From cryptocurrencies and NFTs, to Facebook’s rebranding as “Meta, headlines are full of game-changing digital concepts almost every day. DAOs, or Decentralized Autonomous Organizations, were birthed by cryptocurrency and are likely here to stay.  With the recent passage of a Wyoming state law recognizing DAO LLCs as legitimate business entities (the first state to do so), the once-clandestine world of cryptocurrency has been officially connected to the legal mainstream. DAOs have already begun to transform the modern business world. 

WHAT IS A DAO?

DAO stands for “Decentralized Autonomous Organization”.  They consist of three  core components: 

  • Organization = a DAO consists of a group of people with a common objective. 
  • Autonomous = this organization is governed by a set of coded rules programmed into a “smart contract”. 
  • Decentralized = there is no central authority governing the organization; rather, the member votes automatically trigger action by the smart contract. 

Membership and voting power within a DAO are established by ownership of digital assets called tokens. Tokens grant abilities, rights, votes, power, and/or other utility to the owner of the token. Token ownership is immutable and exists on the blockchain, and enables the DAO to remain decentralized. Token holders can make decisions as a group, without the need for a central authority or intermediary, using smart contracts to automate the voting process. 

Tokens are typically given in proportion to financial contributions given to the DAO, but tokens (and the voting rights they offer) can be distributed in a variety of ways.  

  • Each member can have one vote: any token holder receives a vote, regardless of how many tokens they own. 
  • Each member can vote according to their contributions: token holders receive votes based on the number of tokens they hold. 
  • Or, they can allocate voting rights in any other agreed arrangement. Anything is possible. 

EXAMPLE – ConstitutionDAO

ConstitutionDAO was a group that created a DAO in order to crowdsource funding and buy an original copy of the United States Constitution from a Sotheby’s auction. This bid ultimately failed, but they managed to raise $47 million dollars in cryptocurrency from members who acquired $PEOPLE tokens.  ConstitutionDAO members were later able to redeem their $PEOPLE tokens via a refund process.  DAOs propelled into national headlines as a result.  

If they had succeeded, ConstitutionDAO would have had to collectively decide what to do with their copy of the constitution.  This is where the decentralized voting comes in.  

  • Members would be able to submit proposals, such as suggesting a specific museum to showcase their copy of the constitution. 
  • Everyone who was a member of the DAO would be able to vote for or against proposals. 
  • The smart contracts behind the DAO would be able to: 
    • Automatically process transactions such as contributions to the DAO; 
    • Verify the identity of members;  
    • Maintain an immutable record of decisions over time;  
    • Protect the programmed rules from being changed without permission. 

ConstitutionDAO may have been an experiment, but it demonstrates the basic principles underpinning DAOs membership and governance. The same principles can be applied to modern businesses.  

Not everyone needs to use a DAO to accomplish their goal, but the practical applications for DAOs are potentially endless. In summary, advantages offered by a DAO include: 

  • Organizational management (e.g., corporate governance) can be automated; 
  • Record-keeping can be saved on an unalterable blockchain; 
  • Actions, such as financial transactions, can be controlled by smart contracts; 
  • Algorithmic processes are transparent – anyone can review them; 
  • Authority and decision-making as a collective group. 

THE WYOMING DAO LAW 

In March 2021, Wyoming legislators passed an act (SF0038) recognizing a new form of business entity – DAO LLCs. This act, known as the Wyoming DAO Supplement (codified as W.S. § 17-31-101 through 17-31-116), allows for the formation of decentralized autonomous organizations as legal business entities.  States like California may follow in Wyoming’s footsteps by creating laws which allow for similar structures.

The process for creating a Wyoming DAO LLC requires many of the same steps as creating a standard LLC. The organizer must: 

  • Register an agent for service of process in Wyoming 
  • File Articles of Organization 
  • Establish their business purpose  
    • DAO LLCs can only be formed for lawful purposes;
    • However, they do not have to be for-profit entities. 

Additionally, an organizer must: 

  • Include an identifier in their business name designating the entity as a decentralized autonomous organization. Options include: 
    • DAO 
    • LAO 
    • DAO LLC 
  • Provide a publicly available identifier associated with the smart contracts that are going to automate the DAO. 
  • Include a notice in either their articles or their operating agreement stating that the rights of members in a DAO may differ materially from other LLCs. 
  • Identify the management structure. 

There are only two options for the management structure: member-managed, or algorithmically-managed. 

  1. Member-managed:  This is the default option. If chosen, the company will be managed primarily by humans, like any standard LLC. Various components of management can still be automated.
  2. Algorithmically-managed: This option can be chosen if the company is managed primarily by smart contracts. This term is not defined, and there is some ambiguity about the distinction between this choice and member-management. Future amendments to this section of the law are expected.
  3. Manager-managed: This traditionally available structure is NOT an option under the existing law. 

In the event of a conflict between organizational documents: 

  • The Articles of Organization predominate over the Operating Agreement;  
  • The smart contracts predominate over the Articles of Organization.  

A DAO LLC’s smart contracts, the set of rules programmed into computer code, are the ultimate authority in the business entity’s governance.  

REDUCING THE LEGAL LIABILITY OF DAOs 

According to Wyoming State Senator Chris Rothfuss, this act was designed in part to mitigate the potentially unlimited liability created by forming and operating a DAO without a corresponding business entity. A standalone DAO could be interpreted as a general partnership from a legal perspective, which means any member of that DAO could be personally responsible for the debts of other members or even the business itself. After the Wyoming bill was passed, Rothfuss stated: 

“Digital asset stakeholders made it clear to us they were concerned about facing general partnership liability in the absence of a well-defined corporate structure. Our DAO LLC legislation should dispel that concern.” 

Rothfuss also added that legislators wanted to provide legal clarity to the ambiguous DAO environment before the issue enters the courts.

Additionally, he acknowledged that the Wyoming DAO Supplement may have shortcomings or unintended consequences, and it will most likely not be the final regulatory product to govern DAOs.

The important takeaway is that this legal landscape, just like DAOs themselves, will continue to develop and evolve over time.  But like the cryptocurrency and NFT world, evolution in this field works at light speed.

THE FUTURE OF BUSINESS? 

In 1977, the first Limited Liability Company was formed in Wyoming. Despite its advantages, the LLC was overshadowed for decades by Corporations, the original entity type for modern businesses. But over time, the popularity of the LLC began to grow, and today it is one of the most common choices when forming a new company.

Similarly, the passage of the Wyoming DAO Supplement does not mean every business will become a DAO overnight – even if they could, many companies don’t need to be decentralized or autonomous. Many uncertainties still surround DAOs and blockchain technology.  

We do not know what the future holds, but we may know the direction it is headed. Digital assets such as cryptocurrencies have already radically transformed the global economy, and NFTs deliver the promise of utility across the metaverse. DAOs, whether they are Wyoming DAO LLCs or some future iteration, represent the potential next step in the constant evolution of business and law. 

Contact KVK if you would like to discuss using a DAO for your business. 

By Christopher Peel, February 11, 2022.

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