My research on DAO LEGAL FRAMEWORKS: International CryptoPlanning will soon be published in its 2.0 updated version.
Meanwhile, i would like to share with you the summary of its key points, that were presented at EthCC Paris the 21st of July of 2022, to start sharing a bit of the content in advance.
I hereby, as well, share with you the video:
I hope this pre-publication is useful and very soon the full part 2 will be released.
Cheers,
Of course most of you must already know what a DAO is:
A Decentralized Autonomous Organization is a blockchain-based entity, collectively owned and managed by its community (token holders).
In simpler words: set of smart contracts that enable people to easily coordinate in a common goal.
I’ve come today to explain in very little time a quite extensive and complicated matter: Legal Frameworks for DAOs.
But, where do we start from?
Lets make a little mental path to understand the logic behind this big dilemma.
To dao or not to dao Before we find a proper legal wrapper this question is key.
Why should you or anyone care about DAOs?
We should care about DAOs as an alternative to the current long time consuming, costly and bureaucratic existing processes of traditional organizations. This is of special value for communities that do not have the economic access or tools to organize themselves the traditional way.
They came to optimize the way we organize ourselves as a community on different levels.
Thanks to the wonders of smart contracts, with a couple of clicks, wallet copypastes, a DAO is all set to operate.
Do we need a legal wrapper?
If a community of people decides that they want to organize themselves effectively as a DAO, then they will need to answer this question.
There are two main reasons why a legal wrapper might be necessary for a DAO:
The need to execute OFF CHAIN OPERATIONS, to:
Open a Bank account,
sign contracts,
own registrable assets and IP,
file and pay taxes,
hire people,
and/or interact with other individuals/institutions that exist outside of the blockchain.
LIMITED LIABILITY for members, to avoid being considered a general partnership and risk joint responsibility. DAOs need to reduce, mitigate, or allocate risks. Members want to avoid having their patrimony directly affected.
For the DAO to properly understand these two aspects (execution of off chain operations and limiting liability for members), there is an important matter they need to determine:
WHAT IS THE PURPOSE OF THE DAO?
Is it a Social DAO, a Philanthropic DAO, a Venture DAO? A Protocol DAO, a Collector DAO?
Once we get to fully understand the PURPOSE of the DAO, and therefore the kind of activities they would be performing, defining whether there's a need for off chain operations and limited liability becomes easier.
If indeed, these two align with the purpose of the DAO in question, then, most likely, a legal wrapper would be necessary for the DAO to properly and compliantly operate.
Perfect, we are on a good path.
Immediately after understanding the Purpose of our DAO, we need to ask:
Is it FOR PROFIT OR NON PROFIT? And to make the difference between: if it is indeed a for profit, will there be a generation of profit and the need for profit distribution among members?
Whichever legal wrapper that we choose, will have to align with this matter, as well as the tax treatment that they would respectively have. What kind of activities will the DAO perform? How is it taxed? How are blockchain related activities taxed? And tokens?
Benjamin Franklin once said: “In this world nothing can be said to be certain, except death and taxes” … and I might even add gas fees
The tokenomics model is as important in this analysis as the activity performed by the DAO. Understanding the perks of the issued tokens is important, so we can be sure to comply with financial instruments regulations if the case, like licensing and registration. Will the DAO have a governance token that is considered to be a security? ¿A utility token? A hybrid? Will they also have their own payment token? What about member fluidity and the transferability of the tokens?
On the other hand, No one says that a legal wrapper has to “fully” wrap a DAO. In this sense, SILOED structures can be set up to encapsulate different parts of the DAO. As an example, the treasury and different activities and operations of the DAO could be separated to optimize its functions.
Let’s say we have a Philanthropic DAO, therefore, a non profit. This DAO could find itself a foundation for a legal wrapper of its treasury (and if doing so in the US, file for tax exempt status 501c3) and then have its protocol unincorporated, or wrapped in a different entity. or have a different one as an IP Holding, or for token issuance.
And hey! Don't forget, we must also ask: nationality of founders, most members, trade of business. Basically to understand from where the control of the generation of income/treasury comes from + trade or business.
DAOs with significant US membership/activities would most likely be best served with US structure because of: decentralization, regulatory compliance, taxes and potential regulatory risks.
This is important to know because if this is mostly US centered, then its most likely more convenient to have a US based structure. This is because if a DAO has a legal wrapper in a different jurisdiction with US members, control, o trade or business, US regulations might still apply. What does this mean? This mean potential issues with IRS, SEC and or /CFTC. Homework: BITMEX CASE.
DAO members will also have to ask themselves how much they value DECENTRALIZATION and ANONYMITY (/pseudonymity) in their community, as adapting to a legal wrapper will most undoubtedly make them sacrifice these to a certain extent.
Beyond the philosophical debate of the core values of DAOs, its autonomy and decentralized key features, it is important to point out that a legal wrappers would mean centralizing decisions and executions of operations to a single potential point of failure.
This is also because the current regulatory world is not yet prepared to fully deploy DAOs, bringing a lot of REGULATORY UNCERTAINTY, and the risk of working in a gray area threatens to become “the floor is lava” at any point.
The mantra “move fast, break things” can be more costly than we believe, and, definitely, not a healthy or sustainable mindset.
This only enhances the fact that contingency planning before fully deploying the protocols of the projects themselves is fundamental, and working from a solid legal structure from early beginnings is also shown to be key.
So, what are the existing options for DAO LEGAL WRAPPERS?
Potential legal wrappers for DAOs, currently, either adapt to already existing corporate entities, or new legislation on the matter (these are the fewest).
Few jurisdictions in the world provide direct legal recognition to DAOs as legal entities.
We can mention Wyoming in the US with Bill 38, recognizing DAOs as Limited Liability Companies, Tennessee also providing a model of LLCs for DAOs (or DOs) and Marshall Islands DAO LLCs.
LLCs in general provide a quite coherent background for DAOs to “touch base”. They offer the same liability shield as corporations with the flexibility and tax benefits associated with partnerships as they get to avoid double taxation inherent with C corps. Bad part: member lists requirements (not so good for anonymity nor token transferability). Therefore, Delaware does provide an option for DAOs to incorporate as LLCs, but in this case with their normal LLC Act. Take into account that it requires that every member of the DAO becomes member of the LLC and to update everytime this changes, which can go against the flexibility that tradable governance tokens provide.
We have got other structures like Vermont BBLLCs, Colorados Co-operatives or LCAs and in case they are non profit: Private Foundations and Public Charities , The Political Nonprofit , Social Clubs which let you apply for tax exempt statuses on 501c , and UNA: Unincorporated Nonprofit Associations (las one with less administrative formalities)
For example:
A Venture DAO wanting to pool funds of members to later on decide via voting on where to put these funds, would probably find suitable to incorporate as Delaware LLC, like the case of Flamingo DAO or Metacartel. If they dont mind member registration and updating.
If we realize that the trade of business and nationality of founders is outside of the US, then more international options arise on the panel.
As mentioned, Marshall Islands, an Associate State to the US, in February this year made an amendment to their Non-Profit LLC Statute (based on Delaware’s LLC Bill).
In Europe, the names Malta, Liechtenstein, Switzerland and the Channel Islands arise.
In Malta “Technology Arrangements” adapt to DAOs and work similarly to an LLC.
Liechtenstein and Switzerland are some of the countries with the most and clearest regulations on blockchain, providing the most regulatory certainty to blockchain related projects. Therefore DAOs could find a legal wrapper as a Foundation or Cooperative in Liechtenstein or in a Swiss Association. On the other hand, these structures can be the priciest, up to 100k just on being set up. Beyond the mentioned set ups in Liechtenstein, Purpose trusts are also an option for DAOs. Similarly with the Channel Islands of Guernsey and Jersey.
Cayman Islands are very known for providing legal structures to many crypto related projects and even DAOs, with Foundation Companies. A Foundation Company is a flexible vehicle that operates similarly to an incorporated trust and that can be structured without shareholders and are able to carry on off-chain operations. This can also be an expensive structure compared with the others.
WHAT I TALKED ABOUT
Going through the analysis to decide on what Legal wrapper works best for a DAO LEGAL FRAMEWORK can feel like this,
Many matters have to be reviewed:
to dao or not to dao
purpose of the dao
level of decentralization required
need for off chain operations
limited liability for members
for profit or non profit
nationality of members and trade of business
tax analysis
tokenomics
How do we get the DAO to be transparent and compliant?
We have been working with the OpenVino project for a while now. Openvino is a decentralized open source platform that enables wineries all over the world to tokenize their bottles of wine and sell their tokens from the very moment of harvesting, optimizing their cash cycle. They even presented yesterday their latest project called BioDigital Certification, as a new way for wineries to self certify as organic without the need of costly and bureaucratic intermediaries. Sounds familiar, right?
We are currently working with OpenVino, with the next step: OPENVINO DAO, where DAO token holders would earn revenue from transaction fees, created on the platform (tokens created from different wineries all over the globe), and have then the right to vote on what to do as a community, trying to understand through this path the doubted necessity of a legal wrapper or not.
So you can see how new challenges arise day by day from unexpected sources?
ENDING
This is a lot of information in very little time, I know.
And at the same time, yes: Legal frameworks for DAOs lack regulations. And not every structure suits every DAO.
Different kinds of DAOs exist, with different purposes, dynamics and means of decentralization, and the selected structure should reflect that accordingly.
This might even sound like an unpopular opinion, but some DAOs just want to have on-chain governance and not worry so much about “the revolution” they mean to the old-fashioned corporate world.
Educating ourselves is the first step, beyond DYOR, please feel free to contact us, as One Big Lab, can do this for your dao.
Because these are exciting times, times to BUIDL, and not only for devs, but for lawyers and policy makers as well.
These are exciting times.
Please don't hesitate to contact me or my team for any doubts on the matter.
Merci a tout le monde.
—-
NOTES:
Best for Decentralization: LCA, LLC, (operational and governance flexibility) —> can be done on chain by members.
For profit distribution: —> LLC or LCA or a Foreign Foundation (Important to distinct: member nationality, where control comes from, trade or business)
Foreign Foundation has a Board = makes it more centralized than the rest of the options. Still, better for anonymity and member fluidity. DAO members can vote on telling the Director what to do. There is also the figure of the Supervisor. The Supervisor makes sure the Director complies with the purpose of the DAO. Rigid registration, costly, more complex. Careful: it has no US control over the treasury. Has to be able to demonstrate this.
CAYMAN ISLANDS: blacklist of the EU AML and Grey List of the Financial Action Task Force.
NONPROFIT 501C: it limits the treasury to a charitable purpose. Would require significanT off chain control.
INVESTMENT CLUBS - LLCS: Investment clubs have exemption from registration with the SEC, limiting their activities: avoiding issuing membership interests that are securities, less than 100 members, no public solicitations nor public offerings, require active participation of members on voting, non transferability, members have to be fully disclosed.
NON INCORPORATED: good if no revenue and demonstrable decentralization (technical and legal) + autonomy through execution of code.