The impact and rise of DAOs in the legal industry

What is a DAO?

A decentralized autonomous organization (DAO) refers to people who have organized themselves into a company or other organization without creating a traditional hierarchical structure or centralized leadership. Most DAOs are fully online, with members meeting in person rarely, if at all. Blockchain technology powers a DAO, making all transactions transparent and immutable.

Because of the DAO’s potential application in many traditional organizational frameworks, such as business and government, researchers are studying the possibility of adopting the DAO structure in these areas. DAOs are also seen as a possible solution to solving corruption and bureaucracy, given their proven efficiency and transparency.

This article will deep dive into the rise of DAOs in the legal industry as well as the limitations and benefits of DAO-based structures for law firms.
How do DAOs work?

DAOs function through a system of smart contracts and decentralized governance. Smart contracts are computer protocols that facilitate, verify or enforce the negotiation of agreed-upon terms. They can be used to automate many governance processes, such as voting and asset management.

Smart contracts are written in code and are encoded into the blockchain, making them irreversible, transparent and immutable. DAOs are efficient, in large part, due to the ability of smart contracts to automatically execute agreements without any intermediaries. 

As long as its conditions are met, the smart contract is executed. Smart contracts can also be used to automate workflows, allowing DAOs to complete tasks without the need for a centralized authority or overseer.  

Rules are created via community voting

Rules are voted upon by the community and written into the DAO's smart contracts. These rules can be changed through subsequent voting, making DAOs highly adaptable. 

Because they are transparent and open, no one can change the rules of a DAO without the community’s consent. This prevents a single entity or group from manipulating the rules to suit their needs.

DAO tokens can be purchased or awarded

Members can purchase DAO tokens to participate in voting or other governance activities. DAO tokens can also be used to incentivize certain behaviors. For example, a DAO may issue tokens to members who complete tasks beneficial to the DAO. These tokens can then be used to vote on proposals or access exclusive benefits.

Several proposed procedural solutions have been put forward in the legal industry in recent years. Platforms like Luminance sought to incorporate the use of artificial intelligence (AI) in legal, particularly for contract reviews, lease reviews, data protection, due diligence and more. Diligen, another platform, uses machine learning to analyze contracts.

While such platforms have greatly improved legal workflows among the firms that have adopted them, they have not had a major transformative impact on the industry at large — at least, not at the level expected if DAOs are to be adopted as frameworks for legal entities soon.

But the legal industry isn't one to "flow with the times," so to speak. To this day, many firms still hold fast to traditional business models and corporate structures. In fact, most still refuse to adopt legal tech solutions like Luminance and Diligen.

DAOs have already made their foray into legal territory, although the road to adaptation on the structural and administrative level is still quite long. In 2021, ConstitutionDAO, which sought to purchase a copy of the United States Constitution, shut down after losing its bid at Sotheby's.

The project, rooted in the idea that the general population could own a copy of the Constitution, sought to purchase one of the last remaining copies of the Constitution and put it on public display. The project took off in a big way and raised over $40 million worth of Ether (ETH). 

After losing its bid to a private bidder at $43.2 million, the group collectively decided that the project had run its course. The raised funds were refunded to the original contributors.

Although it did not succeed in achieving its goal, ConstitutionDAO marked a pivotal moment in the awareness that the DAO as a framework could potentially transform the legal landscape.

Autonomous legal entities

Scholars are also looking into the legal implications of autonomous legal entities and how they may solve (or complicate) current problems in the industry. By definition, an autonomous legal entity is an entity that can act on its own behalf without the need for human intervention. This is similar to how a DAO functions, as a DAO can exist and function without the need for a central authority.

 Currently, there are several projects that focus on creating autonomous legal entities. In a recent webinar on interoperable governance held by the Stanford Center for Legal Informatics, the following concerns were raised:

  • How would automated legal entities be regarded by the law?

  • What rights would these entities have? Would they have legal personhood?

  • How would their liability be apportioned?

  • What does the current legal literature have to say about automated legal entities?

Research by the MIT Computational Law Report highlights that the law is currently inapplicable to the underlying algorithm (powered by AI) of DAOs, specifically autonomous legal entities. The main concerns are about AI's liability and legal status.

With DAOs, the primary concerns are linked to liability. As in, how would the law hold DAOs liable in specific situations, especially where crime is involved? There's also a quagmire of other issues, which we'll look into below.

DAOs are not recognized as legal entities

One of the biggest hurdles to DAO adoption is that most states do not recognize the DAO as a legal entity. Without being legally recognized, a DAO need not comply with the state’s registration provisions. 

Therefore, DAOs are not entitled to the corporate privileges available to traditional corporate entities. This not only limits the types of businesses they can operate but it also prevents them from entering into commercial contracts.

Unlimited liability

There is also no uniform regulatory framework for DAOs. Many fall into partnership status because they cannot be incorporated, imposing unlimited liability on their members.

As long as DAOs are not legally recognized, they also do not have limited liability protection. This means that contributors to a DAO can be held personally liable for the debts and obligations of the DAO.

This is a significant limitation as it would likely deter many potential contributors from participating in a DAO. The lack of limited liability also makes it difficult for DAOs to raise capital since most investors would be unwilling to put their assets at risk.

Risks of distributed governance

Another concern with DAOs is the risk associated with distributed governance. Because DAOs are usually decentralized and have no central authority, they are often governed by rules encoded into smart contracts. There is a potential for these rules to be hacked or manipulated, leading to disastrous consequences.

Regulatory uncertainties

Another challenge DAOs face is the regulatory uncertainties by which they are surrounded. It is unclear how existing regulations would apply to DAOs as most are not explicitly designed with regulations in mind. This creates a risk of regulatory action, which could potentially stifle innovation.

For example, traditional corporations are subject to Anti-Money Laundering (AML) and Know Your Customer (KYC) policies. These are designed to safeguard corporate entities against money laundering and fraud. In the context of a DAO, these would ideally protect members, token holders and customers.

However, since DAOs are anonymous, compliance with AML–KYC policies is quite complicated. Jurisdiction is also an issue, as most DAOs typically include members from around the world. Such complications often deter people from forming DAOs, thereby stifling innovation due to legal uncertainties.

Despite the complications and concerns listed above, DAOs remain a viable system for the legal industry. As discussed above, there are already certain proposals for navigating the legal complications associated with setting up autonomous legal entities.

So how would a DAO-based corporate structure apply to a law firm, for example? First, tokens and token-based voting rights need not be part of the equation, as these are not necessarily required in DAOs. For example, in traditional law firms, partners act as equity holders and perform management functions. They do not have separate groups of managers and shareholders.

A DAO-based structure would benefit law firms for the following reasons:

It's worth noting, however, that in terms of organizational hierarchy, law firms may still retain their current corporate structure even when DAOs are introduced. This is because law firms continue to function as top-down organizations, which is more suited to traditional hierarchies.

Incorporating DAOs safely to grow

Compared to the legal entities currently in existence, DAOs stand out with operational efficiencies. DAOs are capable of rapid pooling and deployment of capital, for one. And with the right coding, DAOs can automate most business processes too. 

This is why some of the world's billionaires are turning to DAOs to not only protect but grow their wealth. The key, however, is to do so safely and efficiently.

One way to ensure this is by working with a team of experts who understands the technicalities of setting up a DAO and the regulatory concerns that come with it. This will help you avoid any legal complications down the road and ensure that your DAO runs smoothly.