By May 2016, the DAO held a massive percentage of all ether tokens that had been issued up to that point (up to 14%, according to reporting by The Economist).3 At roughly the same time, however, a paper was published which addressed several potential security vulnerabilities, cautioning investors from voting on future investment projects until those issues had been resolved.
Later, in June 2016, hackers attacked the DAO based on these vulnerabilities. The hackers gained access to 3.6 million ETH, worth about $50 million at the time.4 This prompted a massive and contentious argument among DAO investors, with some individuals suggesting various ways of addressing the hack and others calling for the DAO to be permanently disbanded. This incident also figured prominently in the hard forking of ethereum that took place shortly thereafter.
DAO was vulnerable to programming errors and attack vectors. The fact that the organization was charting new territory in terms of regulation and corporate law likely did not make the process any easier. The ramifications of the structure of the organization were potentially numerous: investors were concerned that they would be held liable for actions taken by the DAO as a broader organization.
The DAO operated in murky territory about whether or not it was selling securities, as well. Further, there were long-standing issues regarding the way that the DAO would function in the real world. Investors and contractors alike needed to convert ETH into fiat currencies, and this could have impacted the value of ether.
In July 2017, the Securities and Exchange Commission (SEC) issued a report, which determined that the DAO sold securities in the form of tokens on the ethereum blockchain, violating portions of US securities law.8
Traditional Organizations vs DAOs
1. In traditional companies, all agents of a company have legal employment contracts that regulate their relationship with the organization and with each other. DAOs, on the other hand, involve a set of people interacting with each other according to a self-enforcing open-source protocol. Members of a DAO are not bound together by a legal entity, nor have they entered into any formal legal contracts. There is only one governing law – the protocol or smart contract – regulating the behaviour of all network participants.
2. As opposed to traditional companies that are structured in a top-down manner, with many layers of management and bureaucratic coordination, DAOs provide an operating system for people and institutions that do not know nor trust or even know each other. Instead of legal contracts, all agreements are in the form of open-source code that is self-enforced by majority consensus of all network actors. DAOs do not have a hierarchical structure, except for the code. The exact majority rules are defined in the consensus protocol or the smart contract, and will vary from use case to use case.
3. A DAO can be formalised by a smart contract. The more centralised governance rules are, the more it resembles a traditional company. In a more decentralized setup, the governance automatically steers behaviour with tokenized incentives and disincentives.
4. DAOs are open-source, thus transparent and, in theory, incorruptible. All transactions of the organization are recorded and maintained on a blockchain. Interests of the members of the organization are – if designed correctly – aligned by the incentive rules tied to the native token. The Bitcoin Network can be considered to be the first true decentralized and autonomous organization, coordinated by a consensus protocol which anybody is free to adopt.
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