DAOs: An academic analysis of risks and opportunities


DeFi is a hot topic and one that begs the question: what else can be decentralized in addition to finance? Where will the ‘De’ in ‘DeFi’ lead us to? Finance was an obvious first application of decentralized networks of smart contracts. The next frontier is that of decentralized (autonomous) organisations or D(A)Os.

DAOs are already gathering the attention of public authorities. A number of DAOs are already fully functional. More than US$780 million worth of assets is managed by DAOs, according to one source.

We looked at COALA’s draft law for DAOs previously. This week we have another look at this hot topic, but this time from an academic perspective.

Cardozo’s Aaron Wright wrote about the opportunities and challenges of DAOs in the latest edition of the Stanford Journal of Blockchain Law & Policy. Wright has been immersed in DLT, crypto and smart contracts for a long time. He co-authored the book Blockchain and the Law with P. De Filippi, one of the first (if not the first) on the topic. In addition to his position as Clinical Professor of Law at Cardozo School of Law (US), he also founded OpenLaw, a platform where smart contract code and legal agreements meet. He’s one of those few academics already exploring the next technological frontier before most of us have even heard of it.

Wright distinguishes between algorithmic and participatory DAOs, with both facing governance and other challenges. The three key risks of DAOs he identifies are:

  1. Risks of distributed goverance,
  2. Limitation of liability, and
  3. The legal status of an interest in a DAO (is it a security?)


1. Risk of distributed governance

DAOs can have a wide number of participants, all over the world. Governance can be much participatory than traditional corporate entities. Yet, distributed governance is still in its infancy and little tested.

The jury is still out on whether distributed governance can be as efficient (or even more efficient, because of its potential speed and input from a wider range of participants) as the more hierarchical, traditional governance in centralized entities. There are experiments with quadratic voting, for example, to explore new ways of forging consensus among a potentially very heterogeneous and large group of participants.

2. Limitation of liability

Most DAOs are not incorporated entities. Some jurisdictions amended rules on traditional corporate entities to tweak the obligations, to a certain extent,, for DAOs or other on-chain governed groups. Examples are Vermont’s Blockchain-Based LLCs or Wyoming’s DAO LLCs in the US. Yet most DAOs are not incorporated at all. This makes their legal status highly uncertain. Unincorporated DAOs likely won’t have separate legal personality. Their members may face (unlimited) personal liability for the DAO’s debts. Outside counterparties may be reluctant to do business with a DAO as long as its legal status is unclear.

‘For blockchain-based governance to go mainstream, participants will need a clear path to limited liability,’ Wright argues.  ‘From a policy perspective, the important question appears to be the degree to which lawmakers should accommodate the substitution of blockchain-based governance for traditional governance in legally recognized, limited liability entities.’

Wright links DAOs to the traditional literature on the theory of the firm. He discusses the nexus-of-contracts view of the firm and the enabling approach of US business law. Many US business law provisions are viewed as default, off-the-rack options that contracting parties are free to deviate from. The default options are seen as gap-fillers for incomplete contracts.

What about incomplete code for a DAO? Does a DAO also need default gap-fillers (and other default or mandatory) rules? Wright sees several downsides to incorporating traditional legal tools into DAOs, such as traditional natural language provisions to complement a DAO’s code. It can introduce ambiguity and mistranslation into DAO code, he argues, and increase the cost of setting up a DAO.

3. What is the legal status of an interest in a DAO (security?)

Another risk is the legal uncertainty on DAO tokens. Tokens in DAOs can give governance rights, income rights or other rights. On-chain smart contracts give businesses ‘the ability to sell tokens to the public that combine rights in novel ways’, Wright argues. Wright looks at private ordering, contractual views of the firm from the lens of information costs and informational efficiency of markets.

‘With regard to non-traditional arrangements that fall within the definition of “security,” however, there is potential for information costs to be significantly higher given that it will be more difficult for market participants to determine both what the code means and how novel private ordering mechanisms should be valued.’ Purchases of DAO tokens will need to determine the meaning of the underlying code and its significance for pricing the tokens, Wright argues. 

The higher the information costs are, the more informational efficiency of the market can be called into question. This, in turn, can raise more questions on whether a private ordering approach is ‘actually appropriate’, he concludes.


Wright is well placed to offer this informed overview of DAO risks and challenges. He looks at DAOs from a US perspective (he is US-based after all). The private ordering, contractual view of the firm may not be as strongly embedded elsewhere, but that does not take away from the general insights on DAOs offered in this article.

DAOs are already among us. Much like crypto initially, or DeFi at present, DAOs will continue to grow and will hit public authorities’ radars at some point. Wright gives his readers a good head start. Don’t say I didn’t warn you.

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