This article provides an introduction to ___. Please note that this article is an early work in progress and will be updated soon. Enjoy!
Table of Contents
- Related Posts
- What is a Smart Contract?
- What is a Smart Contract?
- Smart Contracts
- by Daniel Larimer
- Traditional Theory of Contracts
- Wedding Engagement as a Contract
- Theory of Reliance
- Concert Singer Contract
- Smarter Contracts
- Multi-Dimensional Property Rights
- Nondisclosure Agreements
- The Value of Trust
- Most Contracts are Unenforceable
- Avoiding Imputed and Implied Contracts
- Is the Peace Treaty a Promise or a Smart Contract?
- Yeah, But, What about…
- What is a DAO?
- What is a DAO?
- Bitcoin: The first DAO
- Ethereum’s “The DAO”
- What is Fractal Democracy?
- June 21, 2022 What is Fractal Democracy?
- How is Democracy Fractal?
- What is Democracy?
- Why Democracy must be Fractal
- Voting is not Democracy
- Fractal Voting
- Fractally — The Next Generation of DAOs
- How to Build Consensus
- Joining a Team
- Creating Content
- Providing Liquidity
- Fractal Governance
- Fractally White Paper Twosday Reveal
- What is the Legal Standing of a DAO?
- June 28, 2022 What is the Legal Standing of a DAO?
- Are DAOs General Partnerships?
- Who is a Member?
- How to Prevent a DAO from being classified as a General Partnership
- What is Property?
- Smart Contracts as Vending Machines
- Tokens that Aren’t Property
- Ownership of Keys not Tokens
- Smart Contracts as Smart Opinions
- Explicit Agreement
- Are DAO’s Unincorporated Nonprofit Associations?
- Legal Status of Immutable Smart Contracts
- Transaction Fees & Profit
- Can you sue a DAO?
- Can a DAO file a lawsuit?
What is a Smart Contract?
What is a Smart Contract?
A smart contract is computer code that deterministically executes an algorithm to determine property rights according to the signed statements of individuals. They enable a community to efficiently and unambiguously reach a shared consensus on who owns what.
Daniel Larimer described Smart Contracts as an ideal expression of the Title Transfer Theory of Contract by Murray Rothbard. While traditionally implemented on a blockchain, we believe the theory of smart contracts can and should apply to all legal agreements.
ƒractally utilizes smart contracts to govern decentralized autonomous communities and encourages everyone to understand the paradigm shift created when a community builds their governance and dispute resolution on top of the theory of smart contracts.
The following excerpt is from the chapter on “Smart Contracts” in the book “More Equal Animals - The Subtle Art of True Democracy” by ƒractally’s founder, Daniel Larimer.
by Daniel Larimer
What is a contract? Why are they binding? How are they enforced? We sign contracts all the time and pay lawyers a ton of money in the process, but how many of us have actually stopped to think about the principles that back contracts? Should all promises be enforceable or only those tied to consideration? Why or why not? The answers to these questions reveal subtle principles that are critical to sustaining a true democracy.
Murray Rothbard and Williamson Evers developed the Title Transfer Theory of Contract, which I believe contains critical concepts for a true democracy. Rothbard’s derivation of property rights is based on the theory of “homesteading” or “first use” and is vastly different from my derivation of property rights as a peace treaty. That said, his theory of contracting relative to defined property rights is still relevant.
While other philosophies claim “rights” as fundamental axioms derived from axiomatic moral stances such as the “nonaggression principle”, I claim that there is no support in nature for their principles. At best, their philosophies amount to a proposed peace treaty. While I reject their axioms as such, I feel that there are ample lessons to be learned from Rothbard’s work about how to design a logically consistent, and enforceable peace treaty (i.e. true democracy).
One of the most important aspects of a peace treaty is to define who owns what, how ownership changes, and how disputes are resolved. Any confusion over ownership creates conflict and conflict is supposed to be resolved by a peace treaty. Therefore, it follows that the peace treaty should define the process by which individuals may contract with respect to their property such that it minimizes ambiguity. This in turn brings up the question of what constitutes a valid contract and how are they to be enforced?
Traditional Theory of Contracts
Before expanding on what that means, let’s review how contracts typically operate today. Contracts are generally combinations of promises “to do” or “to give” something. If you are buying a coffee you verbally contract to give title to cash conditioned on receiving title to a cup of coffee. This contract need not be written down to capture the intent of the parties. This is an example of a “to give” contract. A “to give” contract could easily be represented on a blockchain as a smart contract assuming you created “digital titles” linked to a physical things.
A “to do” contract could be something like an employment contract. Here you promise to work 40 hours in a horseshoe-nail factory next week and someone else promises to pay you cash. In the event you choose not to work it could be considered a breach of contract. In the simple case, you simply don’t get paid; however, in the worst case the “kingdom could be lost”.
For want of a nail the shoe was lost. For want of a shoe the horse was lost. For want of a horse the rider was lost. For want of a rider the message was lost. For want of a message the battle was lost. For want of a battle the kingdom was lost. And all for the want of a horseshoe nail.
Failure to perform on a “contractual” promise can cause grave damages to other parties relying on that promise. When these issues are taken to court under traditional contract theories, the judge will rarely compel you to perform the service. Instead, the judge will usually order you to pay damages to the other party. There is a problem with this, though: what are the damages? How is anyone supposed to know the extent to which other parties rely upon their promises? Would you take a job that promised to pay you $10 thousand dollars to work 40 hours next week, but if you change your mind you own them $10 million dollars in damages? Suppose you get sick or are in a car accident? Let’s assume for a moment that the other party really would experience a $10 million dollar loss without your performance and that this isn’t just a huge and unreasonable penalty. If you knew they were relying on you to the tune of $10 million in damages then chances are you would demand higher compensation in the first place and you would take out insurance to cover any events beyond your control that could make you liable for $10 million dollars.
Wedding Engagement as a Contract
All “to do” contracts are effectively unbacked promises. When you get engaged to be married the courts often consider this a contract. If you are jilted then you can sue for damages and many courts will grant them. The damages could be anything from the cost of the wedding to the loss of a job given up in expectation of getting married. When the parties “agreed to be married” the terms were ill defined and the damages potentially unbounded. In effect, most of the “contract” was never agreed to and is being defined/imputed by the courts after the fact.
Theory of Reliance
Many courts utilize the theory of “reliance” as justification for enforcing promises “to do” things and awarding damages for failure “to do” things. In theory, only “reasonable reliance” is considered valid. If someone is “unreasonable” in their reliance then it is not enforced. The problem with this approach is that it is circular reasoning. It is only reasonable to rely upon a promise if the courts are going to enforce it and courts should only enforce a promise if it is reasonable to rely upon it.
Concert Singer Contract
Imagine someone hired you for $200,000 dollars to sing at a concert. Once you were under contract, they marketed and sold tickets worth $1 million dollars. Now imagine on the day of the concert you get stage fright and opt not to sing. The concert organizer may be forced to refund $1 million dollars in tickets on top of all the expenses of reserving the venue and advertising. If you had sung, the concert organizer expected a profit of $200 thousand with expenses of $800 thousand, but since you didn’t sing the organizer had expenses of just $600 thousand but still had no revenue and failed to realize the anticipated profit. All told, the organizer was economically $800 thousand behind because of your failure to perform.
If taken to court, a judge might make you pay $600 to $800 thousand plus legal fees on the premise that your “failure to perform” caused damages. The question is whether it was reasonable to rely upon a promise to perform. Would you have agreed to sing if you knew the damages you would have to pay for failure to sing? Do you even have the ability to pay those damages? If the court ordered payment, could the organizer even collect it?
What we can learn from this example is that the courts can’t force you to sing and even if they could, they couldn’t force you to sing your best. Furthermore, if you fail to show up the hour before your performance, no court can hear the dispute in time to compel performance and prevent damages.
If it isn’t practical to compel performance, what is the alternative? Courts resolve most disputes by transferring title to property from the promise breaker to the other party. If the promise breaker doesn’t have property, then the courts authorize wage garnishment. In some cases courts give the promise breaker the option to perform or pay. This means that all contracts could be written such that there is no ambiguity regarding damages and everything is simply a pre-agreed conditional transfer of property.
The singer’s contract would read something like: if a song is performed then $200 thousand dollars owned by the organizer is transferred to the singer else $700 thousand dollars owned by the singer is transferred to the organizer. In the event of a dispute a judge or jury would only have to determine whether a song was performed as agreed. If the singer doesn’t have $700 thousand dollars, then the event organizer would need to find an insurer. If no insurer could be found, then the tickets would have to indicate that there is no refund if the singer is unable or unwilling to perform. The audience would end up crowd funding the “insurance”.
Suppose it wasn’t possible to transfer the risk to insurers or customers and the singer didn’t have $700 thousand dollars. This poses an interesting question: can you contract to transfer title to something you don’t own? Imagine the contract read if a song is performed then the Brooklyn Bridge “owned” by the organizer is transferred to the singer else one billion tons of gold owned by the singer is transferred to the organizer. The organizer doesn’t own the Brooklyn Bridge and there isn’t anywhere near one billion tons of gold on the entire planet. Under my interpretation of the Title Transfer Theory of Contract, a contract is invalid if under any conditional outcomes a title transfer is indicated for which any party does not have current title. Anything else would be tantamount to a “to do” contract where the “doing” is acquiring title to the asset so that it could be transferred.
This interpretation of Title Transfer Theory of Contract has profound implications for almost every kind of contract. We are so used to viewing contracts as promises that it isn’t always intuitive to limit contracts to conditional title transfers. If you are not careful it is incredibly easy to fall back into a promise theory of contracts. Even Rothbard fell into this trap in a chapter titled, “Property Rights and the Theory of Contracts”, from his book The Ethics of Liberty.
Fortunately, there is a framework that ensures that it is impossible to construct an invalid contract: smart contracts. A smart contract is effectively computer code that deterministically executes an algorithm based upon the signed statements of individuals. Computer algorithms must be consistent and are unable to assign two owners to the same property at the same time. Anything that can be represented as a smart contract is compatible with the Title Transfer Theory of Contract. If it cannot be represented by computer code then it probably isn’t a valid, logically consistent, contract. The only thing the courts need to do to enforce smart contracts is to ensure that the physical property referenced by the smart contract is under the control of the owner specified by the smart contract. A smart contract need not be represented in software code in order to be smart. From this point forward I will refer to contracts compatible with the Title Transfer Theory of Contract as Smart Contracts.
Now let’s review how Rothbard fell back into the promise theory of contract. Rothbard’s mistake was in his example of a loan for $1000 dollars with a promise to repay $1100 dollars in a year. Let’s look at an excerpt from The Ethics of Liberty:
“Suppose that Smith and Jones make a contract, Smith giving $1000 to Jones at the present moment, in exchange for an IOU of Jones agreeing to pay Smith $1100 one year from now. This is a typical debt contract. What has happened is that Smith has transferred his title to ownership of $1000 at present in exchange for Jones agreeing now to transfer title to Smith of $1100 one year from now. Suppose that, when the appointed date arrives one year later, Jones refuses to pay. Why should this payment now be enforceable at libertarian law? Existing law largely contends that Jones must pay $1100 because he has “promised” to pay, and that this promise set up in Smith’s mind the “expectation” that he would receive the money.
Our contention here is that mere promises are not a transfer of property title; that while it may well be the moral thing to keep one’s promises, that is not and cannot be the function of law (i.e., legal violence) in a libertarian system to enforce morality. Our contention here is that Jones must pay Smith $1100 because he had already agreed to transfer title, and that the nonpayment means that Jones is a thief, that he has stolen the property of Smith. In short, Smith’s original transfer of the $1000 was not absolute, but conditional, conditional on Jones paying the $1100 in a year, and that, therefore, the failure to pay is an implicit theft of Smith’s rightful property.”
The mistake made by Rothbard is that a title cannot be transferred until the conditions are met; furthermore, Jones cannot agree to transfer title to $1100 dollars he does not have. If Jones wanted to spend the $1000 dollars he conditionally received from Smith, then the condition would be a lien that followed the $1000 dollars. If Jones used the $1000 dollars to buy a laptop from Alice he would have to disclose that he doesn’t have clean title to the $1000 dollars because he has not yet paid $1100 to Smith. Alice would have to accept the credit risk of Jones not paying Smith and would therefore make the transfer of title to the laptop contingent upon getting the lien on the money lifted. If Jones failed to pay $1100 dollars to Smith in one year, then Smith retains title to $1000 dollars and Alice retains title to the laptop. If Jones keeps the laptop he is a thief. If Alice keeps the $1000 dollars she is a thief. The $100 dollars of interest is an unenforceable promise that only exists as the condition upon which transfer of title to $1000 dollars may be effected. Titles held to money conditioned on different promises are not fungible. This means that there is no efficient way to use encumbered assets as money.
So how would lending work under a smart contract? Your contract with the bank will be something like: if required monthly payments are not made then title to the house is transferred to the bank. No promises are made, just predefined conditional transfers of assets to which the parties have clean title. Normally, recourse bank loans also hold you liable for the difference between what the bank can sell the house for and your loan balance. This arrangement would be invalid because all assets subject to the contract would have to be owned at the time the contract was entered in order to agree to transfer title to those assets. Since the borrower doesn’t have the money to pay cash for the house, she cannot sign a contract that transfers title to the cash. Any promise to pay cash would should be unenforceable because such a promise could not be implemented in computer code as smart contract. This means that only non-recourse collateralized loans are enforceable via smart contracts.
A smart contract on a blockchain is effectively an automated escrow agent which holds title to all assets subject to conditional transfers. Computer code governs how titles transfer based upon how the people involved in the contract interact. A smart contract could be implemented manually with a human escrow agent. A contract’s enforceability under a true democracy should be limited to the transfer of assets managed by the escrow agent. The parties to a contract need not hire a 3rd party escrow agent so long as they personally account for all liens on any property in their possession. In the event of a dispute a 3rd party can be brought in to interpret the smart contract and evaluate the conditions. Anyone who fails to transfer physical possession after such a ruling is no different than a thief.
Under the law of the jungle you could agree to transfer title to your body in the event you fail to follow through on your contractual terms. This would allow you to be thrown in prison, forced into a labor camp, or tortured until you comply. At the extreme you could contract to allow others to kill you. Since your body is practically indivisible, you would only be able to use it as collateral for one contract at a time. Imagine what would happen if you contracted to transfer title to your body in event of default in two different contracts with different people. One person wants to harvest your organs and the other wants to put you in a work camp. Once someone has a lien on your body it isn’t possible to sell your body to someone else or encumber it with additional liens. While such a contract might be possible, a community dedicated to protecting the independence of its members would be wise to not recognize and enforce such contracts.
Generally speaking, I would recommend that a community forbid enforcement of any loan with recourse beyond the collateral. This would include unsecured credit card debt. All contracts should be settled by title transfers for which it is impossible to put someone into bankruptcy. Bankruptcy is only possible to the extent contracts were written with respect to assets the parties did not have title to at the time the contract was agreed to. Credit cards could still exist, but the only recourse would be a note on someone’s credit rating. This may limit their ability to get future credit, but will not allow creditors to reclaim funds.
Multi-Dimensional Property Rights
Property can be conceived of in many dimensions. It has a location in three-dimensional space, but also in time. If you contract to lease a car next week you cannot double book the reservation because title in the use of the car at that time is no longer yours. Likewise, you cannot transfer title to money next month until you have title to that money next month. If a contract conceives of title transfers for assets that may not exist at the time of the transfer, then it should have a fallback. A promise to pay $1000 dollars next month is not binding unless you have title to it and encumber it with a lien. Property may have an infinite number of dimensions depending upon how you divide up “usage rights”. Time periods are simply one kind of usage right.
Let’s consider another kind of contract, a “nondisclosure agreement”. Such a contract would have to read: if information is disclosed then title to property is transferred. Would you sign a nondisclosure agreement that read: if information is disclosed then title to $1 million dollars is transferred? First of all, you would have to have $1 million dollars that is not encumbered by other contracts. Imagine that you only had $1 million dollars, and you signed a nondisclosure agreement with a 100 year term. Under a smart contract, you would have to lock that money up for 100 years and could not use it for anything that wasn’t subject to your ability to disclose information and cause transfer. If you wanted to sign a second nondisclosure agreement you would need to find other assets to secure it with. If you don’t secure a nondisclosure contract with title to assets you own, then it would be an unenforceable contract. In this case, the cost of breaching the nondisclosure contact is only your reputation (e.g. credit rating). In practice, nondisclosure contracts should be restructured as “fee for disclosure” or have short windows of time during which assets are encumbered.
What about “noncompete” clauses? Like nondisclosure, it is a meaningless promise only enforceable by reputation damage unless you encumber the title to other assets on condition that you do not compete. An employee with no assets would have very little with which to back a noncompete agreement; however, a large company could back the agreement with equity.
Community peace treaties that aim to implement a true democracy should recognize property rights and smart contracts with respect to property title. Furthermore, promises “to do” things should not be enforced as such, but instead property titles should be transferred subject to pre-agreed “objective” conditions. It is not reasonable to know how other people are relying upon your promises and what damages they might claim; therefore, it is not possible to consent to open-ended damages. Without consent a contract is not valid nor is the “democracy in name only” that attempts to enforce it.
One of the greatest innovations of the blockchain industry is the concept of smart contracts. When implemented on a blockchain, a smart contract is a “self-executing”, deterministic agreement among parties enforced by a community without reliance on a credible threat of violence. Traditionally smart contracts are used with respect to purely digital property because the blockchain has complete authority over its database. Representing all property rights under a “software is law” mindset provides a useful framework for constructing smart contracts enforced by more manual means. In principle, all agreements should be capable of representation in software which manages the transfer of title of any and all property based upon relatively objective conditions. Any contract that could not be translated into equivalent code should be considered invalid.
The Value of Trust
Organizing higher-order communities on top of the law of the jungle depends upon trust. Without trust, contracts become much more expensive to document and enforce. In low trust environments many transactions are not even possible because the cost of creating a contract is greater than the value of the transaction. Reputation is the basis of trust and failure to keep promises will damage reputation and increase everyone’s cost of doing business.
Contract law should largely be re served for high-value transactions and everything else should be unenforceable in the courts. At most a court or private arbitration system could render an opinion that you broke a promise. That opinion, being public record, would, in turn, impact all your other business dealings. This should be incentive enough to keep your word without getting into subjective damages.
One of the benefits of organizing society according to the Rules of Relative Power (Chapter 4) and Encapsulation (Chapter 5) is that it is easier to build trust in small communities and that can make these communities more efficient in many ways. Trust is a function of Dunbar’s research into the number of relationships our brains can maintain. Trust is largely based upon knowing people and there are only so many people whom you can know well enough to directly trust. When you heavily rely upon indirect means of trusting people you risk transferring and concentrating power in ways that can undermine true democracy.
In societies where 99% of the people you meet can be “trusted by default” things prosper. In societies where you can only trust your friends and family things stagnate. Extensive reliance on a community peace treaty to enforce promises in contracts is already a sign that trust is decaying. In an ideal world, reputation would be highly valued and therefore trust is so high that written promises are only required to remind the parties of the agreement. In such a society everyone takes the non-recourse risk that the other party will default. Loans are made without liens being filed at the courthouse. Doors are left unlocked and children play in the streets.
We should not attempt to replace trust with contracts nor enforce promises by courts assessing subjective damages. Ambiguous evaluation of contracts breaks down trust in the peace treaty (government) itself and yields too much subjective and undemocratic power to the courts. That said, smart contracts and community courts are a necessary background upon which trust can be built. The more predictable court rulings become the less time people spend fighting in court and the more quickly people settle things among themselves. Predictable court rulings require a philosophy of contract that is equally predictable. It is for this reason that I believe everyone (or at least every lawyer) should strive for a deep understanding of the Title Transfer Theory of Contract so that they can write smarter contracts.
Most Contracts are Unenforceable
We already live in a society where 99% of contracts are unenforceable. Lawyers cost hundreds of dollars per hour. Navigating the system without lawyers is error prone and takes months of study. Even if you win in small claims court, 80% of the judgments are never paid. The inability to pay a judgment is another failure of the promise theory of contract. Judgments on smart contracts are either payable or the other party is subject to criminal theft. I will go into more detail on criminal justice in the next chapter.
Once you move beyond small claims court, the legal fees start mounting quickly. I was in a business dispute and was given an estimate of $100K in legal fees to enforce a case I felt was open and shut, and that was just my side of the expenses. Despite the obvious facts, the lawyers couldn’t give me any reasonable guarantees of winning. Fortunately we came to a settlement, but only after incurring thousands of dollars in legal fees. Many times in divorces, the cost of fighting over the assets is greater than the total value of all assets of the marriage. In most cases, it makes more sense to suffer a loss than to pursue enforcement of contracts. Once you realize this, you realize that we are already living in a world where the vast majority of contracts are unenforceable.
Avoiding Imputed and Implied Contracts
Sadly, one of the biggest reason for entering a contract today is to attempt to avoid the courts imputing an implied contract in its place. Most contracts spend a ton of ink making it explicit that nothing was promised, represented, or owed. Still more ink is spilled making sure the customer takes personal responsibility for any and all risks associated with the transaction. In effect, contracts have become about all of the potential, unreasonable, and unexpected liabilities that could be implied by courts simply by interacting with other people. It is so bad that you cannot even “give software away” for anyone to use without 50% of the “free software license” being about limiting liability.
Here is the BSD license:
THIS SOFTWARE IS PROVIDED BY <COPYRIGHT HOLDER> ‘‘AS IS’’ AND ANY EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE ARE DISCLAIMED. IN NO EVENT SHALL <COPY- RIGHT HOLDER> BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, EXEMPLARY, OR CONSEQUENTIAL DAMAGES (INCLUDING, BUT NOT LIMITED TO, PROCUREMENT OF SUBSTITUTE GOODS OR SERVICES; LOSS OF USE,DATA, OR PROFITS; OR BUSINESS INTERRUPTION) HOWEVER CAUSED AND ON ANY THEORY OF LIABILITY, WHETHER IN CONTRACT, STRICT LIABILITY, OR TORT (INCLUDING NEGLIGENCE OR OTHERWISE) ARISING IN ANY WAY OUT OF THE USE OF THIS SOFTWARE, EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGE.
Not only does this disclaimer account for 50% of the license text, but it is also in all capital letters. The MIT license also spends about 50% of its text on the same kind of boiler plate.
Under a smart contract all potential liabilities and conditions are explicit. Contracts only get drafted for big ticket items and are completely unnecessary at all other times. We eliminate a large percentage of “economically pointless” contracts when everyone knows that a “verbal contract” is not enforceable and that the courts cannot create “implied contracts”. A society based upon smart contracts completely eliminates the vast majority of the “contracts” you sign and the smart contracts that remain are vastly simplified.
This simplification of contracts empowers people and disempowers courts. This makes everyone more equal and therefore is a critical component of true democracies. In a subsequent chapter on Financial Integrity it will become clear how smart contracts prevent most forms of “legalized” financial fraud. The next chapter deals with how justice can be had when you are harmed by someone with whom you had no contract.
Is the Peace Treaty a Promise or a Smart Contract?
Smart contracts are built upon an assumption of a preexisting agreement over property rights. Rothbard proposes we agree that the first person to homestead gets assigned the property rights. I propose that property belongs to whoever can control it. That control is subject to physical strength and social strength. Two people can agree to recognize property rights, but this agreement isn’t a contract, it’s a mutual promise built on trust and reputation. The promise is only enforceable by the natural “jungle strength” of the parties.
It is theoretically possible for a peace treaty to define property rights and contract law by the reliance theory, by the damages theory, or by any other theory of contract. At the end of the day, all that matters is that trust is maintained and people continue to agree to live in peace rather than war.
Ultimately this means that all contracts are based upon the enforcement of the promise made in the peace treaty. We use jungle power to enforce the promises made to reach peace. So why limit ourselves to smart contracts (conditional title transfers) in the peace treaty? Because the peace treaty must be clear, simple, and sustainable. It must be designed to avoid conflict and moral hazard. It must be designed to prevent abuse under the color of law. Any peace treaty that fails in this regard will not last. All other theories of contract have logical inconsistencies evidenced by the inability to represent themselves as computer code and enforce themselves as a smart contract. These logical inconsistencies lead to conflict and ultimately to failure of the peace treaty. Conflict transfers power to judges which ultimately undermines true democracy as the judges become the arbiters of who owns what instead of the people.
Not everything is equally life sustaining. Not all peace treaties are advisable. The purpose of this book is to provide council to those faced with negotiating a peace treaty under the assumption that all parties have equal jungle power. It is an attempt to present an agreement agreeable to all parties and biased toward none. Smart contracts are the only logically consistent view of property rights I have come across.
How has our current system been working for you? If you have never been to court then you probably have never actually relied on the enforceability of a contract nor experienced the insanity created by the current system. We can do better and I promise you it is worth your time to fully internalize the principles and the power of smart contracts.
Yeah, But, What about…
I have presented the smart contract approach to contracting to many people and have gotten a lot of feedback. We are so used to viewing contracts as promises that we cannot imagine a world that relied only on smart contracts or reputation. Things appear to be working “as is” so why should a book about true democracy advocate such a fundamental change to every business arrangement? Can’t we keep a promise theory of contract and still adopt the other principles of true democracy?
To make contractual promises enforceable (beyond a posted bond), is to imbue them with the characteristics of property. My promise to pay you $1 trillion dollars becomes an asset on your books because, “by law”, if I fail to pay, the government is supposed to make me pay. Everyone should know that I don’t have $1 trillion dollars nor ability to earn it and that there is nothing the government can do to enforce this contract. The damages one seeks from broken promises must come from somewhere. If there are no assets to back the promise then the promise has potentially no value. Any accountant worth their salt knows better than to count their chickens (promises) before they hatch.
If a promise to pay $1 trillion dollars I don’t have is obviously not a valid “contract” then at what point does a promise become valid and therefore enforceable? $1 billion dollars? $1 million dollars? $1 thousand dollars? $1 dollar? The fact that promises should not be considered enforceable should be obvious for anyone doing business with the poor. No matter what contract a poor person signs, if they don’t keep their promise, there is nothing you can do to collect damages. You can’t get blood out of a turnip.
The consequence of enforcing promises, as opposed to conditional title transfers, is to encourage people to build their economic house on a foundation of sand. It enables fraud by transmuting something that should have no value into something that is presumed to have value. An insurance company makes promises to provide a level of coverage that they mathematically cannot keep in certain circumstances. Those relying upon that promise will be disappointed when their insurance company goes bankrupt when they need it most because they misestimated the frequency and magnitude of potential claims.
Manufacturers make promises to provide a warranty. We assume these promises are worth something because people perceive companies to be “big” and “rich” compared their customers. The problem is that in order for a company to make good on its promises it must set aside capital to “self insure” against defects. This capital must come from the customers in the form of increased prices. Because the manufacturer cannot possibly know the magnitude of potential claims nor the liability, they will either end up overcharging or over promising and neither the customer nor the manufacturer knows the reality until the end of the warranty period. From this perspective, a lifetime warranty is an unbacked and therefore potentially unenforceable promise. A company promising a lifetime warranty is selling you a bill of goods unless they are setting aside segregated funds to back the warranty. Due to fierce market competition and price conscious customers, companies often find it cheaper to provide unbacked warranty promises and hope for the best. Try collecting on a lifetime warranty from a bankrupt manufacturer!
Banks make promises to pay on demand, but if everyone attempted to collect on that promise at the same time the bank would be insolvent. How is this a valid contract? How can the governments enforce such a contract? They can’t and they don’t.
Imagine you signed 1000 contracts for various things. In each contract you have the ability to pay the potential damages but only if you don’t default on any of the other 999 contracts. How is this different than fractional reserve banking? Are your counter-parties aware of the risk that you may not be able to pay damages if you fail to keep your contractual promises?
Even under the “promise theory of contracts”, a contract must have the consent of the parties to be considered valid. In order to consent one must have knowledge. How can one have knowledge of the extent to which failure to perform a promise will “harm” the other party if you must wait for a judge to “assess” damages after the fact? If you do not know the limits on your liability then how can you consent? If you lack the ability to pay the damages as outlined in the contract or awarded by a judge, then how is a government to enforce it? The supposed “contract” is invalid to both sides, one side is unable to consent while the other side is unable to collect.
A true democracy should facilitate people working together and building trust. The consequence of defaulting on promises is a loss of trust. We must all take personal responsibility in determining who to trust and bearing the cost of misplacing our trust. If we allow promise based contracts to be enforced with the full “jungle power” of the community then we introduce moral hazard at the most fundamental level. We allow one person to take the risk of trusting someone and expect everyone else to bear the cost of enforcing the collection of damages when that trust was misplaced. The consequence of this is to cause members of society to grant trust to people who do not deserve it. This is because people aren’t trusting each other, they are trusting the illusion of an enforceable contract.
Never do business with someone you do not trust. If trust is lacking, then a smart contract is how a community should document an enforceable contract. If a contractual promise is broken, then your only recourse should be to warn others about the breach.
What is a DAO?
What is a DAO?
DAO stands for Decentralized Autonomous Organization. The description “decentralized and autonomous” was originally coined by ƒractally’s founder, Daniel Larimer, in 2013, to describe the economics of Bitcoin. Larimer described Bitcoins as “shares” in a decentralized company which issued shares in exchange for hashpower.
Bitcoin: The first DAO
If someone wanted to organize humans to autonomously produce highly efficient computer chips for performing a specific task (sha256 hashing), then it is hard to deny the success of Bitcoin. Without any governing structures or centralized coordination millions of people cooperated to build the largest distributed supercomputer in the world. This process is on “autopilot” and “unstoppable” as long as people valued the currency and respected the algorithm.
The critical ingredient to being autonomous is being sovereign over information. Bitcoin, when viewed as a company, can make no promises, hold no secrets, and hold no assets that it is not fully self-sovereign over. By “fully self-sovereign” it means they are solely subject to the Bitcoin consensus algorithm.
A DAO is therefore consensus over information and can never be destroyed unless all copies of the information are destroyed. In the digital age, destroying all copies of anything is next to impossible.
When it comes to “governing a DAO”, the information is “forked” and two copies of the information are created, each of which being fully complete, one of which has a different opinion on some part of the information. The free market, via voluntary exchange, resolves the dispute according to the value placed on each version of the consensus information. One or both sides of the fork can continue and are fully functional. This is the true test of a DAO.
We can therefore say that a DAO is pure information, the value of which is judged by the market. A DAO only depends on the freedom of speech and the open source software to deterministically interpret that speech into a shared consensus.
A DAO has no assets that can be seized, no laws it is subject to. A DAO is nothing more than a shared idea and is therefore bulletproof. If an organization depends upon secrets, then those secrets are centralized and the keeper of those secrets is not bulletproof. If an organization depends upon “shared ownership” of tangible property, then it is not a DAO, because the property could be taken or destroyed. If an organization depends upon any information it is not sovereign over, then it is not a DAO.
Ethereum’s “The DAO”
For example, “The DAO”, an Ethereum smart contract, raised a record amount of Ethereum tokens to be managed in a “collective investment scheme” governed by another token. Despite the name (“The DAO”), we contend that it was merely a smart contract operating under Ethereum. Ethereum being a DAO while, “The DAO”, was merely a transparent, smart contract operated, collective investment scheme. When the smart contract was exploited it forced the entire Ethereum blockchain to fork in order to resolve the dispute. This fork became known as Ethereum Classic.
A smart contract is only as decentralized and autonomous as it is independent. If “The DAO” had no shared state with Ethereum (the ETH balances), then there would be no way for an Ethereum fork to change “The DAO” and “The DAO” would have had to fork itself if there was any dispute.
The transparency and independence of information is what makes a DAO “autonomous”, but what makes it decentralized? A DAO is decentralized when it continues to function regardless of what any subgroup of people do. As long as some people value the consensus state of Bitcoin, someone, somewhere, will do the proof of work necessary to keep the blockchain moving forward. If, on the other hand, people only value Bitcoin because of what Satoshi or a centralized team is doing to bring value to the consensus information then it becomes centralized.
Steem, the first social media DAO, had incentives that inspired the community to fork Hive when the founding company, Steemit, was sold and the new owner attempted to take the network in a different direction. The information being transparent, combined with the ability for anyone to step up and provide services around the information is what made it decentralized and autonomous. No matter what comes, the organization will keep going.
This is what defines a DAO:
- No Secrets (e.g. communally owned private keys)
- No Legal Standing
- No Tangible or Intangible external Assets
- No Intellectual Property
- No Monopolies on Infrastructure
- Just consensus over forkable Information
If a DAO can inspire the creation of the world’s largest supercomputer powered by extremely advanced custom silicon chips, what else can a DAO do? Can it create a new legal system? Can it motivate a surge in innovation, creativity, and open source software development? Can it find cures to diseases? Can it end corruption? What if a DAO powered by the right governance process could do all these things and more? ƒractally is creating a system that we believe has the potential to revolutionize how people realize the value created with the power of collaboration.
What is Fractal Democracy?
June 21, 2022 What is Fractal Democracy?
Fractal Democracy enables a group of people to govern themselves without being captured by hidden, non-democratic, power structures. It does not make any ideological claims. Winston Churchill once said that “democracy is the worst form of government - except for all the others that have been tried”, but what if there are a multitude of ways to measure the will of the people, and some work while others fail miserably? Fractal Democracy is the best approach to tapping the wisdom of the crowds and reaching consensus on everything from leaders to budgets to laws.
How is Democracy Fractal?
In mathematics, a fractal is something that has self-similarity at multiple scales. So a Democratic Fractal would be a democracy of democracies. More generally, a democracy of democracies, of democracies, of…
When the United States was founded, the Senate was an expression of Fractal Democracy because Senators were selected by the state governments rather than being directly elected by the people. The United Nations could be a partial expression of Fractal Democracy if all nations had equal votes and were themselves democratic.
A maximally fractal democracy would start with the smallest possible groupings of people, who then appoint representatives to higher-level democracies. Each level of the fractal democracy would minimize the number of members to maximize fractal representation.
What is Democracy?
The term “democracy” derives from its Greek origins in demos (all the people) and kratos (rule). A democracy is a system whereby all the people share power equally. Typically people think this means everyone gets an equal vote; however, voting by itself is a system known as Majoritarianism and represents the rule of the majority over the minority. Under a majoritarian system, the minority has no power, even if they vote, and therefore it would be inappropriate to classify it as a democracy.
In my book, “More Equal Animals - The Subtle Art of True Democracy”, I make the case that democracy requires the consent of the governed. This implies that the governed have the power to secede or leave the democracy. Those that choose to remain consent to follow the group consensus even if they disagree. Without the individual power to leave, a system ceases to be a democracy and becomes the rule of the majority over the minority.
The power to leave entails more than just a right to leave, but also the ability to. If the members of a given democracy are co-dependent rather than independent then they couldn’t leave even if they had the right to. It is therefore critical for any democracy to support the independence of its members or it will devolve into an oligarchy (rule by the few) or tyranny.
Why Democracy must be Fractal
The requirement for members of a Democracy to have the right **and **ability to leave imposes limitations on the size and structure of a democratic system. For example, if all 8 billion people were part of a single “democratic” government, then, while each person may have a “right” to leave, they wouldn’t really have the ability to survive on their own. However, if there were 1,000 countries and each person had a right to leave one country and join any other country that would have them then they gain the ability to leave. Global democracy is, therefore, an impossible contradiction unless it is fractal in structure.
The independence, and therefore power, of an individual, is proportional to the number of countries they have the ability to join. If all 1000 countries block your immigration request, then you have lost your ability to participate freely and with consent in your current country. If there are no countries to which you would voluntarily consent to be a part, then your situation is similar to a single “global democracy”. The more variety in countries available, the more equal everyone’s power to choose one that fits their needs becomes.
It is easier to secede as a group than as an individual. For example, it would be easier for the state of Texas to secede from the United States than for 30 million individuals to leave the United States. Likewise, it would be easier for Dallas County to secede from Texas than for everyone to move out of Dallas.
Therefore, each individual person would maximize their power and independence if they first organized at the most local level possible. A state could become a democracy of counties and the United States a democracy of States and the world a democracy of Countries. With this structure, each person would have approximately 10,000 cities to choose from worldwide or 3000 counties to choose from in just the United States. Each of these cities and counties would have more power and autonomy which in turn means the people within those democracies have more total personal power and more equal power.
If democracy is not fractal in structure then the people will lack the ability to easily coordinate a secession and, therefore, their power to consent is compromised. The power gap between the individual and the group would be too great for any individual to hold the group accountable.
Voting is not Democracy
Democracy means a government of, by, and for the people. This means that it must protect the majority from the minority and the minority from the majority. After substantial research, the only form of “democracy” that can meet this standard is Fractal Democracy and the most common use of the word democracy is really describing something else altogether: the tyranny of the majority.
A typical misconception is that any society that gives the people the right to vote is a democracy; however, what if there are only two candidates on the ballot and they both share common positions which you find abhorrent? What if a dozen people control the media they only present certain candidates? What if political parties with non-democratic governance control which candidates you can vote for?
Voting is just a means to measure consensus; however, those who control the ballot and the media have the unequal power to present the people with a false choice when the people utilize traditional voting processes.
You can have a democracy without all of the people voting. For example, a truly random sampling of just 0.1% of the people could be used to measure the opinion of the majority. It is even theoretically possible that a Kingdom with a solitary ruler could be “democratic” provided that the people retained the ability to secede peacefully. This would be similar to the United Nations appointing the United States to be in charge of international law. If any country did not approve of the rules being made by the United States then they would secede and simply ignore the rules. Then a new group of countries could form for the benefit of mutual collaboration.
- *Democracy is the voluntary cooperation of people or organizations which have approximately equal power relative to each other and sufficient power to stand independent of the democratic organization. **Democracy has nothing to do with voting or the process by which a bill becomes law.
Typical voting processes have a pre-defined ballot which limits the choice of the people. Using fractal voting there is no need for a pre-defined ballot and all members of a fractal democracy have equal opportunity to be heard. This occurs by randomly grouping members into groups of 5 or 6. Each group must reach a consensus among its own members on who best represents their interests. The chosen representatives of each group are then randomly grouped and the process is repeated ƒractally (in a fractal manner). The end result is the integration of opinions of the entire population without any filtering by the media or political parties. A fractal voting system is what enables fractal democracies to truly empower the people while preventing the covert capture of power by the media, the political parties, or even the military.
Help bring fractal democracy to the world. Visit gofractally.com and join our community which utilizes fractal voting every weekend to reward those who make the most valued contributions to the cause. For more background on the principles behind fractal democracy check out my book, “More Equal Animals - The Subtle Art of True Democracy”.
Fractally — The Next Generation of DAOs
It’s time to introduce next generation of decentralized autonomous organizations.
Traditional organizations are archaic and autocratic. Their ownership is distributed according to the Pareto Principle where 1% of the shareholders tend own 51% of the shares and therefore they have 100% of the control. Meanwhile, the vision and values flow down to the workers from a President or CEO.
While 20% of the workers produce 80% of the organizations value, 80% of the profits are distributed to just 20% of the owners instead of going the people doing the work.
Fractally is the next step in the evolution of human collaboration.
Public goods are everywhere, from open source software, to scientific discovery, education, journalism, and charity. We all benefit from the altruistic contributions of others. Wouldn’t it be great if we could turbo charge the creation of more public goods! Imagine a world where everyone has incentive to contribute to a cause - a world where the media serve the people and scientists are free to follow their heart.
Decentralized Autonomous Organizations powered by fractal governance invert the pyramid of power and direct value back to those who produce it. These DAOs are the ideal way to organize people to produce goods and services that benefit a community and are otherwise difficult to produce by private, autocratic, businesses.
ƒractally utilizes a revolutionary process to tap the wisdom of the crowds and decentralize power.
This process empowers the people to reach consensus on the relative value of everyones individual contributions. This enables any community to direct their currency toward those contributing the most.
Ƒractally uses Respect as its measure of value. Each community has its own type of ℝespect like countries have their own brand of dollars or pesos. Respect is the real currency that powers civilization. Let’s face it, we all desire Respect and now with ƒractally you can get the respect you deserve.
With fractally, There are many ways to earn respect. You can help Build Consensus, Create Content. Stake Respect…. Provide Liquidity…. Join a team… and last, but not least, recruit people who contribute to the community.
If you cannot contribute directly, then you can always buy Respect from someone who earned it.
How to Build Consensus
Every week, contributors are randomly assigned to a group of 6 people. These people appear on a video conference where they reach a consensus on how to rank each other from greatest to least contributor. Based upon this ranking,
Contributors receive 1, 2, 3, 5, 8, or 13 units of Respect. If consensus is not reached, then no Respect is distributed to the group. This pattern follows the Fibonacci sequence and is one of many ways fractally mimics nature.
This distribution follows a natural pattern in nature and human societies known as the Pareto distribution or the 80/20 rule. Pareto observed that 20% of the people produce 80% of the output. With the fibonacci allocation, ℝespect is distributed such that 33% of the contributors. earn 66% of the ℝespect. This is a softer form of the Pareto distribution which should tend to distribute respect in relative proportion to the real contributions of the community.
This process then repeats, in a fractal manner, by randomly grouping the most Respected contributors from the first round into new groups of 6. These new groups also rank themselves from greatest to least contributor.The process continues up to 5 times or until there are fewer than 6 people.
Because consensus is built over a recorded video call, and all groups meet at the same time, ƒractally ensures that communities only contain real people and are therefore truly democratic. This foils hackers and bots that attempt to steal the communities respect.
By randomizing group membership and requiring 4 of 6 consensus, ƒractally should practically eliminate party politics within a community.
Joining a Team
Everyone has an opportunity to join a team of 4 to 12 people and double their respect.
Teams receives a matching distribution of respect for any respect earned by their members in the weekly consensus meetings. Then, Each team must also reach a consensus on how to divide their budget among the team members. If your team decides you are not carrying your weight, then they can vote you off the team.
Teams allow you to build relationships and get recognized for contributions not easily observable by the broader community.
Sharing information may be the single best example of a public good. We all benefit when the most valuable information is discovered and published to an easily accessible database. Every community votes on the content they value most, Whether it is scientific research, entertainment, investigative journalism, blogging, or cat videos.
You earn respect when the community likes your content.
The Respect earned grows quadratically with the number of people who like the content. For example, If 2 people like it, then you could earn 4 units of respect, but if 3 people like it then you could earn 9. Content without clear community support is unlikely to earn much respect.
The weight of your like is determined by your ranking in the weekly consensus meetings. In large communities, highly respected community members can have a vote that is 30 times stronger than the least respected contributors.
After 48 hours, the likes are tallied relative to other content, and the contributor receives the appropriate respect.
Liquidity providers hold Mutual Respect for two different communities. As the respective value of each community changes a market maker automatically rebalances the account to ensure the liquidity provider maintains a 50/50 balance of respect in both communities. One or both communities may give additional Respect to those who commit to provide liquidity for a week.
Each community can link together with up to 12 other communities to form a mesh network of mutual respect. All communities are stronger and grow together when they give mutual respect and shared liquidity.
Now that we’ve talked about some of the many ways to earn respect, let’s talk about community makes global decisions. Every team must reach consensus on a team leader and they may change their team leader at any time with 2/3s approval.
The top 12 team leaders from the teams which have earned the most respect over the past 3 months form a council. This council has complete authority over changing community policies and the blockchain powered smart contract that mediates community interactions.
But before any action of the council of 12 takes effect, a mandatory 3 day waiting period is observed during which time the teams have an opportunity to change their leader and retract their vote.
Putting everything together, Fractally provides communities a framework that leverages the power of blockchain technology to motivate people to put in the effort to achieve a communities goals. This is only possible with a process that builds trust and accountability by design.
Everyone benefits when we all work together! Do you have something to contribute? ƒractally encourages you to go for it and earn the respect you deserve!
Fractally White Paper Twosday Reveal
Daniel Larimer reveals the next generation of decentralized autonomous organizations (DAOs).
What is the Legal Standing of a DAO?
June 28, 2022 What is the Legal Standing of a DAO?
This post explores the legal standing of DAOs and provides insight on how to structure your DAO to minimize liability for its members. A DAO, aka Decentralized Autonomous Organization, leverages blockchain technology to empower a group of people to reach a consensus over the state of their organization. I originally coined the phrase “Decentralized Autonomous Company” in 2013 to describe Bitcoin. The thinking was that Bitcoin was autonomously achieving its purpose without reliance on any centralized infrastructure.
Since then the concept of DAO’s has gone viral and people around the world are starting DAOs powered by smart contract platforms. In the process, many have failed and people have started to file lawsuits under various legal theories. This uncertainty around the legal standing of DAOs may discourage people from participating.
- I am not an attorney and what follows should not be interpreted as legal advice nor relied upon when starting or interacting with a DAO. This is merely my personal interpretation of some of the many complex and ambiguous laws that might apply. It is my hope that this article can provide your attorney with a good starting point for answering your questions. In my research, I am reminded that there is nothing new under the sun (Ecclesiastes 1:10). When push comes to shove the courts will classify your DAO under existing laws and Common Law. Informal associations of people have existed for thousands of years so courts have a ton of precedent. *
In my opinion, unless a DAO explicitly officially incorporates, it will likely fall into one of two categories:
Of these two classifications, it is likely in the best interest of everyone involved to take the steps necessary to error on the side of the UNA.
In this article, I will explain what things are likely to trigger classification as a General Partnership and provide some strategies that may help achieve and maintain UNA status. The rules that govern UNAs vary from state to state and country to country and a UNA might be subject to any and all laws that any of its Members are subject to. Either way, it is in the best interest of everyone involved in a DAO to sign an agreement that leaves little room for ambiguity regarding the rights and obligations of the parties. Absent an agreement the courts are free to impute whatever serves their interests.
Are DAOs General Partnerships?
A recent lawsuit against bZx DAO is claiming that the organization is a General Partnership. This would make the Organization, its co-founders, and its Members jointly and severally liable for failing to adequately secure a decentralized finance (DeFi) protocol resulting in the loss of $55 million.
A General Partnership is the default arrangement any time two or more people associate to carry on a business for profit. They can be formed without any written agreements. Unlike officially incorporated entities such as an LLC or C-corporation, each business partner is fully liable for the debts of the business, even if the debt was incurred by the other partner.
A blockchain-powered organization could be interpreted as a modern accounting system that facilitates the distribution of the partnership’s books to its Members. The technology used is not relevant in defining a General Partnership.
The most important thing to understand is that you can accidentally form a partnership just by the manner in which you conduct business. Even without any written or oral agreements. So in the absence of any written agreements among the parties participating in a common venture the status of General Partnership may be imputed by the courts.
The vast majority of states have adopted the Uniform Partnership Act which governs General Partnerships. An interesting aspect of this act is that “a disclaimer of partnership status is ineffective to the extent the parties’ intended arrangements meet the criteria stated in this subsection”.
So acting as a General Partnership makes it a General Partnership regardless of what the parties subjectively claim it to be.
In order to have a General Partnership, it is critical to identify who is and who isn’t a Partner or Member. One potentially important “loophole” is the requirement that “all the partners” agree on who the partners are. Absent any written agreements, “all the partners” must agree to admit a new partner. If the number of partners cannot be ascertained because some are anonymous or pseudo-anonymous then it may be difficult to establish exactly who “all the partners” are and therefore make a “partnership agreement” impossible. More likely, the burden will fall on the more easily enumerated people who started the DAO.
That said, there is still an association among a number of known people and the courts will attempt to draw a line somewhere. If you don’t have a clear understanding of who is or who isn’t a Member/Partner then you might get caught on the wrong side of the line.
Who is a Member?
Whether a DAO is classified as a GP or UNA, the definition of a member is anyone who, under the rules and practices of the association, may participate in the selection of persons authorized to manage the affairs of the association or in the development of the policy of the association.
This definition appears to exclude those who profit but have no participation in the control. For example, an automated market maker may have many people pooling tokens for the purpose of providing liquidity and earning fees. If those that pool funds have no voting rights then they may have a solid argument that they are not Members of a UNA or GP. This would create a situation where the sole members of the “Smart Contract” Organization are those who control the keys that are able to update the contract code (aka defining policy).
This has a fascinating consequence of making the automated market maker “nonprofit” even though those who use the automated market maker may be clearly earning a profit. According to the Uniform Partnership Act “merely sharing gross revenues is insufficient” to form a partnership.
An association of people, whether for profit or not, may be imputed on any DAO and existing laws will apply. The only thing that is to be decided is who are the members and what liabilities those members have.
While General Partnerships have been around longer than anyone reading this, the ability to form large-scale partnerships on an international level is new and revolutionary. It brings the question of which jurisdiction should apply. If left ambiguous those who aim to sue the General Partnership have the opportunity to shop for the most favorable jurisdictions to the plaintiff and the least favorable to the Members.
How to Prevent a DAO from being classified as a General Partnership
As far as I can tell, the single most important fact required to establish a General Partnership is whether or not it is operating “for-profit”. The second most important fact is establishing who, if anyone, are the owners of the General Partnership where ownership is construed broadly to mean the ability to participate in choosing the managers or policies of the organization.
If you can prove the organization is not and cannot be operating “for-profit” then the DAO is clearly not a GP and would therefore fall under the Unincorporated Nonprofit Association (UNA).
The classification of a DAO as a General Partnership also depends upon how one defines a DAO. The term DAO was originally created to define organizations structured like Bitcoin. Clearly, Bitcoin has not been considered a General Partnership. So what makes Bitcoin different from an organization such as bZx DAO?
The primary difference is that DAOs, as originally defined, cannot hold title to property. Holding title to property would make the DAO “centralized” as said property can only exist in one logical place and would have one “legal” owner. In 2013, I stated that a DAO, such as Bitcoin, was like a company that cannot own property.
The idea that a DAO cannot own property has profound implications for the status of a General Partnership. In a General Partnership, there is an intention to make a profit by pooling resources and operating under a common brand name. The intellectual property is common property owned by both partners. The contracts the parties enter into on behalf of the organization create shared rights and obligations between the organization and 3rd parties. When people do business with the organization they are relying on the reputation of the entire organization and not just a single individual.
If an organization’s bylaws forbid it from owning property or entering into contracts then its Members are forbidden from doing business in the name of the organization. Any Member that subsequently signs a contract on behalf of the organization has done so without proper authority. This limits the liability for signing the contract to the specific individuals involved and not to every member of the organization. The mere act of signing a contract on behalf of the organization would be a fraud against the other Members and the other parties to the contract.
Imagine someone approached you and claimed that they represented Bitcoin and wanted to sign a contract as a representative of Bitcoin? That would be immediately recognized by almost everyone as fraudulent misrepresentation.
If a DAO cannot own property then it cannot generate revenue nor make a profit. Some may ask about service providers that own no assets, but the question becomes, how can the company receive and then own the profit if it cannot own property? How can the service provider sign a contract if the rights and obligations that the contract confers would be property? The lack of revenue and/or profit has huge implications for legal standing. All states I have looked at define a General Partnership with respect to an intention to carry on business for profit. Furthermore, without profit, the IRS doesn’t even consider the organization a business for tax purposes.
If your organization stays true to the meaning of a DAO, as I originally conceived it, then there is a strong argument against classification as a General Partnership. On the other hand, if your organization adopts the looser definition of “any organization that keeps its books on a blockchain” then you must carefully consider whether there is any “property” that is collectively owned by the DAO and whether or not profit for the Members is the goal of the organization.
Under my interpretation, the infamous “The DAO” on Ethereum and many other DAOs, such as bZx, are likely acting as unintentional General Partnerships.
What is Property?
The definition and classification of property have huge implications for whether or not a smart contract-powered organization is a General Partnership. For instance, are Ethereum tokens (ETH) property? If ETH tokens are classified as property, then a smart contract governing that property may be nothing more than the automated books of a General Partnership seeking to make a profit for its Members.
On the other hand, if ETH is not classified as the property of an individual or smart contract, then it would be difficult to argue that the smart contract is a general partnership in the business of earning a profit. The problem is, that most people claim and act as if ETH and BTC are their property that can be stolen. In a later section, I will present an alternative classification for community tokens that removes the characteristic of property. For now, it is easy to assume that ETH is property and therefore that smart contracts holding ETH for the purpose of making a profit may be General Partnerships.
Smart Contracts as Vending Machines
Suppose that the smart contract has no governance mechanisms at all. It is akin to a virtual vending machine that anyone may interact with. If the vending machine breaks and allows someone to walk away with the deposited coins and products, then it may be reasonable to hold the person who deployed the vending machine liable. It is therefore wise for anyone deploying a smart contract to have everyone who interacts with it sign a waiver releasing the deployer from liability.
Note that there is a distinction between the engineer who designed the vending machine and the person who took those designs, produced an operational machine, and made it available to the public. Open source code is typically licensed under conditions of no warranty nor fitness for purpose and the users of the open-source software waive all rights to sue the developers for bugs. That said, if someone takes open-source code, compiles it to a smart contract, and deploys it to a blockchain they may be taking responsibility for the performance of the software unless they also get their users to sign a release as a condition of their use.
Given a vending machine can be viewed as a template partnership agreement, those who manage its operation might be considered the Members. A common example would be automated market makers (aka Bancor relays) or NFT auction services. If these services operate on a for-profit basis then anyone participating in its governance may be a member of a General Partnership. Once again, the for-profit basis of these contracts is dependent upon the classification of tokens and/or NFTs as property and whether fees are designed to do more than cover costs.
Tokens that Aren’t Property
Property is a thing that belongs to someone. Tangible things are property. Positive contractual rights are property. The defining characteristic of property is that it is owned by someone and the test of ownership is the unilateral right to control. If someone allows you to drive their car it does not become your property. Use and temporary control do not constitute ownership unless the temporary control was a bargained-for right. For example, you may own the right to use a rental car for a defined period of time. In this case, you are the owner of a contractual right to use, not the owner of the car. The property remains with the person who has the title and who may revoke the right to use it at any time.
Property can be anything that has current or potential value; however, to realize this potential value one must have the ability to sell a clean title to the current or potential value to someone else. Without the right to sell the property you do not truly own it.
Opinions held by other people cannot be your property because their free will is inalienable. You cannot force someone else to hold a certain opinion. Your actions can certainly affect that opinion in ways that may create a profit or loss for you or others but your actions don’t entitle you to change their opinion or to the resulting profit.
With this foundation, a group of people can establish the principle that the person who is currently allocated tokens by community consensus is not the owner of those tokens. Instead, the token balance is merely the inalienable opinions of a multitude of individuals who may change their individual opinions at any time for any reason. In this way, the tokens are similar to the keys to a car which the owner(s) can reassign at any time. Possession of the keys and the power to drive the car where you like does not make the car your property.
That said, if you are the current possessor of the car keys you have the power to hand those keys to someone else in exchange for money. Doing so does not change the title to the car and does not make the new possessor the owner of the car nor does it transfer the right to use the car. The keys merely represent the ability to do something, not the right to do something.
When it comes to blockchains, signing a transaction to send tokens from one account to another can be viewed as a request to update the community’s opinion on the two parties’ balances. If this request constituted a contractual obligation of the community to update the balances in a particular way then the token balances might be property; however, if it is explicitly a request and not an obligation then the token balances are not the property of the requestor or the receiver.
A community wishing to minimize the risk of being classified as a General Partnership needs to minimize the risk of creating positive contractual rights and obligations among the parties. If the parties explicitly agree to treat all consensus states as an opinion subject to change at any time, then no property rights are created, allocated, or transferred on-chain. If your blockchain account is hacked or everyone else decides to zero your balance then you would have no legal right to a claim of theft. If there was a bug that caused the community opinion to change in an unexpected way, there is also no liability because each individual reserves the right to come to their own conclusion using whatever software tools they choose to use to interpret the events they have observed.
Under this model, individuals (not the association) can realize a profit when they receive money (or other property) in exchange for signing a transaction. This is income to the individual and not income to a partnership. The money is received in exchange for the service of using a particular private key to sign a specific message. The money was not received in exchange for the tokens the community now considers to be removed from your account and added to someone else’s account. This is because the community retained the inalienable owner of its opinion of the tokens before and after the transaction.
In reality, the community opinion is not a single thing, as each member of the community is entitled to have a different opinion on the consequences of a signed transaction. It just so happens that the vast majority of people share the same opinion.
Another way to view a signed transaction is as a “celebrity endorsement” which people are willing to pay for in order to sway the opinions of others in a manner that produces personal profit. Every token holder is a minor celebrity and their endorsement of others via a signed transaction has the impact of giving others more non-binding favor in the community.
This alternative view of the nature of blockchain tokens runs contrary to the way most people in the blockchain community act and feel. The movement of tokens from your account without your permission feels like theft. However, such feelings are merely the result of misguided thinking. Whether it is theft or not depends on whether or not a community declares those tokens to be the property of the individual or merely the opinion of the vast majority of the Members.
However, if the community opts to view tokens as property then the ramifications on the status of Smart Contracts relative to General Partnerships could be huge.
Ownership of Keys not Tokens
While individuals may not be able to claim ownership of the consensus state, they can certainly claim ownership of their cryptographic keys. Keys could easily be classified as intellectual property or trade secrets. The unauthorized reproduction and/or use of keys could still be prosecuted and the damages assessed could be linked to whatever money the copyright violator was able to realize in exchange for their use of the illegally copied keys.
This creates a material difference between one’s ownership interest in a balance on a blockchain and their ownership interest in the keys that enable them to influence, but not control, the communities shared opinions.
Smart Contracts as Smart Opinions
Given the new classification of tokens as opinions, a smart contract is merely a tool for generating a smart opinion given a set of signed statements. The opinion may be changed at any time by the community and is not the property of the users of the smart contract. The transfer of opinion tokens to or from a smart contract does not transfer property to or from the smart contract and therefore the smart contract cannot realize a profit. If no profit can be realized by the smart contract then it cannot be considered a General Partnership even if it generates a net increase in the shared opinion on the token balances of various parties.
This perspective on blockchain state as a non-binding consensus opinion and not property runs counter to the way most people act; therefore, it is crucial that everyone who interacts with the DAO explicitly opt-in to this interpretation of their interactions. Failure to explicitly agree to treat tokens as community opinion rather than individual property may leave room for courts to implicitly treat the tokens as property and therefore the smart contracts as for-profit General Partnerships. Ideally this explicit agreement is logged on the blockchain for every key that interacts with the chain.
Are DAO’s Unincorporated Nonprofit Associations?
For the purpose of this article, I will refer to Uniform Unincorporated Nonprofit Association Act (UUNAA) which has been adopted in one form or another by over 20 states. A “nonprofit association” is any unincorporated organization consisting of two or more members joined by mutual consent for a common, nonprofit purpose. This association is a legal entity separate from its members for the purposes of determining and enforcing rights, duties, and liabilities in contract and tort. In other words, the Members of a DAO classified as a UNA have some degree of limited liability even if they never file any paperwork with the government.
The fact that UNAs are legal entities means that they can sue and be sued. They can own property and real estate. They can even appoint a Member to register with the state for the purpose of receiving notices of lawsuits. That is if the party’s membership agreement permits these things.
Interestingly enough, the act requires that all UNAs keep correct and complete books and records of account for at least 3 years and that these books and records are made available to the members for inspection and copying. In other words, a blockchain is nothing more than the automated distribution of a UNA’s books to its Members as it is required to do by law.
It is my opinion that some of the most interesting and important use cases for DAOs are truly non-profit. In fact, the benefits one receives from decentralization are a public good (or club good) and there is really no practical for-profit way of providing these benefits to a population. Sound money is a public good and no centralized business should be in a position to profit from the issuance of money.
Legal Status of Immutable Smart Contracts
Proof of work blockchains put the governance power in the hands of those who choose to perform the required calculations. This creates an interesting challenge for legal classification given that technically everyone in the world is able to participate in governance. This either makes everyone part of the General Partnership or no one. If it makes everyone part of the partnership then any Plaintiff seeking damages from the General Partnership would simultaneously be jointly and severally liable. He would therefore owe himself any damages won. Generally speaking, proof of work blockchains have no governance structure at all and consensus is never final; therefore, they are not likely to be General Partnerships.
If an immutable smart contract is deployed to a proof of work chain and said contract has no governance features then it would be exceedingly difficult to classify it as a General Partnership or Unincorporated Nonprofit Association. However, if the contract has even a modest amount of governance then the Partners/Members would likely be those who can exercise that governance power.
On blockchains with the power to reach consensus on forks, there is no such thing as an immutable contract. Even if a user deployed a smart contract and then removed all keys allowing them to modify the contract would still fall under the management of the broader blockchain governance. In effect, token-weighted blockchains are either a General Partnership or UNA and any “immutable” smart contracts contained within would fall under the management and control of the broader blockchain.
This creates an interesting challenge on whether a smart contract platform can legally separate itself from the contents of the smart contracts it is hosting. If the host platform maintains that all state is a non-binding opinion of the observers then it would follow that nothing on-chain can turn it into a for-profit business.
Transaction Fees & Profit
Most blockchains utilize some kind of “fee” to prevent spam. This fee is paid with the tokens tracked as part of the blockchain state. Whether or not these fees constitute profit depends upon whether the tokens are property or opinion.
Imagine a company, such as Apple, were to accept shares of its own stock in exchange for services. The shares, being a form of property, would be income to Apple. In this case, the shares represent fractional ownership of all the property owned by Apple.
Now imagine if Apple owned no property. Imagine it had no intellectual property rights, no trademarks, and no other contractual rights of any kind. Under this situation, Apple would be unable to sell you any goods or services! Being unable to sell any goods or services its shares would have no intrinsic value nor contractual value.
Now consider a hypothetical unincorporated association called SmartChain in which everyone involved has explicitly agreed that no one may do business in the name of SmartChain and that SmartChain may own no property. The fee represents a non-binding change in the shared opinion of the associates and signing a statement that affects the fee does not guarantee anyone the right to have the transaction incorporated. No tangible things nor contractual rights have changed hands.
Can you sue a DAO?
Yes. Since all DAOs are likely to be classified as either a General Partnership (GP) or Unincorporated Nonprofit Association (UNA), it is my opinion that most DAOs can be sued. If a DAO achieves the status of a UNA then its members have a degree of protection against personal liability; however, if the DAO has no property then there is little point in suing the DAO because even if you win there is nothing to collect. On the other hand, if a DAO is a General Partnership then in many (most?) cases the partners are jointly and severally liable and your lawsuit may be able to collect against their personal assets.
Can a DAO file a lawsuit?
Yes, if a DAO has a governance process by which it can authorize a registered agent and someone who is willing to accept that role then the DAO can file a lawsuit against others. In doing so, the DAO would have to claim damages which would imply that the DAO held common property and positive contractual rights. This status would make proving the status as a UNA more difficult and greatly increase the risk of a DAO being deemed a General Partnership. This is especially risky for smart contract platforms which do not want their tokens to be deemed shares in the General Partnership.
So while it is technically possible for a DAO to file a lawsuit, it would likely result in mutually assured destruction; therefore, unless a DAO has already been deemed a GP or is willing to accept General Partnership status then it is unlikely to ever want to (or need to) file a lawsuit against anyone.
Blockchains and smart contracts empower individuals to draw their own conclusions about the world at a scale that was impossible without the power of modern computers, cryptography, and networks. This enables a new kind of collaboration based entirely on “smart reputation” or “smart opinions”.
In the past, we had to rely upon contractual rights interpreted by courts to determine who owned what. This gives the courts tremendous power over all person-to-person business interactions. If a group of people continues to act and talk as if a blockchain state is the evidence of a binding agreement over fractional ownership of commonly held property then they are likely in the realm of a General Partnership. On the other hand, if a group of people explicitly swears off creating any positive contractual rights or obligations then it is far more likely to be considered an Unincorporated Nonprofit Association.
In both cases a lawsuit can be filed on behalf of or against the association and in both cases there is no need to file any paperwork with the government nor have any explicit agreement in order to form the legal entity. Without an explicit agreement then the government will likely impute the standard previsions defined by the uniform acts. I suspect that most people involved with DAOs do not want these standard provisions; therefore, it is imperative that all parties explicitly adopt mutually agreed upon terms to limit the degrees of flexibility a court or plaintiff has in ascribing liability to those participating in the DAO.
Everything in this post is just my opinion and has not factored in the full history of common law nor the multitude of jurisdictions. Do not rely on this as legal advice, instead please consult your own attorney. Even if my understanding of the “law” is logical, we live under the rule of man and courts can be unpredictable. I am not a lawyer and everything I have said may be wrong or incomplete. Hopefully, one day, we can move to a world powered only by smart contracts and completely eliminate the unnecessary risks associated with interpreting laws and guessing how they might be selectively enforced.