Digital Currency Perspectives
July 21, 2016

Put a Fork in it: What’s Happening with the DAO?

If you have an interest in bitcoin, you’ve undoubtedly heard people refer to “The Blockchain.” Because the term “blockchain” can refer to any distributed ledger where “blocks” are added to the ledge by solving complex mathematical problems, it should more properly be referred to as “the Bitcoin Blockchain.”  Each block builds on the one before it (hence the “chain”), creating a permanent and unchangeable historical record.

Another term being heard more frequently in this area is “Decentralized Autonomous Organization,” which can be thought of as a company incorporated on the internet rather than in a particular state or country.

These two terms have recently come together in the news with the launch of the DAO. The DAO is similar to a digital venture capital fund based on Ethereum, a digital currency built on blockchain technology. The DAO is structured so that proposals for investment  are submitted and investors enter into “smart contracts” that dictate the parameters under which funds may be released if a specific proposal is approved by the investors.

Beginning in April 2016, investors quickly contributed about $150 million worth of Ethereum to the DAO. In June 2016 the DAO was hacked, draining nearly half of the total amount and moving it into a separate account. The hacker utilized a known security flaw in the software algorithm of the DAO, leading some to suggest that because the hacker was just following the rules, he (or she) had done nothing wrong.

The Ethereum community considered many proposals to address the issue, ranging from doing nothing to implementing a hard fork to effectively return the stolen money to investors. A hard fork is an agreement by the community that a new chain of blocks will be started. This is a technology solution and is not unique to Ethereum. For alternate reasons, there have been regular, ongoing discussions about hard forking the bitcoin blockchain. The hard fork was implemented this week and the funds taken by the hacker are in the process of being returned.

It’s been an interesting time for the Ethereum community. On July 10th, Grant Fondo and I had the opportunity to present to the Silicon Valley Ethereum Meetup on some of the regulatory aspects facing digital currencies and decentralized autonomous organizations. We flagged that regulatory perspectives can be very different from those of related technology communities, where the focus is often on disruptive innovation, rather than compliance with what are often perceived as burdensome legal restrictions.

Regulators are charged with preventing crime and safeguarding consumer interests and are not willing to jeopardize these principles for the sake of innovation. Regulation has already begun to take shape in the form of state money transmission requirements, and federal requirements by agencies such as the Securities and Exchange Commission, the Internal Revenue Service and the Financial Criminal Enforcement Network. We believe that further regulation is likely and our discussion explored how this regulation may evolve in the coming years.