Decentralized Autonomous Organizations: How to Resolve Disputes

CT continues the series of articles on how DAOs are changing traditional markets and law enforcement. This time we look into possible approaches to the dispute resolution.

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Decentralized Autonomous Organizations: How to Resolve Disputes

CT continues the series of articles on how DAOs are changing traditional markets and law enforcement. This time we look into possible approaches to the dispute resolution.

Previously the different obstacles that impeded the application of the traditional law enforcement environment to DAOs and the necessity for dispute resolution mechanisms were discussed. Below you will find a couple of possible ways that may alleviate this situation but the answer to the problem requires an out of the box approach to disputes and their role in commercial transactions.

Possible but fundamentally flawed approaches

One way DAOs could settle disputes is by appointing a legal representative who would act as the only real world link to the company.  Why would a DAO establish a legal representative in the first place is quite simple: other DAOs and large businesses won’t transact with shady DAOs who can’t be held responsible for their actions, so from a commercial point of view it makes sense to, while looking to preserve the investors identifications, build a structure that is capable of committing to a deal and be held responsible for its actions.

The key aspect to this approach is that if the legal representative is the only physical person that can be linked to the DAO this person needs to have access to the DAOs funds. Why? because eventually he would need to comply with the sentence. If a DAO is found guilty of breaching a contract and its only link to the real world is a person who doesn’t have the power to execute the court’s sentence then we are back to square one.

This approach, while quite simple at first glance, comes with a few notable obstacles.

First: while proving that the legal representative has access to the funds on day one of the dispute would be pretty straightforward, making sure that the DAO doesn’t remove his access would be a concern.

Second: while this would work for commercial and civil disputes, if the DAO was accused of committing a crime then, as you may imagine, it’s legal representative can’t be held responsible for the actions of its client unless he took part in the crime himself.

Other possible solution would be to set up the DAO addresses as a multisig scheme with a trusted third party guardian who, in the case of a legal dispute, would release the payment if needed. This mechanism is not desirable because the DAOs funds would depend on the good behaviour of the third party arbitrator who could either be bribed or just run away with the funds.

Prevent rather than amend

The logic so far is clear: if the DAO can’t be trusted to voluntarily execute a sentence nor can it trust a third party with its funds then the only possible solution is to avoid the dispute altogether.

This may shock some people but it’s actually the most reasonable answer to the problem. Commercial relationships don’t need litigations to exist, it just happens that up until recently there were no realistic means to avoid such disputes. Before smart contracts existed parties needed to trust each other to carry on their part of the agreement; A pays B and just hopes for B to sent him the item they agreed on. If B did not then a court would intervene and try to get to a fair solution.

Bitcoin and Ethereum Logic

The landscape nowadays has fundamentally changed. Technology now enables a wide arrange of solutions that dramatically reduce, even sometimes eliminates, the risk of being defrauded.

If A wants to buy something from B then, based on the evaluation of both their reputations, they can set up a payment scheme that is procedural and which, if both parties keep their words, greatly incentivizes good behaviour.

Keep in mind that a similar logic is the basis of Bitcoin, Ethereum and cryptocurrencies in general. Miners or stakers can choose to ignore the protocol rules and try to cheat the network, but they know that in doing so they would end up losing money because their blocks would never be recognised by other nodes and all the electricity lost in the process means that they would be much better off if they just followed the rules accordingly.

Smart contracting your way out of disputes

Imagine for example that A has agreed with B to pay a determined amount for a machine. A is smart and knows that paying up-front means there is a huge risk that either B never delivers the machine or delivers a bad-quality product. In order to avoid this the parties agree to settle an escrow smart contract where A first deposits the full amount. At this point B knows with certainty that A has the money to pay and that such payment is almost guaranteed if he delivers on his word. Carrying on 15% of the payment is released up-front, another 15% when the machine arrives at destination, and the rest after two months of use if the machine works as expected (which parameters would be agreed beforehand and checked by the escrow).

This approach works for payments associated with the delivery of a certain item, but with a few tweaks it would be pretty effective for preventing breach of other contractual clauses too. To this end, and just as a simple example, 0.3% of all payments could be destined to a different multisig escrow arbitrator address which would act as a “let’s keep our word” stash. If either party broke the contract then they would lose the accumulated money on this address and the escrow would return the funds to the other party to compensate possible damages.

While similar procedures are possible and are indeed used today with traditional contracts and the fiat banking ecosystem, the current way to do it is ineffective, expensive and it’s implications to the overall risk is not so evident. Why? because the lack of a blockchain and therefore the dependency on trust means that risk is not eliminated, it’s just pushed to third parties (banking sector, the third party who would check if the machine works as intended, etc).

While all the previous is true it’s fair to conclude that this approach isn’t a one-fits-all. There will be more sophisticated transactions that may require additional or different safeguards. Creative solutions to these problems will prove to be good opportunities for skillful programmers and entrepreneurs. On the meantime, and while its details exceeds the scope of this article, solutions like Zero-Knowledge Contingent Payments further enhance this logic.

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