DAOs: the challenge of untraceable entities in the financial world
The recent decision of the Maker DAO protocol to move forward with its full decentralization process, so that the governance of the protocol rests entirely with the holders of the tokens themselves, opens a debate regarding the viability of structures without legal ownership.
The Maker Foundation fulfills its promise, moving from the traditional centralized governance model to a system in which the right to vote rests exclusively with the token holders. This vision, advocated since the founding of Bitcoin as a paradigm of decentralization, promotes the democratization of decisions automatically through a smart contract, since no participant has the capacity to make decisions unilaterally. It is, therefore, the consensus through the staking of the token, the mechanism that defines the lines of action of the protocol. Maker DAO, then, becomes a Decentralized Anonymous Organization (DAO). And what is a DAO? And before that, what is Maker?
Understanding Maker:
By way of summary, and without prejudice to being able to go deeper into the particularities of the protocol, we can say that Maker DAO is a decentralized lending platform on Ethereum that supports the price of a token called DAI, a stablecoin collateralized on-chain by means of a cryptoasset. To do so, the issuance of the DAI is conditioned to the prior collateralization of the amount to be generated by cryptoassets (usually Ethereum). The protocol, therefore, uses mechanisms to stabilize the price of DAI through incentives on participants or investors, so that supply and demand are arbitrated to stabilize the value of DAI around 1 USD.
Maker DAO allows to eliminate the volatility associated with cryptocurrency trading in a decentralized way, as the spearhead of the DeFi paradigm, through a dynamic system of guaranteed debt positions. On the other hand, DAI is an ERC 20 token, built under Ethereum. Ethereum, through its smart contracts, allows users to interact with algorithms that maintain the same properties of immutability, security, etc., especially because such smart contract is hosted or validated by its registration in a particular block of the Ethereum blockchain.
DAI works through a dynamic overcollateralization system, in which the user opens a CDP (Collateralized Debt Position), through which he/she deposits as collateral via smart contract a given volume of Ethereum (although USDC, or Basic Attention Token, is also used), and receives a preset amount of DAI (ratio 1 USD = 1DAI) printed by the protocol based on the volume delivered, together with interest defined according to a dynamic interest rate.
The risk lies in the potential inability to repay the DAI received, in which case the collateral deposited (similar to a pledge contract) is enforced, together with a penalty. The smart contract additionally sets a Liquidation Rate (liquidation threshold, set at Maker at 150% of the debt), by virtue of which it is determined at what level of the collateral price the position is executed, unwinding at the price at which the collateral is quoted.
Ex: if I have a debt of 90 DAI, based on the collateralization of 1 Ethereum (Price = 180 USD), with obligation to return interest (commission or Stability Fee) for = 90*0.075 = 6.75 DAI (which are paid in DAI or Maker, to subsequently “burn” /amortize it, and reduce the money supply of DAI or Maker), and the Liquidity Rate = 90 * 150% =135. If the collateral price falls below 135, the collateral is auctioned, and the debt position is liquidated. Each CDP owner sets the volume of DAI to be received, knowing that, if the Liquidity Rate is exceeded, the collateral is called in USD, and a penalty is additionally paid.
If in the DAI creation process a collateralization degree of 150% is required, previously fixed by smart contract, the value of all CDPs can be aggregated, comparing the aggregate value of the collateral, and the aggregate value of the issued DAI, and checking whether the preset ratio is actually met or exceeded.
Due to the complexity of the article, the price stabilization mechanisms through the Stability Fee and the DAI Saving Rate, as well as the Emergency Shutdown, will not be mentioned in this article.
Understanding DAOs:
Once the Maker protocol model and its DAI stablecoin have been minimally grounded, we move on to analyze the DAOs, which is the governance scheme that, as mentioned at the beginning of the article, will be used when the Maker Foundation is dissolved.
DAOs can be defined, according to Cointelegraph [1] , as “entities without centralized leadership.” Decisions are made by the set of token-holding participants (although in some cases, a minimum number of them are required), “according to a set of rules specifically defined in the protocol.”
The advantages of DAOs have already been listed in the current literature: first, it gives continuity to the concept of decentralization, which is a principle of the DeFi ecosystem and distributed registry architecture. The problem that DAI solves is often referred to as the Principal — Agent Dilemma, and is formulated as follows:
There is always a conflict of interest, which is articulated by the different priorities between the agent or CEO of the company and the principals or stakeholders. The latter, as shareholders of a company, assume the maximum risk, since the resources contributed to the company are in the form of equity, and therefore carry no obligation to be repaid, but they also participate in the maximum benefit through a double channel: dividends, which are not limited, as opposed to the percentage of the nominal value of the debt, and the potential revaluation of these shares. Meanwhile, since the CEO’s remuneration is partially, and sometimes mostly fixed, the alignment of risks is different, and this leads to different decision-making by the two.
In this sense, the DAO eliminates this problem, since it does not include the figure of the agent acting on behalf of the stakeholders, and includes them in the DAO itself, participating directly (as opposed to the representative nature of the exercise of control in traditional governance schemes) in the management of the entity or protocol. Moreover, having committed tokens to participate in the management of the DAO, the inefficiency of governance is eliminated and the interest of all participants in the preservation of the network is fully aligned, as this results in the revaluation of the tokens and the fees generated by the Maker lending ecosystem.
However, DAOs raise numerous problems of a legal nature. In particular, the main issue revolves around the notion of entity, which is confusing, since, under the current legal scheme, the existence of a legal entity entails its incorporation and registration under an administrative procedure sanctioned in a body of law in any jurisdiction. Any legal entity is associated to a given jurisdiction, and in no case, its digital character can prevent such registration. And this is so because any entity, by its mere existence, is a subject of rights and obligations.
Therefore, the proposed definition raises a question: is a DAO a legal entity and, therefore, should this definition be reconsidered, or should it be registered in one of the figures provided by civil and commercial law for entities without legal personality (like a fund, for example)?
And yet, before going further into the question, another preliminary question arises: if a DAO is governed jointly and severally by all the holders of the tokens, and these tokens are indeed the property of the holders of the tokens, given thatthey have been acquired by a contract of sale, could it be understood that a DAO is an entity without legal personality, even though its governance corresponds to a group of people, natural or legal? The answer, although it has not been answered on a jurisprudential or legislative basis, seems that it could call into question the current legal configuration of the DAO, either by referring the liability of the DAO’s actions to a subsidiary liability to the holders of these tokens, or by proposing other formulas that, in some way, make the participants of the DAO liable for the actions or omissions that they execute.
On the other hand, it is important to point out that the decisions to be made by the token holders that govern the protocol are totally limited to those established in the smart contract, and no participant by itself has the capacity to alter the rules of the smart contract. In the event of doing so, and because of the protocol’s own blockchain architecture, a fork would occur.
Under the current framework, protocols leveraged on DAOs lack legal personality, and therefore, cannot be subject to rights and liabilities. In this sense, the issuance of the protocol governance tokens, which is covered by an issuance contract, and which included the Maker Foundation as the obligor of the same, becomes now null. Why? Because, in our opinion, the capacity of subrogation in said contract by the new issuer must start from the premise that said issuer is a natural or legal person. There must be an obligor to be held liable for damages arising from the breach of the obligations set out in the smart contract. As long as such subject is not registered, and is not identified in the legal traffic under any of the modalities provided for, two options arise: first of all, consider it as not enforceable against third parties, or create a new figure that, despite the non-compliance with the mechanisms and administrative procedures provided for the incorporation of a company, can bedeclared de facto as such.
On the other hand, and continuing with this barrage of questions, the prerogatives or legal actions to be calibrated by the Maker DAO, being by nature neutral, do not allow inferring the potential exercise of any action or omission that could be declared in any jurisdiction as a crime or administrative misdemeanor.
The capacity of the holders is limited to the calibration of the parameters to be modified. However, the MIP (Maker Improvement Proposal) must be voted on by the network. In the event that the proposals include code modifications that could be declared illegal in any jurisdiction, they would be considered a crime or misdemeanor by the DAO. And this brings us back to the initial problem: who claims liability, is it joint and several liability among the DAO participants, can no one be identified, insofar as the exercise of a voting action does not represent a criminal act per se, or can the action be brought against the DAO?
Let us remember in any case that the liability of legal persons, already sanctioned in some legal systems, provides for pecuniary consequences, and the DAO keeps in its address the liquidity generated by the protocol itself, which is distributed as a dividend among the holders of the tokens. So, in the event that the protocol violates any rules, how can the protocol be forced to pay a fine?
Conclusions:
All these unresolved questions make DAOs less feasible as valid governance mechanisms in a regulated scheme, since, in our opinion, legal personality is a constitutive element of the relationships between subjects of a contractual relationship. And therefore, in order to be included in the existing legal and commercial traffic, it is necessary for these organizations to pass through the administrative and registry funnel foreseen for organizations. The big problem, in such a case, is the appointment of an administrator or board of directors to assume the risks derived from the actions or omissions that generate crimes or misdemeanors, as well as to clarify or redefine the concept of shareholder.
Insofar as the participants in the governance of the DAO receive the tokens and commissions derived from the services rendered, and benefit from the revaluation of their tokens, the risk and profit mechanisms appear to be assimilated to those explained above, but a legal framework that expressly assimilates this novel form of decentralized company into the set of registrable companies or legal entities is lacking.
