Protocol Berg v2: Teresa Carballo, zimt - Delegation and the Legal Challenges

Um yeah, welcome everybody. Uh we are uh happy to present you today um delegation and its legal risks and me and Terza we are both lawyers and then we are working together with some uh crypto projects protocols. Um so we are happy to share with you today our um uh what we have seen so far in the space and the risks that we have identified along the way. Okay. So for the agenda first we're going to start with like the basics.

So like sometimes in crypto we forget there's like a word out there that has explored this before. So we're going to talk about the legal basis. We're also going to be speaking about how it looks actually right now like in different dows and stuff like that. We're going to be speaking about the legal challenges and the risks associated with delegation and sort of like practice cases, use cases and how we look at this looking forward. I mean since we are both lawyers it would be really inevitable that we would come to you with a disclaimer.

Um so yeah nothing in this talk is a legal advice or financial advice. So please do not take any of this uh and you know as an advice and um this also does not create any attorney client relationship with you. Um and everything we share here is purelyformational and educational purposes. So it doesn't necessarily represent any perspectives, goals, values of any of the protocols or projects that we are connected with. And of course if you have some legal questions please talk to a lawyer.

Okay. So as I was mentioning okay what we try to do initially is just to like set up the context and like see how this delegation looks in other areas of law. So like I try to like related a lot like in my mind some people might think differently but like in my mind I just I just see like delegates as just like this um senators or like people who work for the nation. So that's how I envisioned them. But like this is not the only way it can be seen.

It also can be seen in the cor corporate governance perspective either as directors or as representatives of the companies. I mean like this is just like going back to like the legal basis doesn't mean it is this is representation or delegation in the web tree space. So the way we can like see it uh is just like for example like when you have a corporation or a foundation you would have individuals who represent this company and are supposed to act in the best interest either of the company or the purpose in case it's a foundation or for example on the part of direct shareholder representation through a proxy that would be who they're accountable to. So like one of the biggest questions we're going to be answering is sort of like who are delegates accountable to and like in this scenarios this is who they're accountable at the real world like outside of like web three space in just like the corporate and like political science perspective. So when it comes to the civil law perspective basically contract law um I want to talk about like what is representation so that we can all have a similar understanding going forward.

Um so in the legal world one person can act on behalf of another for the other person and this is called representation and the mostly common the most common tool used for that is a power of attorney in briefly it's a PA and the person giving the power of representation to the other person is called principal the person receiving that right is called agent and and um how the PIAA works. So basically uh the agent can sign the contracts, makes decisions or access accounts for the principal, right? Because the agent is doing something on behalf of the principal and he is or she is powered with that and we have like different types of PAS. So uh depending on the jurisdiction there might have there may have so like different kinds of uh than what we have listed here but basically a general PA uh gives a really broad powers to another person. Basically the agent can do whatever um he or she wants uh for on behalf of the principal and for the principal.

And when it comes to limited, POIA is basically specific for uh tasks that the principal wants to conduct with the help of the agent and generally it also has some sort of a duration. And then the durable POA is a tool for the cases where the principal is not able to decide for him or herself basically in case of accidents or some sort of like illnesses. Um so depending on the jurisdiction also the shape of the POA might be different. some um in many cases you might see um written PAS signed but in some sometimes it can be also notorized and witnessed and here you see the schema basically on the left hand side we have principle and on the right hand side an agent and the PA uh which basically includes the terms of the representation and um basically the principle is legally bound by the actions taken by agent. So imagine this if agent signs a contract it's going to be as if the principal signs it.

So you may understand that like agent is has this like power on um upon a person right upon the principal. So u most of the cases that's why um agents have also uh fiduciary duties to um I mean for um for the principal. So for example we have duty of loyalty for agents. So it means that the agent must always act in the best interest of the principal. Then we have duty of care.

The agent must make decisions with reasonable care and competence just as uh they would with their own affairs. And then we have duty to act within the scope of the POA. So the agent shouldn't go beyond the scope uh of this PIA otherwise it could be a breach of the representation uh rights and then we have duty of transparency because we are expecting agents to be transparent with their principles and then duty of accountability basically the agent may need to report back or justify their actions. Okay. So like it's the way Dows are represented into like internally into the real world they might be a little different.

I'm mostly in the part of like how these entities are being represented either by their directors or their supervisors or their representatives or mandates outside true legal entities. Um, now we're going to speak mostly about like how it works internally and like I do have like here pointed out two really important questions that are like the core of this presentation who are that are okay who are these parties actually accountable to and what happens when there's a conflict of interest. Okay, so if you want to start with the delegates, this is a really hard question that I always question myself. Okay, so like are the delegates that are being delegated tokens to represent the token holders to take certain decisions and voting in proposals are they accountable to like the delegates to like the delegators I mean or are they accountable to like the whole network or the whole ecosystem? This is like a very important question that we're going to be like addressing through this workshop.

And then the other question is like what happens if there's being a conflict of interest like I mean like you as a delegate you're supposed to disclose okay so like this proposal is actually of interest to me and I should like abstain to vote but like we don't really have other than those mechanisms or just like sort of like a code of conduct or sort of like this different um things in the space. um how do you actually like enforce that? So like that's a really good point. And then on the external part oh no second point okay this one is like a bit more clear. So like what happens when there are members of a committee that have been appointed by the DAO like but by by the token holders by the delegates or by which the other parties I do think here it's like much more or less complex because like here you're understanding your responsibility is towards the ecosystem in general and um on the other part this is like what I do in my little practice but in the other part we have to like understand that this representation like this votes that you're having on Shane or of Shane or whatever.

Um they're actually probably not in all cases going to also have a reflection in the outside world. So there's going to be a contract, an agreement, there's going to be something that's going to be happening and then for that part this correlation between the votes that are happening within the DAO and then how's that correlated to the legal entities that are going to be acting behalf of those individuals have to have like certain like vulo like a certain how do you say that in English like a certain like bond um and there has to be like counter balances and like there have to like check and balances between these both parties. But at the end of the day, a director of a legal entity proin Cayman is going to be the one that's going to be executing some of the decisions that are requiring the offshane um sorry like the real world scenarios. So let's talk about some decision mechanisms in Tos. Well, we really like this tweet.

Um so when governance changes in real life, people die. But when governance changes in web 3, it's a Tuesday. We're still early. But this space is still experimenting with uh different methods actually. So here you can see different uh decision mechanisms that we kind of like identified for this talk but obviously it's not um it's nonexo exhaustive list.

Um so in the on the first side we have this like direct token voting where um you have token holders who vote and the execution happens on chain via smart contracts most of the time. The pros is that like it you have a transparent system but at the same time it can lead to voter fatigue or a veil dominance and then we have delegated voting and then you have the delegates who actually vote on proposals and this can be again offchain or on onchain executed. Um it is more like scalable at least this is what is now like thought of um as and it's also expected that more informed people more people who are um active on these uh on these networks actually join. Um but on the con side we may have delegate decentraliz sorry centralization and low accountability. And then we have snapshot wing which is again um somehow exclusive to token holders but it's a kind of an off-chain mechanism offchain wing mechanism.

Um so the execution requires uh basically an off-chain signal then sometimes onchain execution like depending on the topic and how the system is created. Um it can be really cost effective because like you don't have to actually spend gas. Um but it's not enforceable if you don't have in a follow-up contracts if you have like onchain execution. So someone needs to push the button. Um then we have like multisync execution.

Basically it's more exclusive to elected signers. Um and the execution can be manual offchain or onchain as well. The pros would be like you have uh secure treasure treasury control because you know who is controlling what um and you have this like hybrid flexibility. Um but it may not be again fully decentralized and sometimes it can be slow. Um also this space is experimenting with like layered by cameraal voting system where you have like a mixed of uh waters.

Um and the execution can vary again based on the structure. Uh and the pros it could be inclusive or balances of power because then there's like token holders and then they are actually um selecting some other people um to uh vote on their behalf. So you have this like by cameraal system and on the con side it's quite a complex design and um it's kind of like harder to coordinate. So the delegation the topic of the day and why do we really talk about delegation because I've been in the space like late 2017 and I've been hearing all the time how do you make people vote? Um so the delegation is the process by which token holders assign their governance rights to someone else named the delegates.

And these delegates are usually individuals or teams who are more informed, active or trusted to vote um responsibly on behalf of others. So this is the their this is the expectation. Um then why the delegation exists? As I said, we don't know how make how to make people vote. So maybe delegation will actually be a solution here.

So that's why um we have like in terms of turning the low water turnout to like a higher turnout delegation might step in here or again I if you have like governance fatigue if you have too many proposals too frequently and if you're expecting your token holders to vote on like every every proposal then you may create a governance fatigue. So delegation might be a solution for that and also delegation is expected to help with the scalability. Um on the benefit size basically um you can also get much more like specialized expertise information through delegation. Um because most of the time people who sign up for delegations are uh quite active on this you know on the forums and they are basically following all the news and developments and everything. Um and it's maybe more efficient because well the delegates who are actually willing to vote they will vote much more frequently so it will keep things going um and again scalability because it would probably uh reduce bottlenecks.

So in this in this space we see unis swap, optimism, enso um use active delegation models u to uh basically overcome this uh challenges that I just said. Yeah, just like as an example um of the vikal the vicamal um we have like optimism. I know like today or yesterday they did change a lot of their things on this aspect. Um but they do have like this two parts where like citizens they're on one end and token holders they're on the other end. So they re I know like the one of the biggest changes was on the citizenship part.

Um so like if anyone here has some info on that I want to share like in the Q&A that'll be great as well. Oh yeah. Another thing that the space is experimenting with and we found quite recently is the automated uh delegation and it's coming from OAL. Um so basically once you have this like OAL governance uh token and if you do not delegate it willingfully then the system delegates it for you automatically. So basically you lose control over your voting power.

Um but this is a kind of a backup system for Oel because they don't want any um governance tokens to to stay dormant and they want to keep them active in the system. Okay. So like one of the legal challenges we see in all of that it's about the liability liability in two aspects. Okay. So I'm delegating to you.

So those tokens are actually still mine. So like I still have control over the execution and I can I can have I can have like that liability. And what happens if those who I delegate to are not acting in the best interest and or like they voted on a proposal that was considered sort of like against the law. And then on the delegate perspective it's like okay so like I'm the one taking the final decisions. Maybe I don't have like the final control of the tokens but I'm putting my name out there.

And there have been like certain um there have been like certain cases um for example in unis swap they were like they were like some of the delegates they were like receiving subpoenas which are like notifications from like the US um in certain parts of the regulation site in descent. So they were like, "Okay, so like I'm not actually legally shield and I'm receiving these notices in my house or like wherever." I don't know if they were in their house, but like they were receiving like this notices and there's kind of like this like okay so like how should I proceed? Um, one of the recent uh things I've seen that I mean like um I'm not well we haven't seen the practice how it's going to be worked but it's a really interesting point that it's particularly on the delegation part is with the CK association um they have an astron but in this context it sort of like grabs ups the delegates so you have to like opt in and like be a member of this astron association in order to participate in the voting of any proposals. So, I was just like reading the bylaws.

There was like no like there I thought there was going to be sort of like a list of all the addresses that oped it in into like this uh membership. It it isn't like a visible this. So, I don't really know how like shielding this is, but this is sort of like an interesting perspective. And another interesting point is for example like a lot of like the big SPCs when they delegate they actually have contracts with the delegators with their delegates. So this is something they're using like also to shield themselves that this decisions they're not like participating directly in.

So yes, so when it comes to second legal challenge, we can talk about accountability and the risks uh arising from directly delegation itself. So um the first risk that we see decentralization basically uh one delegate can get the delegation from many token holders and kind of kind of like accumulate the voting power and basically it would lead to centralization. Um the second thing the stealing of votes and bribery. Um basically behind the closed doors some people may have some agreements with token holders to get their votes and uh we have also seen um lobby and dark as example just to support that kind of um model. Um as a third risk we can talk about abuse of delegation powers.

So um in the space currently to my best knowledge uh the delegates um go on the forum and then they identify themselves they introduce themselves what they do etc just to gain the trust of the token holders. Um but there is no identity proof like there is no identity verification. We actually are bound to the statements of what they have told us. So in this case we cannot really see if they have you know conflict of interest or other intention behind this. So this can definitely actually lead to an abuse of delegation powers.

And then we have conflict of interest basically again through the online material that the delegates have written. We we are not able to find out the conflict of interest. So it needs to be disclosed but there is no enforcement uh if it is not disclosed. And then regulatory exposure. Terza just said like said that some delegates at UNIS swap uh received subpoenas in the US.

Basically it's a legal notice and um so with the delegation process when you put yourself out on a forum and introduce yourself basically you become discoverable and that will make you uh exposed to these kind of like regulatory risks as well. And having no liability shield is also uh a bit concerning for the delegates. And here um for about the first risk basically the centralization not decentraliz centralization um we have a case study about optimism dowo. So um optimism dow has a valgated voting system as well and on the uh h token house side we have one token one vote model on the citizen house sides we have one person one vote model but if you see the uh chart on the right side basically six delegates are controlling like each of them are controlling more than 5 million op tokens meaning that they have actually quite a big power in decision- making like you you can see it on the on the graph uh which is below the veils doesn't really represent the um token holders per se. It's kind of like in the optimism ecosystem.

It represents anyone who's able to meaningfully shape the decision making system. So delegates can be also um called as uh veils. So um the key takeaway about optimism dow is that um without the mechanisms preventing the centralization basically we are um undermining the um the the dowo foundational principles and the basically the principles of distributed governance. Yeah. So like on this part of like being accountable, I think like we want delegates to like be accountable but accountable to who?

Um and this are like things we can like add like for example like one of my the most important points I see here is regarding the conflict of interest. I mean like this has been like a lot of studies on this end from the governmental perspective and like how important it is for like not participate or like avoid like situations in the ones you have a conflict of interest. So like that's like super important. Um there are also like I mean we see a lot of this entities about this um Dows actually having like non-binding sort of like constitutions on that end but like in order to like opt in you should like be like okay so like I'm going to like sort of like follow these rules. Uh there's like this point of like okay they're nonbinding and like what happens and it's been like it's happened before that like you breach certain like rules in one D and then just like you go to another one like maybe no one knows you there so you're going to start from scratch.

So like those are like a little like some issues that we see. Another like really important point that I see on the part of the accountability is like who am I incentivized like who incent who gives me like incentives to like participate. So like if you would say that the projects itself they give incentives to like the delegators delegates to like vote and act in the best interest of the DA. That's one thing but like what happens when the interest from the delegates that are being participants come from particular projects. So like at the end of the day who me as a delegate should respond to like this the individual who's like paying me or the broader community.

So like these are like questions that come to my mind and the next challenge would be that smart contract vulnerability. So it's yes it's a very generic uh vulner like a risk uh that we see in all like smart contracts but within the governance uh context um basically if we have bugs in governance contracts it can it can lead to b lead to uh errors in contracts uh and incorrect w tallies or delegation loops or override bugs or inelability to revoke or update delegations properly. Um these can be uh quite counterintuitive in the s for the system that that is built. Um of course we have exploits and attacks um that can hijack the governance and we can uh also talk about the governance manipulation here uh because uh delegates themselves can also collude coordinate or even be bribed through the smart contracts. um without the off-chain context, basically malicious proposals can be also passed like even though um they are socially unacceptable.

And on the legal side of this, um it's kind of like um hard to again talk about the liability issues here because like imagine like you have a bug and we need to figure out first like is it a really a bug or is it a f feature or is it basically an abuse and no jurisdictions have a clarity on that at this point. So um when it comes to the mitigation strategies for that like we can maybe talk about uh the thorough auditing and maybe the use of post switches time locks and veto powers and basically the delegate responsibility frameworks. Oh yeah. So the golden nuggets uh that uh we want us uh we want uh you to take uh away from this talk is that delegation it might be necessary or maybe not necessary it's up to you but like it's definitely risky and we have personal liability risks uh continue and obviously the design must be also balanced between efficiency and this um uh accountability. So like yeah like I think like this brings us with more like questions than answers.

Um I thought we were gonna have more time for questions or people to put input but I don't know if anyone has like any sort of like questions until now. Oh we have them in the screen. Oh can we legally stay 100% anonymous while delegating our vote to be trusted by a party in a doubt? I mean like legally anonymous in what way? Like because like when you delegate like like you're not like your like your information is not being made public at the end of the day like you don't have to like KYC in order to delegate I don't know if it was like regarding on that end via set of or contribution via s and in case in the system isn't that being forced voting and how do you how do we know the alteration happens actually like there was like someone who pointed out this question in the in the in Twitter and then like the community like they responded back and they say they only use this for like certain um quorums in the ones like the quorums made And