governance and management occur face to face with a handshake and a signature. Sure, we now have video conferencing and digital document signing, but these are tools designed with the previous assumptions in mind.
TheDAO makes new assumptions; locality doesn’t matter. The Curators, Contractors and Token Owners can be anywhere and engage in economic activity. This is a paradigm shift. We will need to rethink all of our old assumptions. Why do we need offices? What is the role of middle management in an era of smart contracts? How do nation states legislate, audit and protect the consumer if TheDAO does not operate in that state?
DAOs could outcompete traditional corporate structures. Like the networked working trend is challenging the traditional model of labour with individuals working in a single job for a long period, DAOs could disrupt the corporation itself by offering a more fluid funding model with networked shareholders. The whole decision-making process is potentially more efficient, scalable and diverse. DAOs provide the framework to realise the potential of the blockchain — removing intermediaries in marketplaces. Who would have thought this would include the company itself?
What are the risks?
It’s easy to say that locality doesn’t matter, but the fact is, in the world today: where a business is based, does matter. There are three important risk areas that DAOs have to face in today’s world; economic, technical and legal.
The holdings of TheDAO are, and always will be, held in Ether, a highly volatile crypto-asset. For example, the total size of the fund (around 11 million Ether at the time of writing) has been worth anywhere from $90M to $154M in just the past two months. Likely to a majority of backers of TheDAO this is a non-issue as they were already invested in Ether. To a prospective investor who holds capital in fiat currency, however, this poses an additional risk over the risk of financial success or failure of the individual projects that TheDAO invests in.
On the side being funded, Contractors receive their funding in Ether and pay their profits to TheDAO in Ether. As Contractors are real-world businesses, they likely have fixed costs that are specified in fiat currency, and could receive their revenue in fiat currency as well. Trading in multiple currencies has always come with a risk, even to current businesses, but the currency risk of transacting in Ether is of another level.
In any investment in technology, there is a technical risk. Administration systems might contain errors, bank transfers might fail, developed products might be faulty. In this case, the impact of a technical error is greater than in traditional investment vehicles. TheDAO exists only as technology. Hence, if a technical error in the underlying Ethereum network or TheDAO itself causes for example loss of funds, those funds are irrevocably lost. There is no bank to call. The developers of TheDAO aim to avoid this through careful development, testing and thorough auditing, but there are no guarantees.
A first small bug in the code of TheDAO has already been found in practice. The impact of the bug was low: the price increase of tokens in the crowdfunding sale was started one day later that planned. It does make clear that even well-tested code can lead to unexpected results. In the case of TheDAO those results are irrevocable.
The wide suite of international laws relating to commerce and equity raising are simply not ready for TheDAO:
First, investors and companies are increasingly regulated as to how investment opportunities are marketed and executed. Those regulations are quite different from country to country around the world but none of those regulations fully contemplate a structure such as TheDAO. That will mean increased risk for founders raising money in this way as it will be unclear as to whether the fundraising is legally permitted, especially as the owners of DAO tokens are not guaranteed to have qualifications to make sophisticated investments.
Second, due diligence and a suite of investor protections that typically sit in (non-smart) shareholder agreements will need re-visiting. These are areas that are not necessarily legal requirements but investing is all about “buyer beware” — investors need to do the thinking up front. Not just about the business opportunity at hand, but also about the management team’s engagement and ensuring that IP/goodwill of any particular venture is being created in an entity that can be sold or floated to crystallise value for the investors. Traditional due diligence and contractual remedies when things go wrong all need re-visiting in a DAO scenario.
Finally, that point around value creation is fundamental. How will the investors make their return? The best tech companies are floated or sold to a strategic buyer. Can a DAO be floated? Not yet. Can a DAO be sold? Technically yes, but is that likely? Perhaps not right now but it’s not impossible. It will be quite mind-expanding for almost all strategic buyers currently, though.
DAOs as a disruptive innovation
We are at the beginning of a bold experiment into what a company should and can be in the digital age. Almost all businesses today are aware of disruptive innovation and worry about new competitors undermining their business models with new technology. But they may have all been looking in the wrong place. It might not be the business model that’s undermined; it could be the whole corporate structure itself.
The crowd sale of tokens runs until the 29th of May 2016.
This post was originally posted on the Outlier Ventures blog. If you enjoyed the post, please recommend and share! Thanks
Disclosure: The authors have no affiliation with TheDAO and are not invested in its tokens.