Decentralized Organizations and The Rule of Law

From Fintech Lab Wiki


The notion of decentralized organization is broad and may include a wide range of institutions ranging from private to public and even the level of regulation required may change substantially in relation to the functions and the responsibilities that have to be decentralized.

As a starting point, to properly frame the discussion in relation to the research project goals, we briefly review the two basic setups that represent the starting point for the proposal of a new legal infrastructure that fosters efficiency of existing decentralized organizations.

First we will explore the legal issues that are open and the emerging discipline that tries to regulate the so called Decentralized Autonomous Organizations (DAO hereafter) in the crypto space. Second, we will review a lesser known regulation that has been created and is now in use in Italy to improve the coordination and raise the level of integration of small and medium enterprises that can formalize their productive agreements relying on the 'contratto di rete' a business network contract.

Regulation of Decentralized Autonomous Organizations: state of the art

The proposal to rely on DAO to constitute an innovative form of organizing business activities, whose characteristics, indeed variable and combinable to the point of constituting entities very different each other, deserve in-depth studies in order to exploit their interesting potential. A number of legal issues have to be addressed to make this proposal consistent with current European and national regulations

In particular, the typical DAO is characterized by a non-hierarchical structure, where the paradigms of agency theory, applicable to traditional corporations, can undergo significant upheaval. In this sense, the management of DAO is entrusted to token holders and to some extent to stakeholders, who both may or may not operate on the basis of the principle of collegiality. Therefore, the organization can be defined as decentralized, changing the pillars on which traditional corporate governance is based, inferable from legal provisions or corporate governance codes, and thus approaching a more innovative model of platform governance.

Decentralization is made even more pregnant if combined with organizational autonomy and automatization, as it is based on smart contracts and, therefore, distributed ledger technologies. Beyond the possible legal qualification as a contract or as a mere means of executing a contract, what characterizes the smart contract is the rule-of-code principle, on which the self-regulation of the DAO is based, which allows the automatic execution of the provisions contained therein, eliminating the need for intermediation. The blockchain on which the smart contract is based, however, requires the work of parties other than organizational members, such as miners and core developers.

The complexity of the phenomenon, which contributes to its undoubted charm, clearly emerges from the interweaving of legal, economic and technological profiles, even if only hinted at here. Therefore, even in the face of by now multiple practical experiments and the first pronouncements on DAO obligations and liabilities, as well as in the light of an analysis of current forms of regulation, what emerges is the need to deepen, first of all doctrinal, DAO governance profiles.

As a phenomenon that has developed essentially online without serious reflection on their legal structure, DAOs often operate without a clear and predetermined legal status. This leads to uncertainties about the relationship between token holders and between them and the DAO, with the risk that, as they carry out business activities, they can be qualified as partnerships.

In order to solve the uncertainties relating to the absence of a clear legal form and the identification of the applicable law and court of jurisdiction, there has been a tendency to set up DAOs according to clear legal models. In this sense, DAOs are sometimes established in the form of a company or a foundation, thus relying on general models that, due to their characteristics, are suitable for incorporation of DAOs. Among companies, partnerships and limited liability companies are preferred, which are considered to be the most suitable corporations to incorporate DAOs as they are more flexible.

The analysis of the legal models used for the establishment of DAOs and the sectors in which they are concretely employed suggests that DAOs can be used for the pursuit of both non-lucrative and lucrative purpose, even if limits to the purpose that can be pursued may be imposed by individual national jurisdictions. This means that depending on the jurisdiction and the legal form in which the DAO is incorporated, there may be specific limitations to the purpose.

A further issue of complexity concerns the difficulty of identifying the jurisdiction to which the DAO belongs and the applicable law.

The DAO formation is a complex procedure, carried on by the so-called founders, as it involves an intersection between empirical-technological profiles, concerning the elaboration of the underlying IT structure of the DAO, and purely legal profiles. From a legal point of view, the analysis of the best-known legal models in the international regulatory landscape shows that the formation of a DAO can take place according to the forms provided for limited liability companies or foundations, depending on the legal nature of the chosen entity. Consequently, depending on the model chosen, the articles of incorporation or bylaws may be required.

Moreover, a key step in the establishment of DAOs concerns the raising of the capital needed to start the project, which is usually gained through the issuance of DAO voting tokens against the transfer of cryptocurrencies native to the blockchain on which the DAO is established. The initial offering of tokens constitutes an Initial Coin Offering (ICO) and is therefore subject to the relevant regulations.

As long as the tokens underlying the DAO can be qualified as financial instruments, their issuance is governed by the regulation of the issuer’s offers of financial products to the public. In contrast, for other types of tokens, the recently adopted European regulation, known as MiCAR (Reg. EU 2023/1114), applies.

A famous example of a DAO concerns TheDAO, which was “the first high-profile realization” of a decentralized autonomous organization running on the Ethereum platform. TheDAO case also represents a popular example of the application of the Howey test to a DAO.

Firm Networks and the Italian Regulation

The phenomenon of firm networks is of undoubted interest both, in general terms, for its potential as a widely used tool for increasing the innovative capacity and competitiveness of the participating business entities. To better understand the characteristics of this phenomenon, it may be interesting to compare it to other forms of business cooperation, including, in particular, the consortium, the joint venture, the company group or the European Economic Interest Group.

The network contract has been specifically introduced into the Italian regulatory framework by Law Decree 5/2009, whose article 3, paragraphs 4ter - 4quinquies, still provide the relevant rules. The Law Decree 5/2009 has so introduced in the Italian contract law, differently from what happens in all the other legal systems, a specific type of contract to rule network relations between business entities. In particular, pursuant to the above-mentioned paragraph 4ter, “with the network contract several entrepreneurs pursue the purpose of individually and collectively increasing their innovative capacity and competitiveness on the market and to this end they undertake, on the basis of a joint network program, to” carry out one or more of the activities listed in the article. Since the rule expressly refers to entrepreneurs, the contract can be entered into by individual entrepreneurs, partnerships, corporations, cooperatives, social enterprises, as well as all those further forms of collective enterprises, such as the Third Sector Entities insofar as they exclusively or principally carry out business activities, albeit non-profit. The network contract is subject to registration in the section of the business registry in which each participant is registered.

The network contract is configured as a plurilateral contract with common purpose, having associative cause. Under the original legislative framework, the possibility of attributing an autonomous legal subjectivity or legal personality to the network was debated. Following the amendments made in 2012, the aforementioned article 3, paragraph 4ter, now expressly excludes that the network is endowed with legal subjectivity, without prejudice, however, to the possibility of its acquisition by the express will of the parties. So, it is currently possible to constitute firm networks both with or without legal subjectivity.

Of particular interest are the profiles related to the organization and governance of firm networks. Infact, the great flexibility of the contract type allow the participant business entities to organize in very different ways the profiles related to the patrimonial autonomy, the decision making processes, the exercise of voice and exit rights, the procedure of network contract’s modification.