Law and the Blockchain

• Author: Usha R. Rodrigues
• Position: M.E. Kilpatrick Professor of Law, University of Georgia School of Law
• Pages: 679-729

679

Law and the Blockchain

Usha R. Rodrigues*

ABSTRACT: All contracts are necessarily incomplete. The inefficiencies of

bargaining over every contingency, coupled with humans’ innate bounded

rationality, mean that contracts cannot anticipate and address every

potential eventuality. One role of law is to fill gaps in incomplete contracts

with default rules. Emerging technologies have created new, yet equally

incomplete, types of contracts that exist outside of this traditional gap-filling

legal role. The blockchain is a distributed ledger that allows the cryptographic

recording of transactions and permits “smart” contracts that self-execute

automatically if their conditions are met. Because humans code the contracts

of the blockchain, gaps in these contracts will arise. Yet in the world of “smart

contracting” on the blockchain, there is no place for the law to step in to supply

default rules—no “legal intervention point.” The lack of a legal intervention

point means that law on the blockchain works in a fundamentally different

way from law in the corporeal world. Business organizational law provides a

prime example of how the law uses default rules to fill gaps in an incomplete

contract and how the law works differently in the blockchain context.

I. INTRODUCTION ............................................................................. 680

II.ORGANIZATIONAL LAW AS A GAP FILLER ...................................... 686

A.THE FIRM AS AN INCOMPLETE CONTRACT ................................ 686

B.THEORIES OF THE CORPORATE FORM ....................................... 691

1.Limited Liability ............................................................ 692

2.Asset Partitioning .......................................................... 694

3.Exceptions that Prove the Rule .................................... 695

III.THE 2016 DAO ............................................................................ 697

A.BACKGROUND ......................................................................... 697

B.GOVERNANCE OF THE 2016 DAO ............................................. 701

C.THE “HACK” AND HARD FORK ................................................. 704

*

M.E. Kilpatrick Professor of Law, University of Georgia School of Law. I thank participants

of the University of Washington Faculty Workshop Series, the Firs t Annual Works in Progress

Program on Blockchains and the Law, the Minnesota Law Faculty Works in Progress Workshop,

and the 2018 Law & Entrepreneurship Retreat.

680 IOWA LAW REVIEW [Vol. 104:679

D.THE DAO’S UNEASY FIT IN EXISTING

ORGANIZATIONAL LAW ............................................................ 706

IV.THE PROMISE OF THE BLOCKCHAIN .............................................. 708

A.LIMITED LIABILITY .................................................................. 710

B.ASSET PARTITIONING VIA CONTRACT ALONE ............................ 713

V.LEGAL INTERVENTION POINTS ...................................................... 714

A.THE PURE BLOCKCHAIN BUSINESS ORGANIZATION .................... 715

1.The Possibility of a Purely Blockchain Entity .............. 715

2.The Problem of Blockchain Governance .................... 717

B.CORPOREAL ENTITIES WITH ASSOCIATED BLOCKCHAIN

ORGANIZATIONS ...................................................................... 721

VI. CONCLU SION ................................................................................ 727

I. INTRODUCTION

In 2016, a decentralized autonomous organization (“DAO”) launched

on Ethereum, a platform that permits layering programs called “smart

contracts” on top of a cryptocurrency.1 This DAO was “decentralized” because

no one person or entity controlled it; it was “autonomous” because it ran itself,

and it was an “organization” of a type the world had not seen before. More of

a “virtual venture capital fund” than a corporation, the 2016 DAO (as I will

term this particular DAO) sold tokens in cyberspace that entitled the holders

to certain voting rights, including the right to vote on proposals for projects

that the DAO would fund.2

The 2016 DAO might sound like unintelligible science fiction, but

businesses organized in the virtual world of the blockchain have raised

millions of dollars over the past eighteen months using this platform.3 For

purposes of this introduction, all the reader needs to understand is that

blockchain technology permits “smart contracts” that allow coders to layer on

top of currency exchanges particular conditions under which those

exchanges will occur.4 In other words, these contracts are self-executing. The

Ethereum blockchain can record not only “X paid Y nine ether,” but also “X

1. Kevin Werbach & Nicolas Cornell, Contracts Ex Machina, 67 DUKE L.J. 313, 350 (2017).

2. Id.; dat81, What If the Whole World Was Operated by Blockchain?, STEEMIT, https://steemit.com/

crypto/@dat81/what-if-the-whole-world-was-operated-by-blockchain (last visited Oct. 31, 2018).

3. Giulio Prisco, The DAO R aises More Than $117 Million in World’s Largest Crowdfunding to Date,

BITCOIN MAG. (May 16, 2016, 2:09 PM), https://bitcoinmagazine.com/articles/the-dao-raises-

more-than-million-in-world-s-largest-crowdfunding-to-date-146342 2191.

4. Antonio Madeira, The DAO, The Hack, The Soft Fork and The Hard Fork, CRYPTOCOMPARE

(July 26. 2016), https://www.cryptocompare.com/coins/guides/the-dao-the-hack-the-soft-fork-

and-the-hard-fork.

2019] LAW AND THE BLOCKCHAIN 681

will pay nine ether Y if the Dow Jones Industrial Average reaches 30,000”

(ether being the unit of cryptocurrency on the Ethereum blockchain).5 These

smart contracts enabled the 2016 DAO to implement fairly sophisticated

governance and exit rules autonomously on the blockchain.

The 2016 DAO was an enormous success—raising $150 million worth of

ether in just a few months.6 It was also a tremendous failure: Because of a flaw

in its code, an unknown individual was able to siphon about $50 million into

a private account, before being foiled by a technological fix that unwound the

DAO and restored all DAO participants’ ether to its original holders.7

Although the 2016 DAO failed, entrepreneurs following its lead launched

235 initial coin offerings (“ICO”) in 2017, raising a total of $3.7 billion from

the public.8

DAOs may represent a dead-end in the history of business

organizations—that remains to be seen.9 What matters for the purposes of this

Article is what the 2016 DAO can tell us about the nature of contract law and

business law, and the potential for the blockchain to upset fundamental

expectations about the role of law in both fields.

Academic literature teaches, quite correctly, that all contracts are

incomplete.10 For one thing, it would be inefficient for two parties to try to

anticipate each and every future contingency and hash out an appropriate

contractual response.11 But even if two parties were ambitious and patient

enough to attempt such a feat, it would prove impossible. Given the bounded

rationality of humans and the uncertainties of life, one simply cannot contract

for every future possibility.12

5. The astute reader may wonder how t he blockchain knows when the Dow Jones

Industrial Average reaches 30,000. This question of how the blockchain receives reliable input

from the outside world is a key problem blockchain businesses must address. Artem, How Do Oracle

Services Work Under the Hood?, STACK EXCHANGE: ETHEREUM, https://ethereum.stackexchange.com/

questions/11589/how-do-oracle-services-work-under-the-hood (last visited Oct. 31, 2018).

6. Madeira, supra note 4.

7. To be precise, the Ether eum blockchain forked, creating two parallel Ethereum

blockchains, Ethereum and Ethereum Classic. On the more popular (and valuable) Ethereum,

the code was rewritten as if the DAO had not launched. But in the alternate reality of Ethereum

Classic, the DAO continues to exist and the $50 million transfer of funds did, in fact, occur. What

Is Ethereum Classic? Ethereum vs Ethereum Classic, BLOCKGEEKS, https://blockgeeks.com/guides/

what-is-ethereum-classic (last visited Oct. 31, 2018).

8. Cryptocurrency ICO Stats 2017, COINSCHEDULE, https://www.coinschedule.com/

stats.html?year=2017 (last visited Oct. 31, 2018). Note, however, that not all ICOs are DAOs.

9. Although, more DAOs are organizing. See infra Section V.A.2.

10. Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of

Default Rules, 99 YALE L.J. 87, 92–93 (1989).

11. Robert E. Scott & George G. Triantis, Incomplete Contracts and the T heory of Contract Design,

56 CASE W. RES. L. REV. 187, 190 (2005) (“A contract is incomplete if it fails to provide for the

efficient set of obligations in each possible state of the world.”).

12. See Scott Baker & Kimberly D. Krawiec, Incomplete Contracts in A Complete Contract World,

33 FLA. ST. U. L. REV. 725, 725 (2006) (“Contracts are never fully complete, because some