KLRI : KOREA LEGISLATION RESEARCH INSTITUTE

Ⅰ. Backgrounds and Purposes

▶ Analysis of Organizational Legal Status of Decentralized Autonomous Organizations

○ While the establishment and activity of decentralized organizations is increasing, the definition and organizational legal status of decentralized autonomous organizations are unclear in Korea

-As of March 2022, there are 4,832 DAOs and the number of participants reaches 1.8 million

-However, at present, the definition of what a decentralized autonomous organization is not unified yet

- DAOs cause fundamental changes in the way organizations operate

- Considering the recent rise of interest and the possibility that it will be used as a means of attracting investment for various projects, it is necessary to reorganize the domestic legal system

 

Ⅱ. Major Content 

▶ Features and Types of DAOs

○DAO issues its own token, grants voting rights to members, makes decisions through voting based on blockchain technology, and can code any rules, but has no corporate personality

○ There are various types of DAOs such as Protocol DAOs, Investment DAOs, Collector DAOs, etc

▶DAO and Corporate Governance 

○ In the case of DAO, while reducing the agency problem of corporations, other agency problems arise

- The point of claiming the advantages of decentralized autonomous organization is that DAO can solve the agency problem inherent in the traditional corporation type, but the decentralized decision- making process by token holders increases the coordination cost, and the board of directors like the initial development team people of similar status are likely to set the direction and strategy of the organization and pursue personal interests at the expense of others, like directors.

- Also, like the rational indifference of shareholders, in the case of DAO, token holders are highly likely to choose indifference due to the time it takes to review each business proposal

- If delegation rushes in, the advantages of decentralization may be undermined, minority token holders may face the same risk of exploitation as minority shareholders, and vote buying issues discussed in stock companies will emerge

○ Difficulty in changing the blockchain system based on smart contracts

- DAO's activities and tasks are restricted by the consent protocol, but it is not impossible to modify the underlying blockchain code. However, the basic protocol change procedure takes a very long time and the procedure is complicated

○ Creditor Protection Issues

- In the case of a stock company, creditors have the right to repay the company's assets, but legal treatment is uncertain respect to the protection of creditors of DAO

▶ Risks and limitations inherent in DAOs

○ DAO has risks and limitations such as concentration risk, operational risk, technology risk, tendency to concentration, lack of specific mechanisms for damage such as investor fraud, and competition with centralized organizations (eg, corporations)

- DAO is characterized by a horizontal decision-making structure, but the actual token holding appears to be quite centralized, and all decisions within the organization are made by voting, which leads to long-time inefficiency and operational risks such as low turnout

- Other technical risks include intrinsic risks such as hacking attacks and coding errors and the large and freely transferable DAO token issuance, the greater the likelihood of fraud and opportunistic abuse

○ The need of clarifying who the legal entity is 

- In DAO, token holders are participating in multiple countries, not just one country, and business activities can be carried out across borders. While decisions and business execution are decided by voting between participants, external transactions or investments must be linked to offline, so it is inevitable to acquire and hold assets offline, which is the real world, and to engage in legal actions with other legal entities.

▶ Legislation related DAO

○ Vermont’s BBLLC Act passed in July 2018 (blockchain-based limited liability companies, “BBLLCs”)

- Although Vermont's BBLLC Act does not explicitly mention DAO, the BBLLC Act is generally applied when blockchain technology is used in an important part of business activities

- In the operating agreement, summary information on the purpose or mission of the company, the degree of decentralization, information on the blockchain technology used (whether public or private), the protocol against security breaches, and the right to vote on certain matters, procedures for exercising and voting rights, procedures for becoming a member, and rights and obligations of participants should be described

- Whether to adopt a decentralized governance structure for the DAO’s stake structure and operation, whether the DAO is publicly offered, and whether the DAO operation method should be a voting structure according to a smart contract is also specified in the operation contract 

-The scope and qualifications of the members are determined according to the BBLLC operating agreement, and fiduciary duty is imposed on the BBLLC members and the management of the governance group, etc.

- Member’s interest in DAO includes both governance interests and capital interests

○ Wyoming's DAO Act enacted in 2021

- As the first state legislation in the United States that was enacted customized for DAO, it is meaningful in that it recognized the legal status as a separate legal entity by distinguishing the DAO whose governance structure was coded by smart contracts and its members for the first time in the United States

- In order to be recognized as a DAO LLC, it is mandatory to indicate “DAO”, “LAO” or “DAO LLC” in the name of the DAO

-There are two types of DAOs: member-managed DAOs and algorithmic managed DAOs

- The DAO's articles of incorporation must contain a public key that can publicly check the smart contract used to manage and operate the DAO. It should be modified and improved. If the DAO's smart contract is updated or revised, the DAO's articles of incorporation must also be changed.

- The position of a member is no different from that of a general LLC.

- In the case of an member-operated DAO, voting rights are in principle proportional to the digital assets contributed by each member among the total invested digital assets when the voting rights are exercised

- In the smart contract, the articles of incorporation, or the operating contract, the transfer of shares, withdrawal, investment refund, dissolution, etc. can be restricted, and the number of quorum can be freely determined.

- Members of DAO are not subject to the duty of fiduciary duty under the law unless otherwise specified in the articles of incorporation, and the right to read, copy, and provide information to DAO records is not recognized. The DAO is not obligated to provide any information about the organization's activities, financial status, or other than the information disclosed on the open blockchain.

- In the case of DAO, the articles of incorporation or operating contract must include the phrase “the rights of DAO members may differ materially from those granted to members of other limited companies”

○ Tennessee DO Act of 2022

- Tennessee is the second state in the United States to allow DAOs to be established as LLCs, and the main contents and regulations are similar to those of Wyoming

- In particular, in case of inconsistency between the smart contract and the articles of incorporation, the effect of the smart contract takes precedence over the articles of incorporation, and a quorum of members is required to make a decision. 

- DAO will be forcibly dissolved if there is no activity within one year of establishment or if the business statement is not approved

- The difference from those of Wyoming is ① First, the Tennessee law uses the term DO (decentralized organization) rather than DAO ② Second, while Wyoming law divides DAOs into member-managed and algorithmically-managed DAOs, Tennessee law categorizes member-managed and smart contract-managed.

○The three states' legislation on DAOs has been evaluated to be advantageous in that it can be incorporated as a company using the same procedures as LLCs, grants limited liability and legal personality, and provides predictability to stakeholders

○In short, establishing and operating a DAO in the form of BBLLC, DAO LLC, Do LLC in United States, governance structure can be devised through blockchain technology to meet the purpose of establishment, and major operations and activities are decided through votes by participants and recorded in a smart contract based on blockchain to secure the effectiveness and transparency of registration and disclosure, and corporate personality. 

▶ Review on establishment, operation and function of DAO from the perspective of Corporate Law

○ Establishing a DAO in Korea, there is not much incentive to establish using the complicated establishment procedure of stock company, and it does not fit the purpose of DAO of decentralization.

○Compared to a limited company, there is no need to appoint a director or auditor, and the performance of the investment consists of purchasing the tokens issued by the DAO, and there is no requirement such as the payment of the full amount of the investment or provision of the entire property, and registration is not required for DAO

○Compared to a limited liability company, the members are confirmed by entering their personal information in the articles of incorporation.

○ In the case of DAO, the quorum required for token holders to approve a proposal may vary from case to case and can be set at 51% or less, whereas under the Company Act, the quorum for a general meeting of shareholders is usually determined by a general or special resolution requiring a majority.

○ Compared to a limited liability company, it is inconvenient in that a limited company must have more than one director.

○In the case of a stock company, various disclosure systems are in place to protect shareholders and stakeholders. The disclosure system is largely divided into disclosure under the Commercial Act and disclosure under the Capital Market Act. On the other hand, in the case of DAO, information is disclosed in a community update method.

○ As for verification of accounting materials by a third party, external audit is mandatory for listed companies in the case of stock companies, and external audit is mandatory for unlisted companies only for companies that meet the requirements of the External Audit Act.

-On the other hand, in the case of DAO, activities are transparently disclosed based on the open source code built on the blockchain, so auditing by a third party is not required.

○A DAO can also set a reason for dissolution in the operating contract or the articles of incorporation, and there is a hard fork as a reason for dissolution unique to DAO.

○ Summary

-In the case of establishing a DAO in Korea, it cannot be recognized as a company under the current corporate law, but must be recognized as a partnership or an anonymous partnership under the civil law. In the case of a partnership under the civil law, all members bear unlimited liability, and in the case of an anonymous cooperative, the business operator as a transaction party bears unlimited liability. In the case of an anonymous cooperative, members who are participants do not have the right to engage in business, have only the right to monitor.

-The DAO does not exactly correspond to a limited liability company under the Korean company law. In the case of a business executive of a limited liability company, since executive’s name is an essential item in the articles of incorporation, it must be determined at the time of incorporation. However, this requirement is not consistent with the decentralized organization.

- In short, in order to accept DAO under the current company law, it 

  is necessary to provide a legal basis for separately accrediting an organizational form that conforms to the DAO. It also should be taken into account that the demand for these types of organizations will increase as blockchain technology and smart contract-related technologies develop.

▶ Direction for the protection of participants

○Although there are uncertainties about blockchain technology, the demand for the use of businesses and establishment of organizations using these technologies is spreading around the world. 

-In United States, they commonly use the existing limited liability company jurisprudence to establish a company in the form of a company, thereby resolving uncertainty about the responsibilities of members

-It is necessary to examine the trend of whether the company can enjoy the advantages of establishment within the framework of the DAO legal system and enjoy the business activities of the organization using DAO in the future to see if it brings true innovation.

 

Ⅲ. Expected Effects

▶ We should not overlook the concern that, if left unattended despite the  large and widespread demand on the legal basis and provision in related  DAO in practice, it may give unexpected disadvantages to the general public who participate as members in organizations based on smart contracts that are rather difficult to understand.

○ Also, it cannot be ignored that there is a risk of mass production of an organizational form that raises capital but does not have supervision or regulation. 

- It is also necessary to take into account that the general public can see damage through fraud or ignorance. At least, if it is included in the company law system, it can be expected to have the advantage of securing transparency through articles of incorporation, registration, and disclosure system, and the effect that government supervision is possible.

▶ In particular, it is expected that the attention of the supervisory authority on DAO, the fact-finding survey, and the provision of information on it on a regular basis will help to raise the public's awareness and capacity