How a Lack of Governance Undermined the ConstitutionDAO

Recently, ConstitutionDAO captured everyone’s imagination as it turned a group chat joke into serious money.

In just one week, the ConstitutionDAO raised a whopping $47 million in Ether (ETH) from a reported 17,437 donors to bid on an original copy of the U.S. Constitution.

Inspiring as this was to many (especially high school history teachers), the effort ultimately fell short when the project was outbid at auction. Soon after, ConstitutionDAO founders announced they would refund the money — minus pesky ETH gas fees of course.

While mainstream media sees this as a funny anecdote, for those in crypto law, the ConstitutionDAO has raised a number of key questions for the space.

Most prominently, there is the question of how to balance an organization’s need to make decisions with a DAOs dispersal of all decision-making authority. Hint: it’s not easy and sometimes impossible.

Read on in today’s article to see how critical the issue of governance turned out to be in the ConstitutionDAO case.

Table of Contents

What is a DAO really?

First, let’s clarify what a DAO is. DAO stands for Decentralized Autonomous Organization. This is an organization that runs trustlessly via smart contract code on the blockchain. In theory, this means that all decision-making is exercised by holders of governance tokens rather than a centralized authority.

In a DAO, there is no board of directors or officers managing the organization on a day-to-day basis. Instead, transparent code guides all matters, except those expressly reserved for the members’ vote.

The trouble is, just because a project calls itself a DAO, this doesn’t mean that the project is in fact fully decentralized. In some DAOs, the project utilizes community voting as the basis for many decisions, even though the founders still maintain control over certain decision-making functions.  

As such, governance token holders have rights and important roles under this form of DAO, but this type of governance can no longer be considered trustless. Instead, participants must trust in the goodwill or “benevolent rule” of the founders. A fact that had a huge impact on how the ConstitutionDAO experiment played out.

ConstitutionDAO’s Governance Conundrum

In exchange for donations to the project, the ConstitutionDAO offered a governance token that gave donors the ability to advise on certain project decisions. For example, where to display the Constitution after winning the auction.

Of course, an “advisor” only advises the people who make the decisions. In this case, the decision-makers were the ConstitutionDAO’s anonymous founders.

This fact was highlighted during the auction, where the founders of the DAO chose not to bid all of its funds. Instead, they decided that a few million dollars needed to be set aside for transporting and securing the artifact post-auction.

So even though $47 million were at the DAO’s disposal, the project lost the auction to a $43 million bid.

Perhaps at inception, the founders believed they were forming a DAO, but once the process got underway, a different direction emerged. There were a number of decisions that were not left in the hands of the people as one would expect in a DAO.

Figuring out how to manage a project is one of the central difficulties in formulating DAO structures. Of course, to the credit of the ConstitutionDAO founders, this all took place in the space of just a few days. Far too little time to develop a strong system of governance. Meanwhile, the ConstitutionDAO team managed to raise an astounding sum from participants. A marvelous achievement in its own right!

Had the bid been successful, it seems likely the project would have formed a corporation or LLC and registered itself as a charitable organization. This would have made the project subject to all the rules and attendant corporate governance therein.

What does this mean for Crypto Law Insiders?

Before investing in a DAO, it is critical to understand the governance rules in place. One should not assume that some idealized form of DAO is being implemented.

Where governance is unclear – like with ConstitutionDAO – one must exercise extra care. In the case of ConstitutionDAO, the founders decided to return the funds to donors. Things won’t always end so well. Not all dictators are benevolent … some pull rugs.

The DAO is an evolving idea in the crypto community which bears watching. The evolution of its legal status and forms of DAO governance will be an important development in crypto.

Scott Cohen

Scott Cohen

Scott Cohen is the Head of Legal at Horizen Labs. A U.S. lawyer and the founder of CLC Partners, a consulting firm based in Panama that focuses on cross-border transactions throughout Latin America. He provides insightful analysis on legal issues affecting blockchain projects and the cryptocurrency space. He is also well-versed on complex restructuring issues, having begun his career in Weil Gotshal's Business Finance & Restructuring Department.