Decentralized Autonomous Organizations (DAOs) as Insolvency Administrators: A Blockchain-Based Paradigm for Debt Restructuring

- by Olivia Nahak, student at Sister Nivedita University. This is 9th winning entry in the National Article Writing Competition organized by CBLT.

Abstract

For ages, the administration of insolvency has been guided by the liquidators, courts, tribunals, and government authorities. At present, past practices are still followed, and competent authorities have taken the direction of the insolvency framework into themselves. Such a traditional approach, however, often breeds inefficiency, corruption, and human error. High legal costs and court fees, case congestion, excessive paperwork, outdated laws on insolvency, and others create hurdles to the insolvency processes, which give a need for alternative solutions.

With a concept first arising in times of advanced technology, Decentralized Autonomous Organizations (“DAO”), based on the blockchain plus smart contracts, introduce a novel technique to corporate financing as well as debt restructuring and asset liquidation. This type of organizational structure assures collective governance plus decision-making automation under predefined rules without any human intervention. Though they have potential, the DAO faces enormous challenges because it lacks legal recognition as well as regulatory frameworks. There is no one general legal framework for all DAOs, very few of which acknowledge it as a kind of legal entity; the others have disputes regarding its legal nature and effects.

This article considers whether DAOs can be used to manage bankruptcies. Can DAOs be used to modernize the current insolvency framework? Can DAOs be recognized by the courts? And ultimately, whether DAOs are a legally feasible and efficient method for the substitution of the conventional bankruptcy approach. The paper presents results that seek to unveil the future of insolvency law and ends with recommendations based on those findings.

Keywords – DAO, blockchain, smart contract, decentralized, insolvency

I.   Introduction

The basic concepts of DAOs have come from earlier forms of decentralized organizations. One example could be Visa when it was young, which employed a chaordic structure[1]. The concept and functionality of DAO became widely known after the “DAO Project” in 2016, but not because it rendered services; rather, it gained fame due to a hack that took place in its system.[2] A mistake in the code for the smart contract enabled a "replay attack," resulting in 3.6 million Ethereum (a decentralized blockchain) being hacked — equivalent to $50 million at that time. All transactions are recorded permanently by blockchain technology, so reversing this hack became impossible; it could only be solved with full reform being carried out in Ethereum, and this led to a lot of controversy.

Under the guidance of Ethereum’s founder, Vitalik Buterin, the Ethereum group voted to change Ethereum’s system, which undid the hack and got back the stolen money.[3] On the other hand, a smaller group disagreed with this decision because they felt “code is law.[4] They argued that the hacker did not break any laws; he simply used a loophole in the code. The split between those who wanted the change and those who did not led to the creation of Ethereum Classic, which kept the original blockchain.

The collapse of "The DAO" acted as a crucial turning point for blockchain tech as it attracted the global spotlight on DAOs and what they can do.

Decentralized Autonomous Organizations (DAOs) may act as insolvency administrators by involving blockchain-based governance structures. This could lead to decentralized decision-making processes emanating transparency and stakeholder-driven solutions while reducing reliance on centralized bodies, where there is usually a conflict of interest.

II. The Basics of Decentralized Autonomous Organizations

To understand Decentralized Autonomous Organisations, three main concepts have to be clarified: blockchain, member-driven entity, and decentralized governance model.

Blockchain Technology

A “blockchain” is a transaction and data management technology that operates on a peer-to-peer network of interconnected networks or nodes[5]. Unlike other payment technologies that require a third-party organization to keep track of all monetary transactions, blockchain focuses on keeping transactions safe between only the concerned individuals. It is a decentralized solution where no third party or intermediaries are involved, thus making the process secure and transparent. All information or transactions go into a block and then link to the previous blocks, making a chain. Once this chain is made up and all the data has been stored, such data cannot be tampered with in anything else. It is like an open-source digital ledger containing information about all completed transactions, such as sending bitcoins.

 Most importantly, blockchain’s most essential feature is “smart contracts”. These contracts are executed automatically upon predefined conditions being met. For example, when a freelancer submits their work, their pay automatically gets executed when the client approves it.

DAO Governance

A DAO is driven by its members; there is no single authority that runs a DAO. Decisions like spending the funds of the DAO or updating policies are made by the members of the entity through tokens and smart contracts. The tokens give voting rights to the members, whereas the smart contracts execute those decisions according to the number of votes.

Lastly, DAO is a decentralized governance model, which means there is no single governing body, and it operates completely based on the votes of its members.

Hence, to summarise, DAOs can be described as a digital process where transactions are stored and secured in a blockchain network, such transactions are operated by DAO members with the help of tokens, and decisions are made by self-executing contracts contained in the DAO.

A relevant example of DAO is Uniswap DAO. It is a decentralized online crypto trading platform on the Ethereum blockchain that allows the automatic trade of cryptocurrencies with no middlemen[6]. Token holders propose and vote for changes in the protocol, how to spend money from the treasury, and plans for the platform. A member has to get at least 25000 affirmative votes to start a proposal. To take the proposal forward for a consensus check, it needs 50000 yes-votes. Finally, in the governance stage, adoption requires 40 million yes-votes. In the end, based on the number of tokens or votes acquired, an appropriate decision is made.

II.i Positive Aspects

As evident from the characteristics of DAO explained, it can be said that DAO provides a wide range of advantages. To begin with, the smart contracts in DAO help to minimize time and cost while implementing decisions. It provides an appropriate decision automatically based on the pre-defined rules it contains, hence making the process much more efficient.

Next, DAO being decentralized removes the hurdles of intermediaries or interference from any third party. Decisions are solely based on the votes of the members, and hence there is no delay in the decision-making process. Most importantly, the decision is viewed as being just and fair because ultimately it is members who are deciding for their cases or transactions.

Finally, such decisions, once taken, are publicly available, making sure that no one can change them. When all the transactions and modifications become publicly visible on the blockchain, it automatically prevents an individual from concealing fraudulent transactions, thereby ensuring accountability. This helps ensure that the whole process is trustworthy and in the best interests of the members of the DAO.[7]

II.ii Negative Aspects

However, such an efficient organization comes with shortcomings as well. First, all information about transactions is susceptible to unethical hacking[8]. This is because of the transparent nature of DAO. Even though the publicity of information on blockchains leads to accountability, it still faces a major issue of security. These pieces of information are only secure to the extent of the coding skills of the developer of the smart contracts. Hackers can easily exploit if the developer overlooks any step or updates a wrong condition in such contracts. Moreover, incorrect coding will also lead to wrong decision-making. This is because, DAO is dependent on self-executing smart contracts, and once votes are cast, these contracts will automatically generate a decision based on their coding. So even when the coding is incorrect, it doesn't stop a smart contract from providing a decision, and hence, such a decision can be incorrect.

Secondly, if the members are responsible for the decisions made based on the number of tokens they hold, it can lead to arbitrary decision-making[9]. This is because members who have a higher number of tokens hold more voting power than those who have a lower number of tokens. These large stakeholders may misuse funds or cast votes for their advantage instead of the community’s, which may result in total ignorance of the opinions of the smaller stakeholders. Additionally, there is no proper body or in-built protection that will prevent such misuse of tokens.

There have been several instances when DAOs have been hacked, leading to huge financial losses. One such example is the Deus Finance DAO, which lost $13.4 million due to a flash loan attack[10]. A flash loan requires no collateral, and it needs to be repaid in the same transaction instantly, else the whole transaction is cancelled. Hackers take advantage of this system by borrowing huge amounts of money instantly, and by using complex trading strategies, they try to manipulate the market prices. For example, the hackers, instead of purchasing crypto assets, first borrow a huge flash loan worth millions of dollars. Then they trade these assets at a much higher rate in the decentralized finance markets, thereby making profits. As soon as the profit is made, they instantly repay the loan before the smart contracts can even react to this scam. By doing so, they trick the DAO’s smart contracts into making a bad transaction. The hacker escapes with huge profits, resulting in financial losses, and the DAO may become insolvent.

III. Inadequacies of the Current Insolvency Regime

It is important to understand why DAOs are proposed to play a major role in insolvency administration. The Insolvency and Bankruptcy Code, 2016 (IBC) governs the current insolvency administration. The code has undoubtedly contributed positively to the insolvency administration by replacing and amending old laws of insolvency laws. However, the progress of the code ultimately depends on how its provisions are implemented. Even though the traditional insolvency processes have resulted in the effective resolution of cases, the code still lacks in certain areas.

The first problem that has been raised is the tedious and arduous process of solving insolvency cases. Currently, in India, there are 16 National Company Law Tribunal (NCLT) benches. However, despite such numbers, the benches still face challenges in expeditious resolution due to case congestion arising out of financial stress triggered by market volatility.[11]

A notable example is the case of Quantum Limited (Corporate Debtor) vs Indus Finance Corporation Ltd, 2018[12]. In this case, Quantum Limited was undergoing a Corporate Insolvency Resolution Process (CIRP). In the ordinary course, this process takes 180 days to complete, but here the Committee of Creditors (CoC) failed to reach a final resolution within the stipulated period. Hence, the Resolution Professional of Quantum Limited requested an extension of 180 days; however, the NCLT argued that the extension request was filed at an inconvenient time and hence it was rejected. In contrast, the NCLAT clarified that in the absence of any objection from the CoC, the extension remains valid, and therefore overruled NCLT’s decision. This judgment emphasized the fact that such strict timelines under the IBC often lead to several irregularities, prolonged litigation, and rejection of cases without adequate justification. 

The next challenge would be Asymmetric information distribution. On numerous occasions, the Resolution Applicants lack knowledge about the entire information of the company’s financial status or the debtor’s assets. This leads to misinformed decisions made by such applicants regarding debt restructuring.[13] In the absence of complete awareness regarding the company’s financial status, preparing good bids or proposals becomes problematic and hence, the insolvency process is ultimately delayed. Additionally, issues like human errors and bias towards powerful creditors ultimately lead to prolonged litigation and excessive delays in recovery.[14]

It is hence evident from such inconsistencies of the traditional debt restructuring methods that there is a demand for innovative approaches. This forges a new path for Decentralized Autonomous Organisations to be an effective addition to the insolvency framework.

IV. The Role of DAOs in Modernizing Insolvency Administration

It is undeniably true that there is a growing need for innovations in the traditional insolvency administration. DAOs can potentially be a valuable inclusion in the insolvency framework by leveraging their smart contracts, blockchain, and decentralized governance. This opinion is supported by the characteristics of DAOs themselves. If we observe the issue of lengthy insolvency proceedings, then DAOs can solve this problem with the use of smart contracts. The smart contracts already consist of predefined rules and the parties to the case must adhere to them[15]. For example, the smart contract has time-sensitive provisions for the submission of claims by creditors, its review schedule, and ultimately distributing the remaining assets to the debtors. In this way, issues can be resolved much faster and there is no need for delay in courts, paperwork, etc.

A prominent case is that of Hector Dao[16]. Hector DAO is a treasury-backed DAO, which means that funds can be allocated with the help of blockchain and it will be governed by its members, instead of a central authority. In this case, investments were made but due to market instability, Hector Dao went bankrupt. Rather than pursuing the court’s services, which would take several years, Hector Dao managed everything digitally. The members voted through digital tokens to acknowledge that it was insolvent and smart contracts were used to automatically allocate residual assets to those who were owed. Moreover, due to blockchain, creditors could simply authenticate the amount of remaining funds because everything was publicly recorded and irreversible, leaving no scope for misuse of financial records. The entire procedure was approved by the British Virgin Islands court, thereby proving that DAO can be used in insolvency proceedings.

Several other issues can also be solved by the use of DAOs. Unlike IBC, where only the CoC takes all major decisions and small creditors have limited input, DAOs help resolve this issue by providing the option of token-based voting, ensuring that the power is not restricted to a central authority and that the relevant stakeholders can provide their opinion[17]. Lastly, in DAO, there is no scope for the creditors to be unaware of the financial information of a company because every transaction is already recorded in the blockchain and is publicly visible[18]. Thus, this helps the creditors to make informed decisions regarding bids and offers and prevents them from acting ignorantly.

Despite DAOs’ legal recognition and advantages, they still face several challenges as stated previously. Therefore, to fully optimize DAOs and introduce them as an integral part of the insolvency framework in India, several reforms and frameworks are still need to be established.

V. Recommendations

To address the challenges and leverage the full potential of DAOs the following recommendations are suggested –

• It may not be viable for the smart contracts in DAOs to handle cases individually since each individual has distinct matters whereas smart contracts have pre-defined rules that use a one-size-fits-all approach; it is not flexible. To solve this, a decentralized autonomous bankruptcy framework for DAOs can be created to leverage its smart contracts and blockchain by digitizing processes to handle insolvency disputes. This same concept was discussed in BrokeDAO, where it was suggested that the smart contracts be coded in a way that would automatically handle bankruptcy situations[19]. It could disburse leftover funds among creditors based on pre-defined rules, liquidate DAO holdings to repay debts, and empower token holders to vote on Dao restructuring. However, this failed due to the inflexible approach of smart contracts as they could not adapt to complex cases. Hence, a possible solution for this could be designing a framework where critical decision-making is overseen by humans, and routine and operational tasks be handled by automated processes[20]. Routine tasks such as debt monitoring, creditor verification, fund allocation, asset management, etc. could be handled by DAOs whereas, in case of disputes that fall outside established protocols, the smart contract can be designed to pause actions and transfer the case to be handled by a human arbitration panel.

  
  

• For insolvency issues to be managed, the legal recognition of a DAO is imperative because, in its absence, the DAO cannot have contracts, asset ownership, or accountability in a court of law. Places like Wyoming (USA) and the Marshall Islands have provisions for DAOs to register as legal entities, thus endowing them with rights just like companies[21]. For example, Wyoming in the USA enables DAOs to register as LLCs[22] and are given company-level rights in the Marshall Islands[23] as well. Further, the international models like the COALA Model Law[24] and the UK Law Commission’s 2024 scoping paper[25] recommend providing DAOs a separate legal status. India could consider adopting a similar approach by amending the Companies Act, 2013, to recognize DAOs as a separate legal entity, or enacting specific provisions in its Insolvency and Bankruptcy Code,2016, to integrate them into the insolvency framework. Through this approach, DAOs will gain legal recognition in India while also aligning the country with international standards.

  
  

• A mixed insolvency system can be introduced where smart contracts take care of regular creditor payments, and chosen arbitrators or governance boards make rulings on complicated insolvency matters[26]. This method provides quick handling while giving room for special situations. The Hector DAO bankruptcy case showed this requirement since courts were compelled to designate joint receivers because the DAO could not manage its insolvency on its own.

  
  

• Another possibility can be Kleros [27]- a decentralized arbitration platform that can improve insolvent DAOs by getting disputes resolved more quickly and cheaply. Even with problems like Jurors not being qualified, it can be reformed through selection based on reputation, raising token stakes, and appeals to legal experts.

  
  

VI. Conclusion

The aforementioned suggestions explicitly outline the reality that DAOs remain a work in progress to replace the traditional insolvency framework. Limitations still exist and additional research and modifications are required. As of now, the situation stands that it is not a complete substitute for the insolvency framework but it can at minimum expedite the process. In the modern era, it is crucial to use technology for our benefit. Ultimately, the article highlights that proper technological advancements and legal recognition of DAOs may impact the future of insolvency law. If not an alternative, then at least we can leverage it in India by implementing a hybrid approach of both automation and human involvement. In this way, beyond just speedy justice, the roles of lawyers will be simplified rather than eliminated.

The subsequent course of action for India can be, first, to update its Insolvency and Bankruptcy Code to provide DAOs a proper recognition. Secondly, the best global practices should be adopted along with creating rules for virtual assets. These steps would enable safe experimentation, hybrid governance, and stronger cross-border cooperation- all of which are essential for boosting growth, protecting creditors, and providing DAOs legitimacy in the digital economy[28]. In conclusion, DAOs retain the capacity to grow in India and can be a suitable addition rather than a replacement if we aim to create a more transparent, efficient, and just judicial system. 

[1] ‘(PDF) DECENTRALIZED AUTONOMOUS ORGANIZATIONS: UNLOCKING THE FULL POTENTIAL OF BLOCKCHAIN TECHNOLOGY FOR THE REAL PHYSICAL WORLD BY EXPLORING SELF-ORGANIZING AND SELF-REGULATING DECENTRALIZAD SYSTEMS BY APPLYING SMART CONTRACTS AND FIRST ATTEMPTS OF APPLYING AI’ [2024] ResearchGate <https://www.researchgate.net/publication/376146407_DECENTRALIZED_AUTONOMOUS_ORGANIZATIONS_UNLOCKING_THE_FULL_POTENTIAL_OF_BLOCKCHAIN_TECHNOLOGY_FOR_THE_REAL_PHYSICAL_WORLD_BY_EXPLORING_SELF-ORGANIZING_AND_SELF-REGULATING_DECENTRALIZAD_SYSTEMS_BY_APPLY> accessed 30 March 2025.

[2] ibid.

[3] ‘(PDF) Blockchain Technology and Its Types-A Short Review’ [2024] ResearchGate <https://www.researchgate.net/publication/359051731_Blockchain_Technology_and_its_Types-A_Short_Review> accessed 30 March 2025.

[4] Spindler Gerald, ‘Digitalization and Corporate Law – A View from Germany’ (2019) 16 European Company and Financial Law Review 106.

[5] Jesse Yli-Huumo and others, ‘Where Is Current Research on Blockchain Technology? —A Systematic Review’ (2016) 11 PLOS ONE e0163477.

[6] Yuen C Lo and Francesca Medda, ‘Uniswap and the Emergence of the Decentralized Exchange’ (Social Science Research Network, 20 October 2020) <https://papers.ssrn.com/abstract=3715398> accessed 29 March 2025.

[7] Jungsuk Han, Jongsub Lee and Tao Li, ‘A Review of DAO Governance: Recent Literature and Emerging Trends’ (Social Science Research Network, 3 November 2024) <https://papers.ssrn.com/abstract=5074046> accessed 29 March 2025.

[8] Ryan Levin, ‘Bankrupting the Matrix: DAOs and the Code’.

[9] ibid.

[10] John Frank Weaver, ‘Decentralized Finance—Risks, Regulation, and the Road Ahead’.

[11] Ankeeta Gupta, ‘Insolvency and Bankruptcy Code, 2016: A Paradigm Shift within Insolvency Laws in India’ (2018) 36 The Copenhagen Journal of Asian Studies 75.

[12] Quantum Limited (Corporate Debtor) vs Indus Finance Corporation Ltd, NCLT [2018]

[13] Gupta (n 11).

[14] Dr Manindra N Nayak, ‘Insolvency and Bankruptcy Code 2016: A Study of Large Stressed Accounts.’ (2020) 7.

[15] Alexandra Sims, ‘Decentralised Autonomous Organisations: Governance, Dispute Resolution and Regulation’ (Social Science Research Network, 31 May 2021) <https://papers.ssrn.com/abstract=3971228> accessed 5 April 2025.

[16] Kara J Bruce, Christopher K Odinet and Andrea Tosato, ‘Bankrupt Crypto Organizations’ (Social Science Research Network, 27 January 2025) <https://papers.ssrn.com/abstract=5115277> accessed 5 April 2025.

[17] ‘DAO BANKRUPTCY- CHARTING THE COURSE FOR BANKRUPTCY COURTS ON THE BLOCKCHAIN’.

[18] ibid.

[19] Ryan Levin, ‘Bankrupting the Matrix: DAOs and the Code’.

[20] ibid.

[21] Aaron M Lane, Darcy WE Allen and Chris Berg, ‘Towards Legal Recognition of Decentralised Autonomous Organisations’.

[22] Wyoming Decentralized Autonomous Organization Supplement to the Limited Liability Company Act, 2021 s 17-31-104

[23] Marshall Islands Non-Profit Entities (Amendment) Act, 2021

[24] COALA, Model Law for Decentralized Autonomous Organizations, 2021

[25] ‘Decentralised Autonomous Organisations (DAOs) – Law Commission’ <https://lawcom.gov.uk/project/decentralised-autonomous-organisations-daos/> accessed 19 August 2025.

[26] Saqib Sheikh and Imtiaz Sifat, ‘Built to Last, Not to Scale: The Long Run of Decentralised Autonomous Organisations’ (2024) 9 Journal of Innovation & Knowledge <http://www.elsevier.es/es-revista-journal-innovation-knowledge-376-articulo-built-last-not-scale-the-S2444569X24000520> accessed 6 April 2025.

[27] Luis Bergolla, Karen Seif and Can Eken, ‘KLEROS: A SOCIO-LEGAL CASE STUDY OF DECENTRALIZED JUSTICE & BLOCKCHAIN ARBITRATION’.

[28] ‘(PDF) Decentralized Insolvency: Analyzing Bankruptcy Protocols for DAOs Through the Lens of Crypto Market Failures’, ResearchGate (2025) <https://www.researchgate.net/publication/394502713_Decentralized_Insolvency_Analyzing_Bankruptcy_Protocols_for_DAOs_Through_the_Lens_of_Crypto_Market_Failures> accessed 19 August 2025.