Decentralized Autonomous Organizations – Vision and Classification Under Corporate Law

"The 50 Million Robbery" is the headline of FAZ newspaper. The magazine Wired speaks of "The Biggest Crowdfunding Project Ever - the DAO - Is Kind of a Mess".

Thus, the so-called Decentralized Autonomous Organization (DAO) first became known in July 2016, at a time when it was in the most unfavourable situation conceivable. The initiators of the project, the Canadian-Russian software developer Vitalik Buterin and his German companion Christoph Jentzsch were convinced that they had created something unprecedented. According to their vision, the DAO should be a self-governing legal entity that automatically executes decisions on the basis of a decentralized voting process among its members. The latest digital instruments should replace any human administration. Enthusiasm about a virtual company led to the first foundation and the successful issue of shares worth a total of approx. USD 152 million. Only a few weeks later, however, the DAO became the target of unknown criminal hackers who stole USD 50 million from the investors. This criminal act, which has not yet been fully resolved, led to considerable doubts about the vision, the initiators and ultimately the underlying technology.

But what is behind the technological vision of a DAO, how can it be legally classified and what relevance does this concept still have today?

Technical Background

A DAO is a structure of various smart contracts, which relate to each other and which carry out measures, when previously defined conditions arise (for further details on this topic, see Dr Christian Philipp Kalusa "Special Topic Blockchain: The Use of Smart Contracts").

The structure of smart contracts is embedded in a blockchain, a digital database that stores information transactions in a decentralized, publicly accessible and tamper-resistant manner. Investors can acquire tokens issued by the DAO, which grant them membership rights such as voting rights or profit sharing rights. These tokens are called equity or utility tokens depending on the respective weighting of their functions.

Equity or Utility Token
Tokens are software protocols that grant the owner certain rights. They are issued in so-called Initial Coin Offerings (ICOs) and can be acquired against payment of a recognised currency or crypto currency. Utility Tokens allow access to certain services or products, similar to an admission ticket or voucher. According to BaFin, this category includes the majority of the crypto tokens known to date issued in Germany within the framework of an ICO. In principle, utility tokens do not constitute securities in the sense of the German Securities Prospectus Act (WpPG) or investments in the sense of the German Investment Act (VermAnlG). In many cases, such tokens are also not financial instruments according to the German Banking Act (KWG). Equity tokens, on the other hand, grant membership rights or claims under the law of obligations to assets which are comparable to those of a shareholder or holder of a debt instrument (e.g. claims to dividend-like payments, co-determination, repayment claims, interest). In general, they are securities as defined in the German Prospectus Regulation (ProspektVO), the WpPG and the German Securities Trading Act (WpHG) and are also financial instruments as defined in the KWG.

In the case of the DAO, for instance, it is defined in advance which quotas are required for a particular resolution among the members. A smart contract, which provides for a specific transaction to a real bank account, is introduced as a resolution template. Each member then exercises his or her voting right via the token. If the appropriate quota is given, the transaction is automatically executed. An executive board or a supervisory board is not required in this scenario.

Legal Classification

The first problem with a virtual organization is the question of the applicable legal statute. The smart contracts on which the DAO is based are operated via a worldwide server network. Membership is also international and people generally only meet online. Hence, the administrative headquarters cannot be the basis for determining the applicable legal regime. Such point of reference is simply not identifiable. What is of relevance must be the so-called lex fori, i.e. the law applicable at the place of the court invoked in the individual case which is decisive. It is obvious that this can lead to different results of the legal classification.

Furthermore, the conclusion of a contract between the parties may raise questions. In order to acquire a membership token via the blockchain, the investor must use a pseudonym. This results in attribution difficulties. Voices in the legal profession, however, consider this problem to be solvable, because pseudonymisation must be clarified with the corresponding calculation effort.

Assuming an effective conclusion of a contract, a DAO would in any case be regarded as a German civil law partnership (GbR) within the meaning of Sections 705 et

seq. German Civil Code (BGB). Since the parties involved deliberately dispense with the statutory disclosure requirements of corporate law - according to their vision they just wanted to create a completely new organizational form - a DAO cannot be structured directly as, for example, a German stock corporation (AG), a German limited liability company (GmbH) or a German limited partnership (KG). Classification as a GbR then ensues by virtue of the legal form requirement, because German corporate law assigns a legal form even if the parties involved are unaware that they are a company.

If the DAO were to be economically active, unlimited personal liability of all members would result analogously in accordance with Section 128 Serman Commercial Code (HGB). This naturally entails high risks.

A different classification of the DAO into the legal forms under corporate law would only be possible, if it were not regarded as the business enterprise itself, but only as a DAO that benefits from the functions of a DAO in the context of financing. The DAO can act as a tool or vehicle for online crowdfunding. However, a GmbH would be "placed in front" of this vehicle, to which the DAO would be affiliated as a silent partnership. The vision of the initiators thus clashes with the matter-of-fact reality of German corporate law. Does this mean that the concept of the DAO is nothing more than a intellectual game?

Relevance and Prospects

Even if the total number of ICOs has already decreased in 2019, there is still a demand for experimental, especially digital, funding mechanisms and forms of organization. The DAO is an expression of this demand. The latest digital instruments are used to achieve an entrepreneurial objective. Here the traditional forms of organization are called into question. However, the DAO experiment should not be seen as an alternative concept but can rather be an inspiration for the design of processes. For instance, a virtual general meeting, which is indispensable in times of the Covid-19 pandemic, could make use of tokens and smart contracts as in a DAO.

In this light, the vision of Vitalik Buterin and Christoph Jentzsch is again of relevance today.

Nevertheless, much would still have to change, before their concept could be fully recognised as a proper legal form of its own. Being a company under German law always means having to comply with mandatory law such as disclosure requirements. In civil law, this is the perpetual conflict between private autonomy on the one hand and protection of legal relations and creditors on the other. Ultimately, only the legislator can make this judgmental decision with general binding effect. In the interest of further innovation, it could be useful to decide in favour of a Decentralized Autonomous Organization.

Julius Weisshaupt