The Viability of Blockchain in Corporate Governance
Blockchain technology is often associated with the volatile world of cryptocurrencies, which has raised concerns about the need for new regulations. However, blockchain also holds the potential to have a significant impact on corporate governance. It challenges established corporate structures and paradigms and has the potential to facilitate corporate law and governance in various ways. Yet, there is often ambiguity regarding the true value and legal implications of blockchain applications in corporate governance. In our research, forthcoming in Board-Shareholder Dialogue: Best Practices, Legal Constraints and Policy Options (eds. L. Enriques and G. Strampelli), we discuss the viability of four ways to utilize blockchain in corporate governance. As we demonstrate, each of them raises questions about whether the use of blockchain technology for corporate governance should be encouraged further or approached with caution as a utopian vision.
- True agentless organizations or decentralized utopians?
In traditional corporate governance, authority and control flow from shareholders to corporate management through hierarchical structures, creating the risk of opportunistic behavior and information asymmetry. Advocates assert that blockchain facilitates the establishment of decentralized autonomous organizations (‘DAOs’) that operate without hierarchical structures. These community-driven organizations powered by blockchain technology can connect creators and users directly. The process of setting up a DAO involves establishing a founding community, developing smart contracts, creating tokens, and defining governance conditions for voting and proposals.
However, while DAOs aim to eliminate the agent-principal structure of traditional corporations, some centralization and agency-like structures may persist. We show that founders often play a crucial role in establishing the DAO and initially hold control over governance decisions before gradually involving token holders. Limited participation rates in voting proposals and the concentration of voting power in a small number of participants further challenge the decentralized nature of DAOs. In some cases, blockchain networks can also lead to the formation of ‘blockchain conglomerates’, where key stakeholders hold significant influence over protocol proposals.
In addition, DAOs present legal uncertainties, liabilities, and complex governance features. For instance, without a legally recognized entity, DAOs can be deemed de facto general partnerships, exposing token holders to joint and several liability.
- Blockchain’s promise for securities issuing and trading
In traditional corporate systems, shareholders of large corporations often face complex custody chains. These custody chains, arising from market arrangements for issuing, trading, clearing, and settling securities, restrict shareholder control and engagement. To address these challenges, blockchain technology offers potential solutions by enhancing transparency and mitigating risks through continuous ownership tracking. Several developments in blockchain-based securities issuance, trading, and settlement have been observed. For instance, the SEC approved the BSTX stock exchange, allowing for faster settlement times and recording all trading activities on a private blockchain. DTCC introduced its Ion project, a blockchain-based settlement platform running alongside the traditional system. Regulation (EU) No 2022/858 permits the use of blockchain technology for quick settlement, but limitations and strict requirements still exist, limiting its widespread use.
The most significant and ambitious blockchain project in this regard originated from the Australian Securities Exchange (ASX). ASX had the objective of replacing their settlement platform, known as CHESS, with a blockchain-based system. However, ASX abandoned the project in November 2022 due to its complexity and repeated delays. This experience highlights the fact that transforming an existing settlement and trading platform into a blockchain-based system is a ‘mammoth undertaking’. While blockchain technology holds promise for addressing challenges in securities issuance, and trading, the migration from existing systems to blockchain-based solutions is extremely complex.
- A fix for proxy plumbing?
Custody chains create complications in the relationship between issuers and shareholders, as intermediaries are relied upon for shareholder identification, information transfer, communication, and voting. The Shareholder Rights Directive (‘SRD’) II in Europe and proposals in the US have recognized these shortcomings and suggest the use of blockchain technology to improve shareholder voting and engagement.
Blockchain technology can offer increased transparency in shareholder voting, resulting in reduced errors and costs, enhanced legitimacy and quality of the voting process, and improved fairness among stakeholders. It also can enable direct communication between issuers and shareholders, allowing for more timely and meaningful engagement. However, research suggests that increased transparency in blockchain markets may also discourage activists and raiders from investing in firms, as they prefer to build share positions secretly.
As we describe in our research, (permissioned) blockchain technology can be utilized for transparent shareholder voting. For instance, by uploading AGM documentation to the blockchain and matching voting rights with shareholders through a KYC process, shareholders can directly cast their votes, or delegate them to proxies. After voting, shareholders can verify and confirm the inclusion of their votes in the voting results recorded and stored in the blockchain network.
Despite the potential of blockchain to provide shareholders with end-to-end confirmation, there is still a lack of widespread adoption for AGMs. Many initiatives in this area fail to materialize, showing uncertain business cases and (technical) complexities when it comes to the use of blockchain for shareholder processes.
- Blockchain for stakeholder inclusion
Finally, we discuss that blockchain technology has the potential to enhance stakeholder participation in corporate affairs, allowing us to rethink established corporate governance models and inspire more inclusive governance structures. For instance, blockchain technology can facilitate meaningful stakeholder engagement, which is important for corporate sustainability due diligence. Stakeholders could be assigned advisory roles or even granted certain (advisory) decision-making rights, as we see in DAOs. Blockchain technology can also enhance the relationship between asset owners and beneficiaries, enabling beneficiaries to actively participate in decision-making processes while providing asset owners with a transparent means of communicating their voting preferences.
While these latter examples have yet to be implemented (if they ever will be), it is vital to contemplate the necessity of blockchain technology in these and the other scenarios described in this blog. The fundamental question at hand is whether blockchain is genuinely indispensable. Depending on the specific use-case, oftentimes alternative systems that enable peer-to-peer connectivity and provide secure, digital record-keeping may prove equally effective.
Various legal, governance and path-dependency issues challenge current blockchain initiatives in corporate governance. Implementation often reveals centralized elements, undermining true decentralization. In combination with technical complexities, these factors hinder the adoption of blockchain technology in corporate governance.
Anne Lafarre is Associate Professor at Tilburg University.
Christoph Van der Elst is Professor at Tilburg University and Gent University.
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