Legal Uncertainty in DAO Disputes: The Merit DAO and Solend Debacle

In May this year, Merit Circle DAO’s token holders voted to refund a seed investor named Yield Guild Games (YGG) $5M worth of tokens for their investment. The reason behind the request to terminate the partnership was that YGG was apparently not adding any value as an investor in the growth of the DAO.
The community vote put the Merit Circle DAO’s investment team in a precarious situation. Despite the requirement to honor the members’ wishes, the proposal would have amounted to a breach of contract.
First, YGG signed a SAFT (Simple Agreement For Future Tokens) with Merit Circle Ltd, not Merit DAO. A lack of precedence in the world of DAO disputes makes it unclear how such a situation would be handled. Secondly, the vote proposed to refund the investors at a zero profit. If acted upon by the developers, the refund would have sent jitters across investors and VCs, who would probably have developed apprehension towards any future investment in DAOs. Nobody would willfully risk being deprived of an opportunity to make a profit off a seed investment. Moreover, the definitive document did not impose any specific obligations on YGG to contribute toward the DAOs growth, beyond the normal financial input of an early-stage investor.
Luckily, the refund was formalized through a joint proposal agreed upon by the DAO and YGG to reach an out-of-court settlement. The proposal was also accepted by members, and it would allow YGG to receive a 10X return on their initial investment of $175,000, thereby netting them $1.75 M . It is worth noting that MeritDAO tokens peaked at about $0.99 in May, yet YGG had to cash out at a predetermined price of $0.32. Currently, the tokens are trading at $0.77.
In this way, a potentially nasty legal battle had been averted.
Most recently, Solend, one of the largest decentralized lending platforms on Solana, passed a vote to allow the takeover of a whale wallet (The name is a portmanteau of “Sol” from Solana, and “lend”) The whale was leveraged to the tune of $170M worth of SOL tokens and had borrowed about $100M worth of stablecoins.
Had Solana’s price hit $22.30, about 20% of the whale’s position would have been liquidated by a margin call. This would have resulted in a cascade of buy orders on decentralized exchanges, OTC desks and other trading platforms by traders rushing to pick up the tokens at bargain prices. The sheer weight of buy orders would have probably crippled Solana , which is already structurally overwhelmed and has been the subject of about 12 network outages in 2022 alone. (So much for calling themselves “the Ethereum killer”)
The developers tried to reach out to the whale initially via all their known social media handles to no avail.
Desperate times call for desperate measures. As the markets kept hemorrhaging and the margin strike price neared, the developers hastily proposed for the creation of a “DAO” by Solend’s token holders, to vote on whether or not to take over the account and take the steps necessary for “an organized liquidation”, or to let the markets take their own course. The vote was passed by an overwhelming majority in 6hrs, half of which the voting mechanism wasn’t working.
What stood out the most was the fact that 95% of the “Yes” vote came from a single whale wallet. Onchain sleuths have since discovered that the wallet had been created just moments before the proposal went up and that the tokens were transferred out promptly after the vote (They also think this wallet was set up by the developer. Imagine the irony of one whale wallet voting for the seizure of another! Satoshi must be turning over in his grave, or wherever he is!)
Despite the gravity of the situation, an action of such nature would amount to spitting in the face of cryptocurrency and decentralization’s core ethos. The entirety of the cryptosphere was up in arms at the negative precedence that would have been set. There was also the possibility of legal ramifications from the whale, who definitely had a contractual agreement with the protocol that did not conceive for or allow any such takeover. (Big reminder, not your keys, not your cheese)
Luckily enough, the markets settled a bit, and Solana did not dip beyond $26. This allowed the developers to put up a second vote that not only invalidated the first one but also created proposals to allow for a less risky liquidation procedure. These included capping loan amounts to a minimum of $50 million, allowing for a 24hr vote period, and lowering liquidation margins to 1% of a portfolio at a time. The whale also re-surfaced (pun intended), and has since begun to move away some of the debt from Solend to other Solana-based protocols like Mango Markets, thereby reducing the possibility of a deluge of liquidations. ( This was after a 12-day silence, which some have opined was a deliberate move to tank the token prices)
The above situations point out how early we still are with regard to the growth of legal procedures and dispute resolution systems in crypto and defi. There are suggestions that contracts need to live on chains, and this can only be facilitated by the emergence of robust optimistic oracles that can devise, execute and enforce contracts in a unified realm.
Moving forward, it appears that smart attorneys shall begin taking into account the possibility of such disputes when drafting agreements between investors and web3 projects. In the meantime, Solend and MeritDAO have managed to avoid getting themselves under the regulator’s lens, but how long shall it take before another scandal of huge legal proportions arises?
Norman Gabula Commercial & Tech Lawyer | Crypto, Blockchain & Decentralized Finance and Consultant Sheria Online.