Decentralized Autonomous Organizations (DAOs), similar to traditional organizations, consist of individuals pooling resources to achieve a collective goal. Unlike traditional setups with hierarchical leadership like CEOs, DAOs can operate democratically, with each member having equal rights in governance and control of assets, primarily via cryptocurrency.
What is a Multisig Wallet?
A multi-signature (multisig) wallet represents a type of digital wallet designed to require multiple signatures, or approvals, from different users before executing a transaction. For instance, in a 10-member multisig wallet with a 70% signature requirement, a transaction executes upon obtaining seven signatures.
This structure enhances security compared to traditional single-signature wallets, where only one private key is needed for access and transaction authorization.
In a multisig wallet, each user possesses a unique private key, and a predefined number of these keys must collectively authorize a transaction before execution. The underlying principle of a multisig wallet is to distribute control among several parties, thereby reducing the risk associated with a single point of failure.
DAO vs. Multisig Wallet
Fundamentally, DAOs are structured around two main elements:
Collective Decision-Making: This involves engaging all members in a democratic voting process.
Management of Digital Assets: Focused on the secure storage and communal distribution of assets.
A simple governance model of a DAO can be compared to the operation of a multisig wallet. Consider, for example, a multisig wallet utilized by a couple to manage their shared savings. Both individuals possess equal decision-making power in this setup and must jointly consent to any financial transactions, mirroring a basic DAO setup for managing funds.
At a minimum, several individuals should hold the keys to the DAO's wallet. Optimal security is achieved when fund transfers require the consent of a governing body, ensuring checks and balances in decisions.
DAOs generally feature more complex governance structures than multisig wallets, especially regarding voting and administrative control. The governance in DAOs often revolves around specific, non-transferable tokens, which require a collective agreement for any transfer of ownership.
In DAOs, decision-making is contingent upon achieving a quorum, which is a minimum level of participation needed to validate decisions. This contrasts with multisig wallets, where the quorum is based on a defined number of participant signatures. In the context of DAOs, this quorum is typically a proportion of the total governance tokens issued, allowing for a flexible and adaptable decision-making process that can be aligned with the organization's strategic objectives.
The rules for distributing governance tokens are custom-tailored to each DAO's specific nature and goals, providing a dynamic and broad-ranging governance model. This system enables the integration of both off-chain and on-chain voting processes. While governance tokens in DAOs serve a protective function similar to multisig wallets, the broader participation base in DAOs introduces additional complexity in achieving consensus, especially for decisions requiring a high quorum.
DAO Legal Wrapper Utilizing a Multisig Wallet
A DAO legal wrapper refers to the legal structure encompassing a Decentralized Autonomous Organization, providing it with a formal and recognized legal status. This legal framework is crucial in bridging the gap between the digital, decentralized nature of DAOs and the traditional legal system.
In this context, a multisig wallet can be instrumental in manifesting consent among a legal entity's officials. For instance, when a foundation is established to steward DAO operations, it typically has a council or board. This council may be responsible for managing the foundation's assets and executing decisions made by the DAO. For on-chain activities, such as amending smart contracts or initiating transactions, the council can employ a multisig wallet.
The foundation might also appoint an official protector, chosen by the DAO, to supervise the council's activities and authorize significant transactions. In this setup, the protector could also be one of the signatories in the multisig wallet arrangement. Alternatively, the DAO might opt to assign multisig signatories from its membership who are not formal officials of an entity designed as a DAO legal wrapper.
Global legal regulations surrounding DAOs are still developing. As a result, documenting decision-making processes can pose challenges but remains necessary. This documentation is essential for legitimizing the actions of all participants within the protective shield of DAO legal structures rather than treating their actions as independent individuals without a corporate veil.
The prevailing legal perspective currently suggests that authorization via a multisig wallet does not entirely replace, for example, the need for a traditional general meeting. Despite this, integrating a multisig wallet within a DAO's legal framework offers a novel approach to ensuring accountability and transparency in decision-making, aligning the decentralized ethos of DAOs with the requisites of the legal domain.
Challenges in Utilizing Multisig Wallets in DAOs
One significant issue is the possibility of multisigs acting contrary to the will of the DAO community or voters. In cases where tokens are used primarily for signaling purposes without providing actual executive control, there is a risk that the actions of multisigs may gradually deviate from the community's interests.
Multisig wallets, typically having a limited number of identifiable signatories, can become conspicuous targets for government regulation and legal actions. The clarity in the identity of these signers makes it easier for regulatory bodies to enforce compliance or for legal entities to initiate actions against them. Additionally, the discretion exercised by multisig signers in executing their authority could give rise to liability issues.
The concentrated authority in a small group of multisig signers can also present challenges in terms of censorship resistance. In contrast, a more distributed set of token holders could offer a higher degree of resistance to censorship. This distribution dilutes the concentration of decision-making power, reducing the likelihood of any single point of control becoming a target for external pressures or attacks.
Case Study: Transitioning from Multisig Governance to Smart Contract-Based DAO
In DAOs, it is imperative to avoid situations where a single person or a small group has exclusive control over the DAO's resources, as this could lead to unauthorized fund usage.
Ideally, DAO funds should be secured in a smart contract, endorsed by the community, and governed by rules that prevent centralization of control.
A DAO-specific smart contract can be developed and implemented to address the discussed challenges. This contract, an adaptation of an existing model but customized to meet unique needs, may include an innovative mechanism for asset voting. It also features a guardian as a temporary control measure that can veto proposals or modify governance parameters during the initial phase for added security.
In a new governance structure, any member can propose changes for community review. Once a proposal secures adequate community backing, it is set for execution, contingent on meeting the quorum and supermajority criteria.
The evolution to an advanced governance model can be executed in several stages:
Initial Deployment: The DAO contract should be launched on the mainnet without administrative control over associated contracts.
Administrative Transition: This step entails configuring the DAO as the administrator for all current contracts. This process involves adding the DAO contract as a co-administrator and progressively diminishing the administrative role of the multisig contract.
Acceptance of DAO as Administrator: For contracts requiring the proposed administrator to affirmatively accept the respective DAO role.
Multisig Contract Removal as Administrator: Following a sequence of successful proposals, the multisig contract relinquishes its administrative responsibilities, positioning the DAO contract as the sole administrator.
Final Phase – Elimination of the guardian: The concluding stage is the community vote to remove the guardian functionality, solidifying the DAO's complete autonomy.
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Prokopiev Law Group is committed to guiding you through the legal intricacies of the blockchain and cryptocurrency sectors, ensuring your project thrives in a compliant and secure legal environment. Contact us for bespoke legal solutions tailored to the unique needs of your Web3 venture.
The information provided is not legal, tax, investment, or accounting advice and should not be used as such. It is for discussion purposes only. Seek guidance from your own legal counsel and advisors on any matters. The views presented are those of the author and not any other individual or organization. Some parts of the text may be automatically generated. The author of this material makes no guarantees or warranties about the accuracy or completeness of the information.
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