As a concept for collective governance, decentralized autonomous organizations (DAO) are replete with hip buzzwords and ideas. Their practical implementation, however, is clunky. The latest example is that of Ooki DAO – a margin lending platform that is being sued by the Commodities Futures Trading Commission (CFTC).
The agency contends that Ooki DAO violated investment laws by offering unregistered tokens for sale. It also charges the platform with functioning as an unregistered Futures Commission Merchant (FCM).
According to the CFTC, Ooki DAO is “an unincorporated association comprised of holders of Ooki tokens.” Those governance tokens, by the way, are a mechanism for profits, meaning holders can sell them when the token’s price increases.
CFTC’s case against Ooki DAO has generated many headlines, not least for the way in which the agency chose to serve the platform. Experts say the case could have far-reaching implications for DAOs.
While they are mostly unregulated currently, DAOs might be forced to consider registration with authorities. That process itself could bring about changes and assign liability to individuals or groups in an organization that claims to be decentralized and driven by community.
But registration with legal authorities will not solve the underlying problems of an experiment that is struggling to retain allegiance to its original cred.
A Question of Liability
The main question raised by the case against Ooki DAO is about liability.
DAOs are formed to accomplish specific goals or missions and have a horizontal structure, as opposed to the top-down hierarchy of a registered corporation. They pool or raise capital from various members to invest in projects. In turn, these investors are awarded tokens proportional to the amount of their contribution.
Another version of the DAO substitutes work, instead of capital, into the equation. Thus, a member’s share of tokens is proportional to the amount of work contributed to the project or venture. The resulting community of token holders is responsible for important decisions involving the DAO.
Theoretically, there are no leaders in the community. Decision making is done online through smart contracts and changes are implemented through code. [Hence, the name autonomous]. The entire process is supposed to be democratic and consensual. As such, it is difficult to find a single person or point of contact liable for the DAO’s decisions.
The CFTC disagrees with this presumption in its case against Ooki DAO. The outfit’s community members are individually liable for the collective’s decisions because it functioned as an “unincorporated association” i.e., not as a limited liability entity or a company, the agency stated.
Ooki DAO rebranded itself from bZerox – an entity that has already been fined by the CFTC – to a DAO format. The blockchain’s founders claimed to have “handed over” the protocol to the community. But those claims seem hollow when you consider that just nine wallets voted on important decisions relating to the protocol in the last six months.
“Ooki operated, marketed and made solicitations concerning the Ooki protocol…The Ooki DAO exists for the exact same purpose as bZeroX before it and specifically to operate and monetize the Ooki protocol,” the CFTC stated in its complaint.
The DAO Window Dressing for Companies
CFTC’s action against DAOs may have been a first but this is not the first time that such entities have stumbled or played hard and fast with rules and their stated mission. An absence of liability is just one of the many problems afflicting DAOs.
Faulty voting mechanisms are another. The purported benefits of transparency have not stopped public spats between founders and investors in which the project’s “community” is a bystander. In their unraveling, such feuds resemble similar fights at public companies or startups.
MakerDAO, a pioneer in DAO governance, was embroiled in one such fracas this past June. A group of its investors, which included big hitter venture capitalists such as Andreessen Horowitz and Paradigm, ganged up on a vote concerning a decision to close operations of a unit within the Maker protocol. They voted against the decision. MakerDAO’s founder voted for it.
Even with their combined token power, the venture capitalists could not outvote the founder’s stake and the unit was shut down. The event’s runup was fractious and there were strong opinions. The process resembled a corporate boardroom brawl, except it was conducted online.
“We should call a company for what it is,” said a MakerDAO community member after the voting. “We shouldn’t call it a community or a decentralized organization that has different voices; we should call it a corporation that has a CEO and has controlling shareholders.”
Another example is SushiSwap, a decentralized finance (DeFi) exchange and lending platform. Its governance mechanism has been hijacked by investors holding significant stakes of its governance tokens. They exercise their power by deciding the outcome of important matters, such as CEO elections or collection of arbitrage profits.
The DAO voting system is technically deficient. The most popular tool for casting votes in DAOs is Snapshot. In order to minimize gas fees for each vote, the tool does not commit final tally of votes to the blockchain.
Instead, a multisignature wallet, or a wallet that requires signatures from multiple stakeholders to process a transaction, receives the votes and is required to verify them and commit the result to the blockchain. Access to the wallet rests in the hands of developers, who may be elected or unelected and may remain unaccountable to the wider ecosystem. In its workings, therefore, the system mimics existing electoral processes in which an intermediary is needed to certify and broadcast results.
Kain Warwick, a crypto founder, refers to the current process as “governance theater” because it has a veneer of voting and decentralization, when the reality is otherwise.
Governance is not the only way in which DAO operations resemble that of their corporate counterparts. In other ways as well, DAOs now function as companies. A concept that was conceived of as an online and autonomous venture has now morphed into the type of organization that conducts in-person retreats and rents office space in New York City.
Do DAOs Need to Evolve?
The modern concept of a corporation has evolved in fits and starts by amalgamating various economic interests of its stakeholders and their concerns over two centuries. DAOs, if they are to succeed, do not have the luxury of such time. They also have limited experimentation at their disposal because their starting point is the existing legal and economic framework. Any attempt to break away from it will render them bankrupt, useless, and, possibly, afoul of the law.
They can only distinguish themselves by proving their original thesis of decentralization and autonomy, through code, of operations. Achieving those goals might require compromises. Reaching decisions in a decentralized network is a time-consuming and constrained process. That will not pass muster in a business environment that prioritizes speed and rapid prototyping over consensus among stakeholders. An autonomous business whose operations are hardcoded runs the danger of running amok unless it is constrained by human agency.
Establishing Common Ground
Most DAOs have already found refuge in existing legal wrappers and registered as foundations and limited liability companies in the guise of a DAO. But more might need to be done to accelerate their development. For example, developing a set of standards for DAO operations and self-regulation might be a good idea. The standards could be similar to corporate governance standards that emphasize a set of values expected of corporations and non-profits.
Establishing a common minimum framework that emphasize common operating principles of various DAO projects will help engender trust from outside investors.
Information sharing between projects could also lead to possible solutions. As an example, low voting turnout is a persistent problem in DAO voting. It has led to the scrapping of the minimum number of votes required to achieve quorum. Such arrangements encourage lopsided wins for investors with a high number of tokens.
How can DAO projects ensure greater participation among their stakeholders? What best practices are necessary to draw voters out to vote in DAOs? Right now, each DAO project seems to exist in a silo and there does not seem to be any mechanism to share information related to the projects.
Admittedly, the idea of borrowing a page out of the corporate rulebook may not go down well with DAO enthusiasts who like to think that they are pioneering a new path. [They aren’t but it is not polite to tell them so]. But, at least in their current format, DAOs will have to make compromises and sacrifice autonomy and decentralization to function efficiently.