Josh Frydenberg’s crypto company challenge

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Human nature being what it is, direc­tors some­times make deci­sions for their own ben­e­fit that harm share­hold­er interests.

As with much of blockchain infra­struc­ture, the DAO attempts to deal with prin­ci­pal-agent prob­lems by cre­at­ing trust­less rela­tion­ships among par­tic­i­pants. “Trust­less” means not hav­ing to trust an actu­al human. Instead, DAOs oper­ate through pre-pro­grammed, auto­mat­ed smart con­tracts on a blockchain.

Human decisions intrude

Investors opt in by trans­fer­ring cryp­tocur­ren­cy to the DAO and receive DAO tokens. The investor’s cryp­to is held by the DAO itself. Deci­sions (for exam­ple, to mod­i­fy the DAO or make an invest­ment) are made by a vote of all token-holders.

There are no direc­tors to vote them­selves extrav­a­gant bonus­es and no man­agers to abscond with com­pa­ny funds. DAOs instead are billed to oper­ate “sole­ly with the stead­fast iron will of unstop­pable code”.

That’s the the­o­ry, any­way. Expe­ri­ence sug­gests there are key, human deci­sion-mak­ers in the DAO, just as in any corporation.

In a 2017 inves­ti­ga­tion, the US Secu­ri­ties and Exchange Com­mis­sion found that, con­trary to claims of decen­tralised gov­er­nance, the vot­ing rights of DAO token hold­ers “did not pro­vide them with mean­ing­ful con­trol over the enter­prise” and they were “sub­stan­tial­ly reliant on the man­age­r­i­al efforts” of the DAO founders and indi­vid­u­als nom­i­nat­ed by them.

With bil­lions of dol­lars in dig­i­tal assets report­ed to be invest­ed in DAOs, the pur­pos­es of which range from buy­ing col­lectibles to deal­ing in car­bon mar­kets, ques­tion marks over the legal sta­tus of DAOs are a grow­ing concern.

The Sen­ate com­mit­tee found that “legal lia­bil­i­ty for mem­bers (i.e. token hold­ers) for these organ­i­sa­tions is cur­rent­ly unclear, and this reg­u­la­to­ry uncer­tain­ty is pre­vent­ing the estab­lish­ment of projects of sig­nif­i­cant scale in Aus­tralia”. It there­fore rec­om­mend­ed that the gov­ern­ment “estab­lish a new Decen­tralised Autonomous Organ­i­sa­tion com­pa­ny structure”.

In its response last month, the gov­ern­ment agreed in prin­ci­ple with this rec­om­men­da­tion. It flagged plans for Trea­sury to con­sult indus­try in the sec­ond half of 2022 on “an appro­pri­ate reg­u­la­to­ry struc­ture for inno­v­a­tive new cor­po­rate struc­tures” such as DAOs.

Opportunities and challenges

Such an inquiry would have to grap­ple with a broad set of ques­tions, includ­ing: Should DAOs be recog­nised as sep­a­rate legal per­sons, as cor­po­ra­tions are? Should DAO par­tic­i­pants be pro­tect­ed by lim­it­ed lia­bil­i­ty? For what pur­pos­es may a DAO be estab­lished? How should a DAO be taxed?

There is also the prac­ti­cal issue of how Aus­tralian law could be enforced on a DAO with anony­mous (more accu­rate­ly, pseu­do­ny­mous) par­tic­i­pants who might be locat­ed large­ly (or entire­ly) overseas.

DAOs and relat­ed blockchain tech­nol­o­gy may have the poten­tial to dis­in­ter­me­di­ate cor­po­ra­tions, just as social media has dis­in­ter­me­di­at­ed media.

But just as main­stream media has sur­vived, adapt­ed and inte­grat­ed social media, blockchain does not nec­es­sar­i­ly her­ald the end of the tra­di­tion­al cor­po­ra­tion. Also, as with social media, cryp­to com­pa­nies bring oppor­tu­ni­ties and chal­lenges – com­mer­cial and social.

Crypto scams

One such chal­lenge of DAOs is thor­ough­ly old-fash­ioned: to min­imise the risks of retail investors get­ting tak­en to the clean­ers by dodgy oper­a­tors. In their addi­tion­al com­ments to the Sen­ate report, the par­tic­i­pat­ing Labor sen­a­tors were “con­cerned to note the preva­lence of scams based on cryp­to asset prod­uct offerings”.

In 2016, soon after an ear­ly DAO was set up, a hack­er man­aged to trans­fer about one-third of its cryp­tocur­ren­cy hold­ings (then worth more than $US50 mil­lion). This “exploit” was reversed by the extreme solu­tion of essen­tial­ly reset­ting the blockchain to before the hack had happened.

More recent­ly, all the $US60 mil­lion ($83 mil­lion) invest­ed in “dog-inspired” Anu­bis­DAO was siphoned off to parts unknown. Last month, $US130 mil­lion was stolen from (bad­ger-inspired?) BadgerDAO.

Con­tro­ver­sy over finance and cor­po­rate forms is, putting it mild­ly, noth­ing new. Just over 300 years ago, the burst­ing of the South Sea Bub­ble led to a ban on new joint stock com­pa­nies with­out roy­al char­ter, under the Bub­ble Act 1720. (The ban was even­tu­al­ly lift­ed through the Bub­ble Com­pa­nies, etc Act 1825.)

Today, cor­po­rate fraud is lam­en­ta­bly com­mon but no one would sug­gest abol­ish­ing cor­po­ra­tions as a solu­tion. The con­sid­er­a­tion of a new cor­po­rate form is, how­ev­er, an oppor­tu­ni­ty to get the design right to min­imise risk.

The warn­ing of the 1984 Gow­er report on investor pro­tec­tion in the UK, that it would be “detri­men­tal to the nation­al inter­est and rep­u­ta­tion if reg­u­la­tion is so lax that we become a haven for crooks”, is every bit as rel­e­vant to cur­rent times and technologies.

Stephen Minas is asso­ciate pro­fes­sor at the Peking Uni­ver­si­ty School of Transna­tion­al Law.

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