Decentralized autonomous organizations — DAOs — hold much promise, but practitioners and governments must be aware of risks, says Wharton’s Kevin Werbach, co-author of a DAO Toolkit that was released at this year’s World Economic Forum.
Decentralized autonomous organizations, or DAOs, are generating much interest in areas like digital finance for the potential they offer in transparency and decentralized decision-making. Kevin Werbach, Wharton professor of legal studies and business ethics, who also heads the Wharton Blockchain and Digital Asset Project, is co-author of “Decentralized Autonomous Organization Toolkit,” a report prepared with the World Economic Forum and released at the Forum’s recent meeting in Davos, Switzerland. This toolkit follows the publication in June 2022 of another report Werbach coauthored, called “Decentralized Autonomous Organizations: Beyond the Hype.”
“There are now hundreds, if not thousands, of these DAOs that have been created with many billions of dollars of digital assets in their treasuries,” Werbach noted during a recent interview with the Wharton Business Daily radio show on SiriusXM. “It raises all kinds of fascinating questions about what it means to have an organization that’s decentralized and is on a blockchain, where people may never meet each other, where they try and govern it using votes based on tokens.”
Listen to the full podcast above or read an edited transcript of the interview below.
Wharton Business Daily: What are Decentralized Autonomous Organizations, or DAOs, and how will they impact decision-making?
Werbach: A Decentralized Autonomous Organization is basically a company, a firm or an organization that operates on a blockchain. Instead of using traditional legal contracts and relationships in a traditional firm, it uses the code of what are called “smart contracts,” or code that executes on the blockchain to handle the various different relationships about governance and decision-making, payments, employment and so forth. All of that happens digitally on a decentralized network.
Wharton Business Daily: Is a toolkit for DAOs necessary partly because there hasn’t been a lot of regulation or focus from governments around the world on this?
Werbach: The project that that we released at the World Economic Forum in Davos is the result of roughly a year and a half of work – a collaboration between the Wharton Blockchain and Digital Asset Project, which I lead, and one of the groups within the World Economic Forum.
There are now hundreds, if not thousands, of these DAOs that have been created with many billions of dollars of digital assets in their treasuries. Some of them are quite large and sophisticated. Some of them are small and experimental. It raises all kinds of fascinating questions about what it means to have an organization that’s decentralized and is on a blockchain, where people may never meet each other, where they try and govern it using votes based on tokens.
There are reasons to think that DAOs may be more transparent and more efficient for some kinds of decision-making than in traditional organizations. There was one called ConstitutionDAO that spun up about a year ago, where a group of people found out that an original copy of the [U.S.] Constitution was being auctioned. In a very short period of time, they got a couple of thousand people together, and raised more than $40 million to collectively bid on that. So, there’s interesting potential here, but there’s a lot of uncertainty and there’s a gap in knowledge. Our DAO toolkit was the second in a work stream that we’ve been doing with the World Economic Forum. The first one was called DAO: Beyond the Hype, which was an informational background paper. For the second paper, we assembled a network of advocates and [went deeply]into the issues.
The Promise and the Challenges
Wharton Business Daily: What are some of the operational strengths and weaknesses for DAOs?
Werbach: The potential strengths are the fact that they are decentralized and anyone can join. The activity is on a blockchain, so it’s transparent. You can design governance structures however you want. These are global phenomena.
All of those are also the challenges because people who don’t necessarily know each other have to figure out how to work together in this decentralized way. You have to figure out how to make decisions and vote and how to effectuate the decisions, and decide where you want hierarchy and someone in charge of particular functions versus everyone having the opportunity [to make decisions]. We had about 100 experts from around the world who contributed in working groups to identify these issues, which we put out in the toolkit.
Wharton Business Daily: As DAOs evolve and build out in the future, it must be important to have conversations with the people working on the toolkit about developing a structure that benefits everyone included in the process.
Werbach: Yes, there’s a tremendous amount of exciting experimentation going on. Some DAOs are already fairly significant in terms of the amount of money that they are deploying for different purposes. But it’s still very early. One of the reasons we’re collaborating with the World Economic Forum is it has global stakeholders including senior officials in government and corporations around the world. You get that community to engage in this debate and understand what’s happening in this space.
But there is a whole set of unanswered questions. You earlier mentioned the regulatory questions. For example, there are fascinating legal issues about what is the legal entity. We have centuries of work in corporate law in different countries about what the different corporate forms are. Which of them, if any, apply to DAOs? These are new kinds of corporate forms, essentially catalyzing a lot of the discussion about the nature of firms and the nature of corporate governance. So those are all important conversations to have, and that’s part of what this project was about.
Wharton Business Daily: To what level does governance potentially reach in decentralized organizations?
Werbach: [We must] examine the different mechanisms of governance in DAOs. Some DAOs are, for example, decentralized finance projects that are managing decentralized exchanges and lending, where they may have billions of dollars of assets that are governed based on participants voting on tokens. Some of them are social impact ventures [focused on]carbon credits or sustainability.
In many cases, we’ve found that those communities are reinventing the wheel. They get started [with an idea of giving]everyone a token – one token, one vote. And then they [confront the gaps]: What happens if someone bribes people to get a lot of tokens? What happens if some people who have tokens don’t participate because they’re not interested? They’re reinventing a lot of the concepts that we see from traditional governance and political theory, including concepts like separation of powers, checks and balances, constitutions, and so forth.
But this is a design space for experimentation. In a traditional corporation, you have a lot of structure that is imposed and is hard to change. Here, organizations can figure out potentially what the right way is to design something for their particular situation.
How Governments Can Get Involved
Wharton Business Daily: Is there an expectation that governments will be involved in the governance of DAOs through checks and balances?
Werbach: There are [a few aspects here]. One is about the corporate structure. Corporations and corporate forms, whether we’re talking about LLCs or partnerships, are valuable in lots of ways. They give people limited liability if you invest and risk losing all of your money. They give you corporate credit. The corporation can sign contracts, it can engage in transactions, and it can sue and be sued. So there’s this question about how to have all of those benefits or the importance of those benefits in a decentralized online environment. And that’s pushing forward some of the discussion about corporate law – and governments are very much involved. There are a number of U.S. states that have passed DAO-specific laws to create new corporate forms for DAOs.
Then, there’s the regulatory question. Questions about, for example, are these tokens actually securities that are regulated under securities law? How are these DAOs taxed? If they’re operating and generating revenue, then they should be taxed. Governments are starting to think about lots of other regulatory questions.
There’s [also]the positive potential that this is a new form of decision- making. We can think about governments and public-private partnerships and other kinds of public sector and public-oriented organizations thinking about potentially using this mechanism.
So, governments should be interested [in the governance of DAOs]if there are objectives that they have that [bring]much more transparent and efficient decision-making using this mechanism.
Wharton Business Daily: In which areas do you expect to see significant interest around DAOs in the next several years?
Werbach: It remains to be seen. In our DAO Toolkit and our prior paper, we have a nine-cell taxonomy that talks about different kinds of DAOs and gives examples. We see a bunch of activity around funding of public goods and investment clubs, especially around digital assets. [For example, in] groups that want to collectively buy non-fungible tokens, or NFTs, we see a lot of activity around finance. Many of the biggest DAOs are decentralized finance platforms, decentralized exchanges like Uniswap, [a decentralized crypto currency trading protocol].
While some of the big, centralized exchanges have collapsed and engaged in fraud, one of the potential opportunities of a DAO is that all that decision-making is transparent. There’s no one who has the power behind the scenes to take the money and run. It’s a collectively governed entity. We’re seeing a lot of interest in that in the crypto space, in the digital asset trading space, in using these governance mechanisms. That’s just a starting point. The potential is incredibly broad.
But what we found in the toolkit is that operational issues are really important in practice. There are questions about scaling, [for instance]– it would be a lot harder to replace a 10,000-person company with a DAO than ones that are smaller, but we might see a 10,000-person company split up into lots of smaller entities, which are themselves DAOs.
Wharton Business Daily: You mentioned the issue of trust. Having transparency in and around DAOs eliminates some of that concern of lack of trust.
Werbach: Yes, and this has been a thread through the work that I’ve been doing in this area all along. A book I wrote is called The Blockchain and the New Architecture of Trust. What’s striking is that the potential of blockchain-based systems is to promote a new and powerful kind of trust, because they are open and transparent, and you’re not required to trust one central administrator who has all the control. Potentially, they can be much more trustworthy than traditional systems.
On the other hand, we’ve seen enormous amounts of fraud and scams and untrustworthy behavior in the crypto world. So, much of what I’ve tried to focus on in this DAO project is a piece of that. A prior collaboration with the World Economic Forum on Decentralized Finance, or DeFi, as well as other work that we’re doing in the Blockchain and Digital Asset Project at Wharton, are about finding those opportunities where this technology can promote trust – and then asking the question of what it will take for it to do that and what we can do to contribute to moving in that positive direction.
This article first appeared https://knowledge.wharton.upenn.edu
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