Associated Incidents
Blockchains, Smart Contracts and the Law
…unravelling the legal issues surrounding The DAO
Reuben Bramanathan Blocked Unblock Follow Following Jun 24, 2016
The public debate following the spectacular implosion of The DAO is a good reminder of two things: laws are always going to struggle to keep up with the pace of change in the crypto space; and we can’t necessarily rely on the legal system to solve all of our problems.
As The DAO’s ETH was being drained, the legal questions began. Is this theft? Is it a breach of The DAO’s contract? Would a fork of the Ethereum blockchain be a breach of contract? Could the attacker sue the Ethereum developers for breach of contract? What could regulators like the SEC do?
All of these boil down to a more fundamental question: what could the law do to help prevent or fix a problem like The DAO? Of course, laws aren’t the same everywhere. But there are a lot of common concepts, even across different legal systems, that can help us break down the issues.
Is The DAO a corporation?
Modern legal systems are designed to allow organizations, as well as actual, real people, to participate. Most legal systems do this by giving organizations some of the legal powers that real people have — e.g. the power to enter into legal contracts, to sue, and to be sued.
But organizations don’t just automatically get these powers. Usually, the organization has to go through a process called incorporation — the forming of a corporation. Incorporation requires legal documents, registration with the relevant government agency, and, most importantly, the agreement of actual, real people, to form a corporation.
There was no incorporation process for The DAO. The token holders of the DAO did not agree to form a corporation. In fact, they didn’t agree to much at all, as we’ll discuss below.
The DAO is not a corporation. Not being a corporation is one of the main features of a distributed organization — that it does not rely on corporate law in order to function.
OK then, is The DAO a partnership?
In many legal systems, a group of people that isn’t a corporation can still operate a business together as a partnership. A partnership is much easier to form than a corporation — it doesn’t usually require registration or legal documents. It just requires that the people involved jointly own and operate a business together.
The explanation of terms of The DAO specifically states “DAO tokens do not represent or constitute an equity ownership stake, share, or equivalent in ANY public or private company, corporation, or other entity in any jurisdiction.”
Reduced to the most basic level, the only connection that token holders have with each other is that they happened to send ETH to the same smart contract address on the Ethereum blockchain (or bought tokens after their creation), with an expectation that the smart contract code would execute. Nothing in that code gives them an expectation or ownership interest in a business.
Token holders can’t prevent anyone from becoming a token holder. Generally in a partnership, the existing partners can decide whether or not to bring in new partners. Conceptually, it’s hard to imagine that I could be carrying on a business jointly with people all over the world, who I have never met, who can join and leave the business as quickly as their trading algorithm can execute orders on an exchange.
A partnership can be implied by conduct, but that probably isn’t the case here, because The DAO didn’t operate a business. The DAO probably isn’t capable of operating a business (at least not without human help). Even if it did, the token holders probably wouldn’t have an ownership interest in that business.
The DAO is probably not a partnership. Although a number of people have taken the opposite view, the stronger argument is that The DAO is not a partnership, for the reasons above.
The DAO is not a legal entity. There have been a number of comments about the need to ‘wrap’ distributed organizations in some form of legal entity. But this kind of misses the point — because it would constrain distributed organizations to the operational requirements under existing corporate law. If the objective is to develop decentralized, more efficient, and transparent type of organizations, then the technology needs to drive changes in law, not the other way around.
Is The DAO a legal contract?
Smart contracts were initially envisioned as having the potential to replace or supplement legal contracts for some functions. But there’s a persistent myth that smart contracts are inherently legal contracts. This is not true. In fact, the main perceived feature of smart contracts is the ability for code, rather than law, to govern. The concept of code displacing law has been around for some time.
A contract is simply a legally binding agreement. In order for a contract to exist, at least two legal entities have to agree to terms, and there must be a transfer of value between them (consideration).
Everyone who