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The Crown, the Market and the DAO

Upon analyzing competing factors, on balance, the Authors question the notion that all DAOs should be considered as constituting general partnerships, discuss different possible avenues for their legal treatment, and provide recommendations for regulators and adjudicators.

Published onJun 24, 2023
The Crown, the Market and the DAO


Decentralized Autonomous Organizations (DAOs) show significant potential for enabling a new form of stakeholder-driven business organization with the potential to democratize certain business processes, dis-intermediate transactions and ease principal-agent issues encountered in traditional corporations. However, the legal status of DAOs remains an open question, and contributes to legal uncertainty for economic actors wanting to experiment with this novel form of business organization. Basing ourselves on company law theory, an analysis of relevant case law and previous academic commentary, we investigate the legal nature of DAOs, with a focus on questions of legal personality and liability. We put forth three competing focal points of analysis, (1) A nexus of rights and obligations approach, (2) an investor protection approach and (3) an innovation principle. Attempting to balance these factors, we question the notion that all DAOs should be considered as constituting general partnerships, discuss different possible avenues for their legal treatment, and provide recommendations for regulators and adjudicators facing this question.

1. Introduction

Decentralized Autonomous Organizations (“DAOs”) are a relatively new subject in academic scholarship. In particular, their legal underpinnings warrant further investigation. This paper seeks to add to the emerging literature by conceptualizing the legal nature of DAOs from a theoretical perspective, and by identifying legal and regulatory governance challenges faced by DAOs, while focusing on the innovative potential that this new form of business organization may provide. Decentralized Autonomous Organizations find their origin in Distributed Ledger Technology (“DLT”), a technological infrastructure allowing for access, validation and updating of records in a decentralized and largely immutable digital database.

The most important feature of DAOs is that DAO records, as well as DAO processes and compensation (generally through tokens), originate from computer code, thus necessitating no human intervention. A DAO is then an organization that runs on computer code that stipulates the provisions in smart contracts whereby a blockchain records all transactions and programmed code. While this new form of economic organization gives rise to substantial potential for innovation of business entities, many surrounding questions remain unanswered, in particular with regards to their legal relevance and contestation. The next section of this paper lays out the principal innovative potential of decentralized autonomous organizations: enabling a new form of business architecture that can complement existing centralized structures, by providing greater efficiency in specific domains of economic activity.

The paper then discusses the implications of contemporary company law theories for these newly emerged forms of business organization. It argues that, as the economic interactions that DAOs engage in make them part of society’s legal fabric and make them susceptible to producing real effects within it, the conceptual basis from which the legal nature of DAOs should be analyzed are to be found in existing company law and legal theory. This is not to preclude the adaption of these conceptual frameworks to the changes that may occur in the legal field through the emergence of DAOs. Rather, it is to say that we must acknowledge the pre-existing conditions before possibly venturing to adapt them.

While the appropriate framework to analyze the legal questions surrounding DAOs is found in existing law of business organizations, such analysis must be supplemented by a clear understanding of what is to be achieved by it from a teleological perspective. This paper lays out three such objectives: (i) the location of a nexus of legal rights and obligations for DAOs, (ii) the objective of investor protection, and (iii) the fostering of innovation. The dynamic of how these three interact will be explored in section IV.

We conclude that DAOs represent an opportunity from an economic perspective, providing novel structures of organizing capital and labor for productive means—yet they present a challenge from a legal perspective due to their inherent rope dance between securities and company law. From an innovation perspective, regulators and adjudicators must find a way to promote economic benefits while ensuring that a legal nexus for rights and obligations of DAOs is preserved.

2. DAO Innovations in Economic Organization

As we currently witness with DAOs, the development of new business organizations has historically been both the facilitator and result of economic progress. New forms of business organization have arisen out of the demands from new forms of economic activity, but have also facilitated these, creating a positive loop of enhanced economic efficiency. The primary innovative potential that DAOs bring to the contemporary economic landscape is three-fold: Firstly, they create the possibility of organizations that better respond to stakeholder needs through technology-based stakeholder coordination.1 Secondly, as a result they can contribute to solving principal-agent issues encountered in traditional firms. Thirdly, they have to potential to disintermediate transactions and thus contribute to greater economic efficiency.

Stakeholder-driven organizations

DAOs allow coordination in the assignment of resources and (economic) activities. Decisions are made by DAO members communally, allowing for the empowerment of members so that each can propose, vote and implement changes to the entity’s functioning. As such, hierarchical management does not exist within DAOs (except for when coded for and voted into effect). Typical concentration at the top of a company can thus be avoided, so that it is not a small minority making decisions. As such, DAOs may offer an organizational structure that is more democratic, with the ability to direct efforts to a wider set of goals.

Usually, DAOs are coordinated by tokens (or non-fungible tokens) that grant voting power, and DAO voting is only open to confirmed owners of these tokens. In this case, however, in some forms of DAOs the amount of tokens one owns delineates their voting power, which could make certain holders much more powerful in voting power, in particular in the absence of legal protections against manipulation or restrictions of actions that could be undertaken by a single individual. This is not the case for all DAOs, as some use different voting mechanisms sometimes even allowing for delegation. In essence, as a DAO builds on computer code and smart contracts, different constellations can be implemented. Complementing the inclusion of members in voting, DAOs are also by design transparent and accountable. Indeed, the code of a DLT and a DAO, as well as the transactions recorded in it, is publicly available. Although the development of this novel form of economic organization is at an early stage, these features point towards significant potential for DAOs to enable more stakeholder engagement in business organizations.

Principal-Agent problem

The principal-agent problem that typically arises in situations where delegation is a necessity is well understood in the management and organizational literature.2 In a typical business organization, it involves misalignment of incentives between principals (shareholders)—who benefit primarily from a company’s long-term profitability and valuation—and their agents (management), who in general benefit more strongly from short-term compensation and retaining their employment. Management of a company can also benefit from a rise in the valuation through bonuses and compensation. However, interests are rarely fully aligned, which might mean that shareholders do not reap the full benefits of the value generated by the company. Compensation packages of higher management might be focused on short-term goals, whereas shareholders tend to have longer term goals. A DAO structure could contribute solving this longstanding issue in business management, as it typically allows shareholders to have a more direct involvement in the management of the organization.

Disintermediating and facilitating transactions

Due to the way a DAO functions by using smart contracts, there is lesser need for intermediaries to administer DAO transactions. A DAO smart contract can assess delivery of a task by the computer code, and then pay compensation immediately. In particular, more trivial tasks can be conducted with immense efficiency. It also allows the organization to benefit from economies of scale and scope in particular when dealing with simpler tasks. Complex tasks may currently be difficult or impossible to handle with smart contracts, but the practical reach of smart contracts will certainly expand over time. Standardization based on coding could thus lead to substantial cost savings, both in terms of drafting a contract, as well as assessing the completion and processing the payment. Moreover, contracts are in general incomplete, as they fail to incorporate every different state of the world. Smart contracts, on which a DAO is built, are not more complete, but have precisely-defined scope and effect with less room for ex post renegotiation.3 As a result, DAOs can deliver many functions with less human intervention than a traditional organization would require.

In an increasingly global world, transactions are no longer bound to nations’ borders. International transactions have generated tremendous wealth but also suffer from increased uncertainty. Dealing with a partner in a different country with a different legal framework might be risky, hence the necessity to build up trust between trading partners. DAOs can help to ensure that certain actions are undertaken and do not require a similar amount of trust. Compensation through token payments is instantaneous, without the need to exchange currencies or involvement of a third party (financial institutions). A DAO that is well-designed would allow the parties certainty regarding the tasks to be performed, the assessment of completion and the compensation thereafter. No third party involvement also significantly increases the speed of transactions while lowering their cost. All of these benefits provide DAOs with a unique place in our current economic landscape and could make DAOs the organizational choice of the future for certain transactions. However, the question of how to assess this novel form of organization from a legal perspective remains largely unanswered.

Legal innovation and market innovation of economic organization have had an interdependent relationship throughout history, facilitating, influencing and supporting one another.4 In this development, legal personality and limited liability, and their extension through different domains of economic activity, have been a major catalyst.5 With the arrival of the medieval commenda, an early form of limited liability equity participation, sea trade in the Mediterranean was set to take off and provided one of the contributing factors of economic re-emergence of the European continent after the dark ages.6 When limited liability companies were first incorporated into the common law in England, the ventures that resulted out of this novel creation laid the foundation for new, (in)famous global trade ventures such as the East India Company.7 The general availability of incorporation beginning during the 1800s then provided for the dissemination of entrepreneurial opportunity.8 This shows how innovation in the forms of economic organization have throughout history been in an interdependent relationship with legal innovation of business organizations. As we lay out below, similar tensions and dynamics are in play today in respect to DAOs and their innovation of economic organization. Just as when sea travel pushed the development of new organizational forms, the arrival of digitalization, and the blockchain in particular, pushes for new approaches.

The primary legal questions that arise for a DAO revolve around legal personality and liability.9 This paper argues that on the basis of current positive law, the question whether DAOs may be awarded legal personality absent the formation of a recognized legal entity must be answered in the negative, based on the simple fact that in the eyes of the law a corporation with separate legal personality cannot be forged by contract alone, nor can the law imply a corporation. By contrast, a partnership, which can exist through purely private agreement, may turn out to be one appropriate default treatment of DAOs, though some reservations arise. We explore these issues from the perspectives of theory and practice, with a focus on the United States. From a theoretical perspective, the emergence of DAOs revives a century-old debate concerning the legal nature of corporations, focused on a state-focused “concession” approach and an agreement-focused “contractarian” approach. From a practical perspective, one must ask the question whether current positive law is sufficiently prepared for the emergence of DAOs, or whether novel legal innovations must go along with this market innovation.

Revived importance company of law theories

The question of whether DAOs should be awarded legal personality, and consequently, limited liability, revives a century-old theoretical legal debate concerning the nature of companies and corporations. With increasing technology-based innovation in regard to economic organization, particularly in new forms of blockchain-induced economic structures, an inquiry into the basic theoretical building blocks that make up our understanding of companies in the contemporary legal context is required. If we are to inquire how blockchain-based Decentralized Autonomous Organisations are to be categorized legally, we must do so on a sound conceptual basis stemming from company law theory. As outlined by Foster (2000), the primary theories of the creation of corporations with separate legal personality are i) Concession theory, ii) Real/Natural entity theory and iii) Contractarian theory.10 For the purposes of this paper, we will focus primarily on Concession and Contractarian theory as the basis of our analysis, as they are the most influential theories in contemporary company law, and provide a fundamental dichotomy as a basis for analysis. Concession theory holds that corporations with separate legal personality and subsequent limited liability can only be formed through concession by the state, even if this concession is given without further conditionality apart from complying with the laws and procedures governing their establishment.11 Contractarian theory on the other hand holds that corporations should, at least from a normative standpoint, be able of being formed by contractual agreement alone. Applying one or the other of these theoretical frameworks to the emerging law of DAOs will have far-reaching consequences in the context of emerging adjudication that is taking place, but also as a baseline for considering the necessity of permissive statutory company law treatment of DAOs.

Concession theory

Concession theory is the archetype of the state-based approach to company formation. In the United States, this approach can be found in landmark judgments such as Dartmouth College v. Woodward (1819), where the Supreme Court held that “A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law. Being the mere creature of law, it possesses only those properties which the charter of its creation confers upon it either expressly or as incidental to its very existence.”12 While Dartmouth College v. Woodward’s legacy is primarily seen in that it “extended the prohibition against a law impairing the obligation of contracts to a charter of a corporation granted by a state”13, it also provides a clear affirmation of concession theory, and as such of the role of state concession in the creation of corporations. The case provides a view of the corporation “as a tremendous capital accumulation device that was only made possible by the state conveying certain privileges to incorporators for which they could not otherwise privately contract.”14

While some have argued that the relevance of concession theory eroded by the late 19th century,15 the US Supreme Court confirmed the continued relevance of concession theory in 1987 in CTS Corp. v. Dynamics Corp. of America where it invoked the exact language used in the Dartmouth v. Woodward case.16 The concession approach has also been followed more recently in lower courts, such as in Neary v. Miltronics Mfg. Servs., Inc (2008) in New Hampshire District Court.17 Many, though not all, leading contemporary scholars of US company law also support this continued relevance of concession theory.18

Contractarian theory

Contractarian theory provides an entirely different legal viewpoint on the corporation. While concession theory emphasizes the importance of the state authority to grant incorporation and stipulate ancillary conditions, contractarian theory views the corporation as a nexus of contracts, focusing on the freedom of contract of the relevant parties, with a minimal role for state intervention. As explained by Klausner (2005), contractarian theory views the relationship between the constituents of a corporation “as one of contract—a ‘corporate contract’”19, which “consists of the terms of a corporation's charter and the corporate law the firm selects by virtue of incorporating in a particular state.”20 The corporation is thus a “nexus or hub of privately structured contractual arrangements” among constituents such as shareholders, managers, employees, customers and creditors.21 Contractarian theory thus conceives of corporate law as a “largely passive adjunct to the contracting process,”22 implying a laissez-faire model of state regulation of corporations, based on an emphasis on individual economic liberty.

Despite the popularity that contractarian theories have enjoyed in academic discourse, they have not been adopted by the courts in their full extent, i.e. granting incorporation and limited liability protection by contractual agreement alone. However, contractarian theories have provided the backdrop to a liberalizing approach in corporate law in some US courts.23 One prominent example of this is in Delaware, a US state that plays an outsize role in US corporate jurisprudence and which explicitly follows a contractarian approach. Former Chancellor of the Delaware Court of Chancery Leo Strine Jr. has stated:

“[T]he Delaware approach to corporate law keeps statutory mandates to a minimum […] our law is a specialized form of contract law that governs the relationship between corporate managers-the directors and officers-of corporations, and the stockholders. Consistent with a contractarian vision, our statute is, by design, a broad enabling one that permits and facilitates company-specific procedures.”24

Scholars have also contended that contractarian theory played a major role in the important and controversial ruling in Citizens United v. Federal Election Commission, where the US Supreme Court ruled that a federal statute banning direct corporate financing of political campaigns was unconstitutional.25 Padfield (2010) argues that the majority and dissenting opinions in Citizens United constituted an expression of contractarian and concession theories, respectively.26 Avi-Yonah notes that the court “explicitly rejected the artificial entity [i.e. concession] theory advanced by Massachusetts (‘corporations, as creatures of the State, have only those rights granted them by the State’).” At the same time, both the majority and dissenting factions of the court were eager to point out the non-dispositive effects of one or another theory of the corporation on their opinions. As such, Citizens United blurs (perhaps intentionally) the question of which theory of the corporation that lies at the heart of US corporate law.27

Therefore, US company law reflects theoretical pluralism between concession and contractarian approaches. On the one hand, the connection of corporate existence to state concession has been confirmed in a line of case law that dates back to Dartmouth College and has been reconfirmed in recent decisions. On the other hand, contractarian theory has played a major role in academic commentary, legislative developments and rulings such as Citizens United.

Implications for DAOs today

This US jurisprudence thus provides a blurred picture of the legal nature of DAOs. If one applies the court-preferred approach of concession theory and the role of the state in the incorporation process, the result is an unequivocal position that DAOs could not be awarded separate legal personality from its members and resulting limited liability. Two main options follow from this approach: either DAOs are treated as “a-legal” creatures, or as a form of implied partnerships. The first option is obviously non-satisfactory considering that DAOs are entities engaging in regular transactions and entering into various kinds of legal relationships, be it sales agreements, securities offerings, employment relationships, etc. On the other hand, one could take the contractarian approach that the essential nature of the corporation is one of contractual agreement between its constituents, and that thus “contracts for limited liability should be broadly enforced even if the parties have not complied with formalities such as incorporation”28. This implies that DAOs could indeed be awarded separate legal personality and limited liability. However, because this approach is not supported by current court jurisprudence, practical effectiveness of this approach would require a novel legal classification of DAOs to emerge through legal innovation.

In essence, we are back to the fundamental problem of a century old theoretical debate: Should we follow James Coke, and confirm that “incorporation cannot be created without the King,”29 or should we follow Ribstein and state that “there is no economic justification for making filing a necessary prerequisite to acquiring limited liability protection”30? From the perspective current of positive law, concession theory remains dominant. In other words, there is not yet a basis positive law for establishing limited liability or legal personality by contractual agreement alone—should this be enacted or somehow upheld in court, it would be a novelty in contemporary company law. Indeed, even in the contractarian literature, the argument that a corporation should be able to come into existence as solely by contractual agreement is put forth as a normative position, but the current relevance of state concession for incorporation is not ignored—in other words, “contractarians acknowledge that a corporation comes into being when a state grants that corporation its charter.”31

Given these legal realities, one is seemingly left with a relatively clear, concession-based view of the most practical approach: to treat DAOs as a form of implied partnership. However, while this approach can be justified in certain instances, it is ultimately unsatisfactory for the reasons that will be laid out below. Thus, in order to allow the innovative potential of DAOs to be realized, we believe that legal innovation is desirable to enable DAOs which would feature limited liability protection, thereby balancing concession with contractarian approaches. It is however not to be expected that concession theory be turned on its head for the sake of this novel type of business organization; in a more moderate expression, an emphasis on contractarian theories would point to the need to develop permissive DAO statutes, so that limited liability can be more easily attained for such entities. From a practical perspective, a more hands-off approach to unincorporated DAOs in adjudication is called for to protect innovation, only invoking the concession-based approach of viewing DAOs as general partnerships where absolutely necessary because the legal and societal interest of concentrating a nexus of rights and obligations outweigh those of protecting DAO investors and facilitating innovation. These are the three teleological imperatives which we find must be carefully balanced in bringing DAOs into the fold of company law.

4. DAOs from a Teleological and Positive Perspective

To offer a balanced perspective on how the further development of the law of DAOs could take shape, this section engages in a teleological inquiry as to the underlying purpose and interests the law is seeking to serve vis-a-vis DAOs and their counterparties. Second, based on these teleological considerations, we investigate positive law, based on case law and statute, to find suitable analogies for the treatment of DAOs in current company law. We thus arrive at three, to some extent competing, viewpoints on the legal treatment of DAOs: (i) a nexus of rights and obligations perspective, (ii) an investor protection perspective, and (iii) an innovation perspective.

A nexus of rights and obligations perspective - DAOs as general partnerships

One primary objective of company law is to define rights and obligations where any individual or group of individuals engage in risk-carrying economic activity, including to protect the interests of creditors and of parties who are injured (financially or physically) by the action of a company. From this perspective, a company can be seen as both a set of contracts dividing economic risk between parties (e.g. between incorporators, or between incorporators and creditors or investors) and as a nexus for regulation and fixed legal obligations (e.g. as obligations arising from torts).32 By analogy, the law needs to define rights and obligations associated with a DAO, regardless of whether the DAO members have thought about such a requirement when commencing their operation. This perspective thus most closely concurs with concession theory. It has also been advanced by commentators who suggest that, absent incorporation, DAOs would or should be seen as general partnerships, and their members would thus be jointly and severally liable for any debts and obligations incurred by the organization.33 We concur with this view in part, based on the necessity of establishing clearly defined focal points for rights and obligations. However, we also lay out reservations to the default treatment of any DAO member as a general partner based on the perspectives of investor protection and innovation, which we lay out further below.

The position that DAOs are to be treated as implied general partnerships has a clear legal basis: the Revised Uniform Partnership Act lays out that “the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.”34 Thus, the criteria that are to be analyzed in the context of DAOs are: whether DAO members are co-owners of a business, and whether they carry on a business for profit. The second criterium will need to be examined on a case-by-case basis, but will be fulfilled for most commercial DAOs. As to the first criterium of co-ownership, it seems prima facie that DAO members will be deemed owners of a DAO. The ownership structure of a DAO is usually determined by token ownership, with members owning a stake in the organization according to the amount of tokens they own (not unlike regular businesses). Such ownership is usually accompanied by rights to receive a proportional share in profits of the DAOs operations. According to the UPA, “a person who receives a share of the profits of a business is presumed to be a partner in the business.”35 By this definition, DAO members would be deemed partners in the business.36 It is furthermore clear from both statute and case law that it does not matter whether DAO members intended to form a partnership or not. Indeed, “statements that no partnership is intended are not conclusive. If as a whole a contract [whether express or implied] contemplates an association of two or more persons to carry on as co-owners a business for profit a partnership there is.”37 Based on the above it seems that, at least in many cases and depending on the nature of their activities, DAOs can be deemed general partnerships.

However, some complications to this definition arise. The analysis is most straightforward if a DAO has a limited number of members. If we imagine, for example, an unincorporated DAO with 30 members, each of which owns a more or less equal stake in the DAO and receives a proportionate amount of the DAOs profits, and partakes equally in decision making, the case is quite obvious. In the case that the DAO defaults and leaves creditors chasing assets, the fact the members called their organization a “DAO” or organized their commercial activities through a blockchain will not be determinative. Instead, in this case the treatment of this unincorporated organization as an implied partnership seems most coherent from a legal standpoint. DAO members will likely have purported to act as “the DAO” rather than as a partnership, which is akin to an unincorporated organization acting as a corporation—in such a case "all persons purporting to act as or on behalf of a corporation, knowing there was no incorporation […], are jointly and severally liable for all liabilities created while so acting.”38 However, analysis becomes more complicated as membership numbers in a DAO increase. If we imagine a DAO whose members number in the tens of thousands, it becomes more difficult to assert that individual members were acting as general partners, given the very limited extent of their involvement. While active DAO members are not passive shareholders as in many companies, the insubstantial impact of minority token-holder’s decisions may point towards treating them not as general partners, particularly where a dominant actor or group of actors control or have significant influence on the decision-making of a DAO.

Investor protection

From this perspective, another legal imperative is presented to which academic commentary so far has devoted less attention: that of investor protection. Specifically, at least some members of a DAO with a high number of members could also be viewed as investors rather than general partners. Even if we generally regard DAOs as general partnerships, there exists strong support for this position as a matter of positive law, based on case law surrounding the potential treatment of a partnership interest as an investment contract. Such treatment points in the direction of shielding at least certain partners from unlimited liability. In Williamson v. Tucker the court held that:

“A general partnership or joint venture interest can be designated a security if the investor can establish, for example, that (1) an agreement among the parties leaves so little power in the hands of the partner or venture that the arrangement in fact distributes power as would a limited partnership; or (2) the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or (3) the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.”39

The US Securities and Exchange Commission (SEC) took this approach in its report on the now infamous “TheDAO” project, where it stated that “the pseudonymity and dispersion of the DAO Token holders made it difficult for them to join together to effect change or to exercise meaningful control,” and that this DAO thus bore “little resemblance to that of a genuine general partnership.”40 Practical application of this approach requires case-by-case analysis of members’ individual decision making power in a DAO. Where there is very unequal distribution of power between different types of members—such as if a DAO features a prominent development/promotion company owning a majority stake, and many dispersed members owning a very small stake, the investor protection rationale would be the most coherent line to follow—thus resulting in limited liability of minority member-investors. As noted, the SEC’s report on “The DAO” supports this perspective. However, the SEC’s approach in that content was also apparently influenced by a primary objective to establish DAO tokens as securities.41 More generally, and absent facts where this classification would be the most coherent, the SEC’s reasoning also gives rise to problems in regard to the general treatment of DAOs where all token-holders are minority holders, because it would create a situation where there exist only securities holders and no general partners.42 In other words, we are left with no nexus at all to concentrate legal rights and obligations of a DAO, ignoring the first teleological perspective laid out above. This dynamic lays out the fine line that DAOs tread between partnership and securities law. In the case that a DAO includes persons or entities with important managerial responsibilities, such as the development and promotion of the DAO, and the rest of the DAOs members are dispersed and own minority stakes, Williamson v. Tucker provides a meaningful starting point for analysis. The case here provides us with the perspective that:

“if, for example, the partner has irrevocably delegated his powers, or is incapable of exercising them, or is so dependent on the particular expertise of the promoter or manager that he has no reasonable alternative to reliance on that person, then his partnership powers may be inadequate to protect him from the dependence on others which is implicit in an investment contract.”43

We therefore suggest that the perspective of member-investors should be followed for minority token-holders, whereas token-holders that are directly engaged in the management, promotion, etc. of a DAO project should be treated as general partners. The borderline between these two statuses may be challenging, but this is an ideal sphere in which case law could develop and articulate standards for determining one status or the other. Williamson v Tucker has begun this process by indicating that limited liability should apply where the “agreement among the parties leaves so little power in the hands of the partner or venture that the arrangement in fact distributes power as would a limited partnership.”44 In practice, this approach would give rise to a viable, short-term path forward for enabling innovation while securing legal imperatives. Given that prudent majority owners/promoters of a DAO can structure their venture as a legal entity (such as a limited liability company), this legal entity would be fully liable for the DAO’s operations while minority holders would be more shielded, depending on the specific facts of the case. “Purist” DAO theorists may object to this view on the basis that DAOs generally do not feature majority token-holders but are truly decentralized entities; however, on a preliminary observation it seems that in the majority of cases there are indeed entities that can take on the characteristics of general partners in DAO projects, be it majority token-holders or entities that otherwise have a decisive influence on the development and decision making of a project. Such treatment has obvious securities law (and other) implications, which should be carefully considered from an innovation perspective. Indeed, the treatment of DAO tokens as securities may not be desirable from an innovation perspective, but might require less legal innovation.

The limits of analogy: Limited liability in general partnerships?

The investor protection perspective outlined above entails the possibility of implying limited liability in DAOs built on case law like Williamson v Tucker. We believe that this approach to DAO liability is coherent and practical, because it would allow for the integration of both teleological approaches laid out above, both providing for a nexus of rights and obligations for DAOs, while at the same time protecting minority investors in a DAO who exercise close to no organizational control. We see a possibility of further developing the case law of Williamson v Tucker to provide for limited liability even without prima facie establishing all DAO tokens as securities. This is based on the fact that while DAO members’ engagement in the organization is often limited enough to warrant investor protection, it might also substantial enough to defeat the Howey test’s requirement of reliance on the efforts of others.45 However, there are remaining problems with this approach in the case of a truly decentralized DAO, where there are no persons or entities exercising decisive or even substantial influence over the organization’s decision making. Here, the investor protection rationale would indicate that all DAO members are shielded from limited liability. But this runs contrary to the rationale of protection of creditors or tort-claimants, because there would be no nexus of legal obligations. Absent the path for legal innovation laid out it also gives rise to the problem of a DAO or its founders potentially having committed a securities law offence—as viewed by the SEC in its analysis on “The DAO.”46

These problems are more easily resolved through the development of legal entities for DAOs, be they DAO-specific or general entities fit for application to DAOs. As such, for the time being, there must be a case-by-case weighing of creditors’/tort-claimants’ interests versus investor protection. In the long term, if DAOs are indeed to become a widespread form of economic organization, these issues will have to be resolved by the development of DAO specific legal entities, or the better adaptation of traditional entities adapted to DAOs. With such evolution (we do not advocate revolution!), the question of weighing the balance between creditors’ claims and investors’ protection will no longer be one of a difficult balancing exercise in each case, which yields limited legal certainty, but will be akin to how such questions are resolved for corporations today. Until this legal evolution for DAOs occurs, a balancing exercise will remain in the case of DAOs which are on the verge of displaying characteristics of partnerships and pooled investments without a clear dominating actor to provide a nexus for legal rights and obligations. In this balancing exercise, we argue that regard must be had to another factor, which favors permissive developments in adjudication and statute: that of facilitating innovation. In essence, market innovation must be followed by legal innovation, in both judicial and legislative developments, in order to find the right structures that allow the innovative potential of DAOs to flourish while fulfilling the goals of the legal system and other policy aims.

Facilitating innovation

At least in principle, there is general, widespread agreement among policymakers that the law should facilitate or at least support innovation.47 In the context of DAOs, several scholars have also emphasized an innovation perspective, which we strongly echo.48 In regulating innovative, emerging technologies, legislators and policymakers face the dilemma of balancing between embracing potential benefits and hedging against foreseen or unforeseen risks that a given technology carries.49 It is well established in law and technology scholarship that regulatory action may negatively impact innovation in several respects, such as imposing technical constraints, forcing additional expenditures, and causing legal uncertainty or delay.50 As argued by Stewart (1981), “the extent of these effects is a function of the stringency of the regulation and the particular regulatory tools employed.”51 On the other hand, an overly “laissez faire” and self-regulatory approach can lead to excessive risks and undercut public confidence in a technology.52 In the case of DAOs, the main innovative potential that we see is found in enabling new forms of economic organization, which is a type of innovation that has driven many important economic developments of the past and generated substantial wealth in doing so (as discussed above). The main risk created by DAOs that we see is that they may act in the market without having a clear nexus of legal rights and obligations.

Legislators can influence the direction that this particular innovation takes by enacting DAO-specific statutes,53 such as Wyoming has done with its DAO LLC, a company form that has been created by the "Decentralized Autonomous Organization Supplement" to the state's Limited Liability Company Act.54 This supplement creates an entity with separate legal personality very similar to a traditional LLC, and that is governed by Wyoming’s Limited Liability Company Act, except in respect to specific provisions contained in the supplement, which provide for additional flexibility needed for DAOs. The supplement provides that a DAO LLC can define itself as a “member managed decentralized autonomous organization or an algorithmically managed decentralized autonomous organization,” and provides that the entity’s Articles of Organization must include “a publicly available identifier of any smart contract directly used to manage, facilitate or operate the decentralized autonomous organization.”55 Such statutes are a step in the right direction for enabling the innovative potential of DAOs to take shape in an environment of legal certainty, which is important both for DAO entrepreneurs and members themselves, as well as for their counterparties. As regards the development of case law, we argue that judges equally should bear in mind the innovative potential of DAOs and adopt a careful analysis of the actual extent of managerial involvement of specific members in determining whether they could be classified as general partner. Currently, this question is put to the test in California, where plaintiffs in Sarcuni et al. v. bZx DAO et al. allege that “given their structures and the way they operate, the [respective] DAOs are general partnerships among tokenholders. That is, they are associations of two or more persons […] of a business for profit (the bZx and Ooki protocols and related products built on them, with the profits being the right to funds held in the respective treasuries).”56 Thus, in this case the exact questions surrounding diverging different legal interests discussed above may find a first answer in a court of law (the Southern California District Court).

We submit that the aim of fostering innovation should strongly inform the weighing of legal questions surrounding DAOs by both courts and lawmakers, including to promote legal certainty around DAOs. As suggested by Wright (2020), a comprehensive classification of DAOs as general partnerships would be a barrier to this innovation objective, since,

“if characterized as a general partnership, DAOs may struggle to attract members, especially those with significant assets. Large businesses, institutional investors, and other regulated commercial entities may be reluctant to invest or otherwise support a DAO for fear that membership would put other assets at risk.”57

The risk that legal uncertainty could obstruct the innovative potential of DAOs should not be underestimated. Nevertheless, it is obvious that a sufficient legal nexus must be established for DAOs, which in the long run will likely require the adaption of company law statutes for this purpose, as was done by the Wyoming legislature.

5. Conclusion

In summary, this paper suggests that analysis of the legal personality, rights and obligations of DAOs and their members can be considered at three levels. At all three levels, we aim to incorporate teleological considerations in terms of both the potential of DAOs and the general goals of the legal system. At the first level, a straightforward application of concession theory indicates that DAOs should be treated as implied partnerships—after discarding the impractical option of “a-legal” entities. At the second level, in order to balance the objective of establishing a nexus of legal rights and obligations with the objective of investor protection, it is appropriate to distinguish between DAO members which should be treated as general partners and those which should be treated as investors with limited liability. At this level, contractarian analysis supplements the pure concession analysis at the first level. We propose a case-by-case analysis of the features of individual DAOs, as well as evolving judicial standards, to inform the distinction between the two categories of DAO members. The third level is largely aspirational rather than related to current practice. With the goal of enabling innovation by DAOs, we suggest that lawmakers and courts should aim to establish new legal structures for DAOs that provide certainty regarding legal personality, rights and obligations of DAOs. Ultimately, at and beyond the third level, it is essential for the success of DAOs as a widespread organizational structure that the law operate as transparently and with as little friction for DAOs and their members as current law permits for traditional corporate entities. Taking into account the historical perspective of how the evolution of new forms of economic organization and accompanying legal developments have enabled economic development and prosperity, utmost care should be exercised by judges and legislators when faced with the difficult legal question emerging for DAOs, in order to effectively balance classical legal imperatives with an innovation perspective.

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