In recent years, investors and organizations have increasingly embraced blockchain technology for a range of business interests from tracking music royalties to supporting supply chain logistics. Now, in a reversal of that situation, an application of blockchain technology is being used to harness the collective power of investors and form organizations.
Decentralized autonomous organizations (DAOs) are the latest blockchain use case for organization and collaboration. The blockchain eliminates the need for a central governing authority and provides participants with greater access, input, and transparency into the organization’s operation, marking another digital step away from traditional transactions and institutional norms.
Essentially, a DAO is a business that uses an interconnected web of smart contracts to automate all of its essential and non-essential processes. DAOs offer open-source, automated, and streamlined operations through the use of digital ledgers. The structures of DAOs may vary, but they are all transparent and verifiable. The majority of today’s DAOs run on the world’s second-largest blockchain, the Ethereum network.
Since their inception less than a decade ago, DAOs and blockchains have been used to raise funds and collectively make decisions online without the need for centralized control. DAOs are powered by their communities and attempt to create more equitable and democratic organizational structures in which all participants—not just those at the top—can make decisions, allocate resources, and receive financial returns.
Wyoming Sets the Pace
As speculative and investment capital continues to flood into cryptocurrencies and DAOs, it is essential to understand what the future might hold for these new, decentralized institutions. So far Wyoming is the only US state that has legalized DAOs, and this has put the Cowboy State in the spotlight for blockchain investors and quickly earned it a reputation as the most “crypto-friendly” jurisdiction. The other 49 states do not recognize DAOs as legal entities but this will likely change as the cryptocurrency space continues to gain in scale and momentum and more states seek to benefit from the varied and tremendous potential offered by DAOs.
Wyoming’s DAO law came into effect on July 1, 2021, and permits the use of DAOS in LLCs (limited liability companies) as long as they maintain a registered agent within the state and meet the other requirements for LLC status. A DAO’s articles of organization may define it as either member-managed or algorithmically managed. When the articles do not specify, Wyoming considers a DAO to be a member-managed organization. For algorithmically-managed DAOs, the underlying smart contracts must be updatable, modifiable, and upgradable. Every time an underlying smart contract is updated, the articles must also be updated to reflect the new agreement.
Per Wyoming’s law, voting rights within a member-managed DAO are based on the organization’s membership interests, calculated by dividing each member’s contribution of digital assets to the DAO by the total value of digital assets held by the DAO at the time of a vote—similar to voting stock in a traditional public company. If a contribution of digital assets to the DAO is not a prerequisite for becoming a member, each member gets one vote. The current law does not cover dispute resolution, an omission that some lawmakers hope to address soon. An upcoming amendment might require that the DAOs’ articles of organization or smart contracts include a process for settling disputes among members. This revision would encourage founders to consider the best ways to deal with disagreements when they form the organization, rather than after a dispute arises.
The same day Wyoming’s DAO law went into effect, the state recognized American CryptoFed DAO as its first legal DAO. Established by MShift Inc., American CryptoFed DAO is a public DAO and the first in the world that aims to create and maintain a monetary system with zero inflation, zero deflation, and no transaction costs. MShift’s powers and rights were delegated to American CryptoFed DAO upon a successful U.S. Securities and Exchange Commission (SEC) filing for its tokens.
American CryptoFed DAO uses governance tokens pursuant to the Token Safe Harbor Proposal 2.0 as outlined by SEC Commissioner Hester Peirce. Using tokens called Locke (governance) and Ducat (stable) tokens, American CryptoFed DAO registered the governance tokens with the SEC. Governance token holders set the rules for the organization and they must vote to make rule changes. Transaction records are stored on the EOS blockchain platform. While Wyoming’s DAO law is innovative and exciting for DAO proponents, before creating a DAO interested parties should familiarize themselves with the benefits and disadvantages of DAOs under Wyoming law.
DAO Pros and Cons
There are many benefits to forming a DAO.
First is overall democratization, as an organization’s creators wield no more power or votes than its newest members. A majority consensus based on voting shares is required to make changes to the organization, its strategy, or its business objectives. The organization’s mission is predetermined and goals are clearly written into the smart code. This means that anyone interested in investing in a DAO must agree to its written terms in advance. It also protects members from conflicts of interest and prevents executives and committees from making decisions that benefit themselves at the expense of the organization as a whole.
There are also drawbacks to forming a DAO.
Specifically, because DAOs are new, they have met with criticism, misinformation, and fraud allegations. Often, language in the DAO code does not provide these organizations with many of the real-world protections and legal benefits commonly associated with traditional business structures.
DAO code may also contain potential security flaws and technical vulnerabilities that would allow voting manipulation.
Finally, any DAO designated as a “for-profit organization” must comply with relevant federal and state regulations. Many observers remain skeptical of the hype DAOs are generating and believe them to be little more than a fad. Others express apprehension over how DAOs can be effectively regulated, as there is little legal precedent applicable to their blockchain foundations, and there is no established legal framework for resolving DAO-related conflicts.
Why You Should Consult an Attorney Before Forming DAOs in the United States
DAOs are innovative, novel, and can pose complex issues. Accordingly, there are many dangers and potential pitfalls for individuals and organizations seeking to avail themselves of their benefits and potential. Anyone seeking to utilize a DAO, whether blockchain newcomer or crypto-savvy, should consult with attorneys who specialize in the burgeoning area of law regarding formation, funding, decentralized trading, and other DAO issues to help ensure that appropriate compliance and protection measures are in place and maintained. .
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