Law and the Blockchain

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

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... (see full summary)

 
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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

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