DAOs: What they are and how they might Transform the Legal Industry

While the legal industry has seen a number of efficiency-driven procedural solutions in recent years (such as Luminance or Diligen), few of the adopted platforms have had a major transformative impact on the law firm as a business. This has bred a modicum of scepticism as to the transformability of the industry in future years and this is, quite frankly, largely warranted. Firms have changed neither their business model (save for, say, offering more flexibility to their employees) in providing legal services nor their corporate structure in adopting legaltech solutions. However, this does not mean that there are no immediate solutions law firms could adopt at a structural and administrative level.

What is a DAO?

A decentralized autonomous organisation (DAO) refers to an organisation structured on the basis of self-executing smart contracts (protocols that execute a particular event if conditions are met) without the need for third party activity (essentially, smart contract governance).[1]

A DAO does not require a managing board to produce metrics and reach decisions based on them, it streamlines and essentially “outsources” that process through smart contracts while allowing for token holder network consensus (i.e. allowing the individuals or entities who hold an equity in the organisation to “vote” in a similar manner to corporate shareholders).

In past uses, this has worked with the input of shareholders (i.e. those who purchased tokens during the ICO) triggering the execution of the smart contract,[2]but that is assuming these uses are the benchmark for how a DAO might be applied in the future. While existing DAOs mostly feature in the crypto space (a well-known example being Dash)[3]there is an indicative trend that a broader corporate adoption is possible or perhaps even likely.

The first major move towards corporate DAO adoption was the launch of what was essentially a crowdfunded venture capital fund in 2016, eponymously called The DAO. The DAO’s tokens (similar to shares in an ordinary publicly listed company) could be bought with ether and the organisation itself was built on the Ethereum blockchain.[4]The initiative was the most successful crowdfunding project in history, raising over $150 million.[5]The idea was that the funds now within the organisation’s pool would be invested in a series of project proposals on which token holders would vote. Effectively, what was created was an Ethereum-based company with token-based shareholders and managers.

So why didn’t it go any further?

Unfortunately, a large chunk of the ether funds within the DAO were drained by an unknown attacker into a child DAO through a “split function”, the intent of which was originally to allow token holders to split off their funds if they disagreed with the majority’s investment decisions. With the DAO containing 15 per cent of all ether, it was necessary to hard fork (essentially splitting the chain and changing the protocol to disregard invalid blocks) the Ethereum chain in order to return the funds lost by the investors to the DAO, which incidentally also resulted in the creation of Ethereum classic.[6]Ultimately, the funds were withdrawn and the DAO was de-listed from Kraken and Poloniex, eventually fading away.[7]

The DAO’s failure might indicate a fundamental flaw in a corporate model based on smart contracts and built on a blockchain, but the flaws that led to the possibility of the attack were unique to the DAO’s ether split procedure (the “recursive call exploit”).[8]Nonetheless, the DAO, being a new business requiring ICO-style crowdfunding, is obviously not the archetype of a corporate DAO. This raises the question of what a more applicable model looks like.

The answer is, quite frankly, presently unclear, as DAO-style organisations are still rare and experimental. What is clear, however, is that many corporate structures would benefit from moving in the direction of a DAO, including law firms and alternative business structures (ABS).

What does this have to do with law firms?

A DAO does not necessarily require token-based voting rights or tokenised shares. Traditional law firms are (with rare exceptions such as DWF) not publicly listed companies (so introducing tokens would be obsolete) and do not have separate groups of shareholders and managers. Partners perform the management function and are generally equity holders, though a large portion of firms also distinguish between equity and non-equity partners, with only the former owning a share of the firm’s equity.[9]

It is because of this that a DAO-based corporate structure is advantageous to law firms in particular. If the management function of the organisation can be vested in transparent smart contract protocols, it would no longer be necessary for partners to juggle management with client work. It should be noted, however, that although one of the major DAO “selling points” is rolling back organisational hierarchy, this aspect is unlikely to materialise in the legal industry. The form of organisation that a law firm is, is not well-suited to the exact model utilised by the DAO, as it is very much a top-down institution that necessitates a more traditional corporate structure.

Nonetheless, there is one strata where it might be applicable. Law firm management is primarily concerned with maintaining profitability across groups and practices and is therefore metric-heavy,[10] a very favourable circumstance for smart contract governance. Data based on revenue, utilisation or realisation could execute a smart contract which would then depend on partner (token holder) network consensus. The immediate benefit of this is streamlined firmwide monitoring and management.

Though all of this is applicable across the board, this might be particularly helpful for smaller firms (i.e. those with fewer than 30 lawyers), 69 per cent of which spend too much time on administrative tasks and 54 per cent of which lack internal efficiency according to a survey by Robert Ambrogi.[11]A Thomson Reuters survey also revealed that lawyers in small firms spend on average only 61 per cent of their work time on practicing law, with the remainder consisting of administrative and managerial tasks.[12]Existing legaltech has made that 61 per cent faster, more efficient and easier, but it is high time firms adopted governance solutions to fill the remaining 39 per cent. The decentralised nature of a DAO might allow smaller law firms to save administrative and governance expenses and instead direct expenditure towards bespoke client needs (i.e. by hiring professional staff, particularly in tech-related fields).

So why not just adopt it?

It is likely that smart contract-driven governance solutions are in store for the legal industry given the advances already made on that front and it is possible that a model at least somewhat resembling a DAO is possible at some point in the future, at least for a certain market strata (i.e. smaller organisations).

Much like the benefits, it is hard to accurately pinpoint the risks involved in adopting a DAO structure. It is clear, however, that fears based around the hack of the DAO need not haunt any firms that choose to adopt this model, as any DAO-like corporate structure in the legal world is unlikely to involve tokens on a public blockchain; that is unless a novelty like a token-based public crowdfunded law firm or other legal service provider rears its head.

Ultimately, a major DAO is yet to present itself anywhere in the corporate world. Most points presented here are entirely hypothetical and derived from problems endemic to the legal industry more so than actual DAO case studies. But this is all the more reason to be hopeful, as the legal market is laden with precisely the issues a DAO can alleviate.

Author: Benjamin Virant

Edited: Panteleimon Athanasiou

Further Reading:

https://singularityhub.com/2016/02/16/how-ownerless-firms-will-soon-live-on-the-blockchain/

https://smartcontracts.live/2016/07/06/how-to-use-humans-to-make-smart-contracts-truly-smart/

References:

[1]Usman W.Chohan, ‘The Decentralized Autonomous Organization and Governance Issues’(University of New South Wales Discussion Paper, 4 December 2017)<https://ssrn.com/abstract=3082055 or http://dx.doi.org/10.2139/ssrn.3082055> accessed 15 June 2020

[2]David Siegel, ‘Understanding The DAO Attack’ (Coindesk, 25 June 2016) <https://www.coindesk.com/understanding-dao-hack-journalists> accessed 15 June 2020

[3]Juan S. Galt, ‘DASH – The First Decentralized Autonomous Organization?’ (Cointelegraph, 12 September 2015) <https://cointelegraph.com/news/dash-the-first-decentralized-autonomous-organization> accessed 16 June 2020

[4]Siegel (n 2)

[5]Joon Ian Wong, ‘The price of Ether, a bitcoin rival, is soaring because of a radical, $150 million experiment’ (Quartz, 20 May 2016) <https://qz.com/688194/the-price-of-ether-a-bitcoin-rival-is-soaring-because-of-a-radical-150-million-experiment/> accessed 16 June 2020

[6]Siegel (n 2)

[7]Samuel Falkon, ‘The Story of the Dao – Its History and Consequences’ (The Startup (Medium), 24 December 2017) <https://medium.com/swlh/the-story-of-the-dao-its-history-and-consequences-71e6a8a551ee> accessed 16 June 2020

[8]Osman Gazi Güçlütürk, ‘The DAO Hack Explained: Unfortunate Take-off of Smart Contracts’ (Medium, 1 August 2018) <https://medium.com/@ogucluturk/the-dao-hack-explained-unfortunate-take-off-of-smart-contracts-2bd8c8db3562> accessed 17 June 2020

[9]Catherine Ho, ‘A law firm IPO? Not so fast’ (The Washington Post, 16 February 2015) <https://www.washingtonpost.com/business/capitalbusiness/a-law-firm-ipo-not-so-fast/2015/02/16/d8085ff6-b09b-11e4-827f-93f454140e2b_story.html> accessed 17 June 2020

[10]Jack Bostelman, ‘The top 5 issues for law firm leaders’ (KMJD Consulting, 4 Ocotber 2016) <https://www.kmjdconsulting.com/the-top-5-issues-for-law-firm-leaders> accessed 21 June 2020

[11]Robert Ambrogi, ‘Exclusive Survey Results: Small Firms’ Greatest Challenges And What They’re Doing To Address Them’ (LawSites, 25 July 2016) <https://www.lawsitesblog.com/2016/07/exclusive-survey-results-small-firms-greatest-challenges-theyre-address.html> accessed 17 June 2020

[12]Stephen Fairly, ‘Law Firm Management: Top 5 Challenges Solos & Small Firms Face’ (National Law Review, 15 August 2016) <https://www.natlawreview.com/article/law-firm-management-top-5-challenges-solos-small-firms-face>