Abstract
Blockchain governance has surpassed the mere structuring of monetary assets and has evolved to create new forms of organisations that function on a democratic framework. This article argues for the grant of legal personality to decentralised autonomous organisations (DAOs), functioning entirely on the blockchain, within Indian commercial law. By differentiating DAOs from traditional corporations, this article suggests that the Government should create a new class of corporations, to allow DAOs to retain their innovative decentralised structure, and be legally compliant.
Keywords
Blockchain, DeFi, Smart Contracts, Virtual Corporations, Legal Personality
Introduction to DAOs
The issue with modern corporates is that there are often too many decision-makers on a hierarchical level, which may increase diversity in the board room, but it also leads to agency issues, such as control and management. In recent years, shareholders’ primacy has led to delinquency in corporate governance standards. Contrasting this attribute, new forms of corporations that eliminate human intermediation and rely on computer programmes have emerged within the blockchain ecosystem, and are termed as decentralised autonomous organisations (“ DAOs ”). DAOs are democratic corporations that are governed through algorithmic codes, eliminating the need for a board of directors or a hierarchical model of corporate governance. Essentially, a DAO is an organisation that operates on a blockchain, and whose functional capabilities are executed through computer programmes known as smart contracts. Smart contracts utilise contingent based approaches, and hence in theory, the discretion of the parties entering a smart contract is eliminated. A smart contract cannot be reversed or terminated unless such conditions are pre-coded ex-ante within the program. Given this level of automation that smart contracts allow, a framework of self-enforcing systems of corporations is materialising across jurisdictions. At the outset, a model DAO can be best defined as a decentralised corporation , which functions entirely on computer codes, is devoid of human intermediation, combining legal, social and economic principles.
EQUATING DAOS TO TRADITIONAL CORPORATIONS
Prima facie, those unfamiliar with DAOs would assume that DAOs are merely software and not a legal entity capable of being registered with the Ministry of Corporate Affairs (“MCA”). The authors argue and advance that DAOs could be a new form of hybrid corporation that merits the attention of India’s financial and commercial regulators. One of the first DAOs of the world, Slockit.com DAO (“Slockit DAO”), was structured as an investment fund, where members could vote on which proposals to finance, and the execution of the transfer of such funds was automatically enabled through the underlying smart contract. Today, DAOs are being used as a means of fundraising, transacting in non-fungible tokens, amongst others. Indeed to fully comprehend the regulatory aspects of a DAO, it is required to first understand the governance of the DAO, and whether it can be equated to a traditional corporate within the current Indian regulatory framework.
A company is governed through a board of directors, where management functions are often hierarchically divided within the company, and shareholders contribute equity to acquire voting rights. In a model DAO, such a hierarchy is replaced with algorithmic codes, which essentially execute the decisions. Moreover, similar to how a traditional company issues shares, a DAO issues tokens that authorises the token holder (or members of the DAO) to vote on various proposals of the DAO.
The operational aspects of the DAO function through the distribution of DAO tokens, and for regulatory consideration, if any DAO is to be granted with legal personality in India, it is essential that these tokens be recognised as securities within the meaning of Section 2(h) of the Securities Contract Regulation Act, 1956 ( “SCRA” ). Indeed, such a consideration has been taken by certain regulators in other jurisdictions. For instance, the U.S. Securities and Exchange Commission (“SEC”) regarded the tokens issued by the world’s first DAO, the Slockit DAO, as securities under Section 2(a)(1) of the Securities Act, 1933 . In the SEC’s opinion, the Slockit DAO’s token qualified the Howey test , as the tokens were freely exchangeable with Ether (a type of crypto-asset), which was further used for financing the actions of the DAO.
We argue that DAO tokens could qualify as securities in India as the definition of securities is interpreted to be inclusive, as can be interpret through the case of Sahara India Real Estate Corporation Ltd. v. Securities and Exchange Board of India, (2013) I SCC I . DAO tokens can be redeemed for other crypto-assets, such as Ether, and can also be traded within secondary markets applicable to crypto-assets, making them freely transferable. Moreover, recent news reports also suggest that the Securities and Exchange Board of India (“SEBI”) would be deemed as the financial regulator for crypto-assets in India. However, for DAOs to be regulated in India, a separate legal personality must be granted to DAOs. In the absence of such recognition, there would be no legal entity to sue, thus creating unlimited liability towards members of the DAO. This would ultimately deplete the attractiveness of forming a democratic, decentralised corporation, whose power is derived from lex cryptographica , or the rule of the code.
LEGAL PERSONALITY FOR DAOS
On the DAO, the transactions are conducted after the voting of the members. Despite this human aspect, the rules of governance are codified algorithmically through a smart contract, which could be equated to the articles of association of the company . The key differentiator here is that, unlike the articles, the smart contract is self-executing, theoretically eliminating the need for a central authority like the board of directors or management. Indeed, for regulation of DAOs to meet traditional company equivalence, a model framework for their incorporation must be created, one that also considers granting DAOs a separate legal personality. This has previously been achieved in Wyoming through the Decentralised Autonomous Organisation Supplement Bill 2021 (“ Wyoming Bill ”), which enables DAOs to incorporate as a limited liability company, thus bringing their regulatory consideration within traditional commercial law. We argue in this regard, that the MCA could consider framing a model law for DAOs, that retains some of the aspects of a private limited company governed through the Companies Act, 2013 (“ Companies Act ”), and also allows for technological innovation to advance, through the use of blockchain, and the ability to incorporate a cyber-space based corporation. This may require certain amendments to the current language of Section 7 of the Companies Act, which entails incorporation requirements.
There have been arguments made by legal scholars, suggesting that DAOs could attain legal personhood or a separate legal personality as a partnership. This could have been because the DAO could fit in the profile of a general partnership, as members contribute assets towards the DAO, and enter into an arrangement to manage the profits which arise through various activities on the DAO. To that end, our opinion is contrasted from such arguments, owing to Section 25 of the Indian Partnership Act, 1932 that provides that partnership firms carry joint and several liabilities, and this has the potentiality of blemishing interests of the investors, ultimately disallowing innovation to foster, decreasing the leverage for technologically advanced corporations to function. Granting DAOs a general partnership status would mean that members would be personally liable for the debts of the DAO. We believe that each member of a DAO should have limited liability, and DAOs as such could be accorded with separate legal personhood in India in one of three ways, (a) as a company under the Companies Act; (b) as a limited liability partnership under the Limited Liability Partnership Act, 2008; or (c) as a new form of hybrid legal entity. The third approach has been taken by Malta through introducing Innovative Technological Arrangements under the Innovative Technology Arrangement and Services Act, 2019.
Policy think tanks, such as the Coalition of Automated Legal Applications, have framed a Model Law for DAOs, which contribute towards creating a legal framework for fiduciary duties for the members of the DAO, the limited liability aspects, protection of minority interests, voting rights, and other aspects which are to be considered during the operations of a traditional corporation. It is important to consider in this regard, that while blockchain fanatics have immersed in the idea of human disintermediation, we believe that complete disinheritance of human intermediation from the DAO would not be favourable, as considerations such as dispute resolution have yet to achieve complete automation. In fact, the Wyoming Bill also requires the maintenance of a registered agent within the state. We propose that the Indian government should follow a similar avenue, requiring DAOs to maintain human interface. This may be done through encoding an Oracle within the DAO, which are essentially individuals (or even programs) that interact with the real world and transmit the information back to the blockchain.
Currently, governments across the globe are debating the rise in crypto-assets and framing policy proposals for the same. Australia in its recent Final Report of the Select Committee on Australia as a Technology and Financial Centre ( “Report” ) has considered granting separate legal personality and limited liability to DAOs. The Report opines various commercial structures which could be accorded to a DAO within Australian law. The most prominent one observed is an amendment to the (Australian) Corporation Act, 2001, to allow for the creation of a new category of an entity, such as a Limited Liability DAO (LLD). While the Report also argues that DAOs could be based on currently existing business structures such as a joint venture, we believe the future of DAOs would be best protected through the creation of a new business structure. However, like any new technologically influenced regulation, the considerations surrounding DAO remain a matter of speculation in a majority of jurisdictions.
CONCLUSION
Legal challenges to emerging technology and innovation are not new. While certain jurisdictions across the world have attempted to keep up with the advent of cryptocurrencies, blockchain and now, DAOs, others have become spectators. Even before the recent razzmatazz surrounding DAOs, legal challenges to corporate personality have existed and have eventually been addressed. The advantage of being an active regulator is the appeal to prospective investors. All business structures, from the incorporation of a one-person company to collective investment schemes, have been a product of innovation and economic growth. Hence, the need of the hour is to be open to dialogue.
