On Monday, a court in the Northern District of California denied a motion to dismiss a lawsuit against LidoDAO. https://courtlistener.com/docket/68095676/115/samuels-v-lido-dao/
A lot of smart people have already said a lot of stupid things about the decision, so it's my turn.
First, this is a ruling on a motion to dismiss, which means the judge had to accept the plaintiff's allegations as factually accurate.
Now read the highlighted language below. Plaintiff alleges LidoDAO has a deliberately diversified shared treasury (not just LDO tokens) and does businessy stuff with it, like deploying it to pay people.
I've consistently maintained that if an onchain arrangement involves a diversified treasury, it's probably a tax entity, especially if the treasury does businessy things. So, from my tax lens (which admittedly isn't identical to state partnership law), the conclusion makes sense.
Once there's an entity under state partnership law, the members can be jointly and severally liable for its actions unless a statute (e.g., LLC or Inc.) overrides that default rule.
There's an unresolved question of who the members are, but the court leaves that for another day.
WHAT DO? As usual, the answer largely depends on risk tolerance.
On one hand, the court seems to see all DAOs as a way for "people in the crypto world to inoculate themselves from liability by creating novel legal arrangements to profit from exotic financial instruments."🤮
On the other hand, it's one judge's view, on a motion to dismiss, and, if you've listened to me for the past few years, you'd know I think "DAO" is a meaningless term and, in reality, there are some voting arrangements that are entities and there are some voting arrangements that are not.
As table stakes, if you don't want a voting arrangement to be treated as an entity:
1. Don't have a diversified treasury.
2. Make all votes self-execute (i.e., the vote either calls a function or doesn't). No multisig.
3. Don't say DAO. It's not an organization.
In my view, if you observe rules 1-3 above, that's just parameter selection. It's like if Netflix irrevocably granted its viewers the ability to vote on which movies get featured and the vote was automatic (so the viewers aren't seen as Netflix shareholders).
The analysis gets harder if fees are streamed to holders. (The fees need to be streamed. If they sit in a treasury, that violates rule #1 above.)
I don't think direct-from-protocol fee streams typically create an entity bc I don't think parameter selection is a business. However, reasonable minds can differ, and you need to talk to regulatory and tax lawyers before you build a protocol. Don't rely on some Grifter's stream-of-consciousness tweet thread.
So, with voting arrangements, where do the businessy things go? How does the arrangement hire software devs or host a front end?
It doesn't.
Rule #2 says all votes need to self-execute. No one can act "on behalf of" the voting arrangement to, e.g., ask devs to do things.
However, nothing prohibits some rando, let's call them John Doe, from forming a Cayman Islands foundation whose purposes are limited to making grants to devs to build out the relevant ecosystem, and requesting a grant of governance tokens to capitalize the foundation.
Maybe, in addition to legally limiting the foundation's purposes, John creates a multisig for the foundation that pays John a quarterly fee and irrevocably restricts its own ability to spend more than [x] amount over any [y] period without token ratification.
The governance tokens then can vote to call mint and send functions to fund that multisig.
Now, John (through the Cayman foundation) is running a business. He can swap the tokens for USDC. He should be legally shielded bc he is doing the biz through a foundation.
What I've described can be replicated for front end hosting and other functions. Crucially, governance tokens don't have a say in the day-to-day execution of those functions because their arrangement isn't a business. (@MetaLeX_Labs calls the Cayman foundations BORGs.)
It would be naive to think the BORG model completely derisks onchain voting arrangements. Judge Chhabria clearly hates crypto, and one can see him (or someone like-minded) stretching to treat any governance tokens as partnership equity. What can we do to further derisk?
One option is for tokenholders - especially whales whose votes often are decisive - to hold their tokens through an LLC. To mitigate the risk of veil piercing, they should observe corporate formalities.
At a minimum, that generally requires:
- Form LLC, with whale as managing member.
- Document LLC's ownership of private key.
- Contractually memorialize whale's intent to execute txns with that private key only on behalf of LLC.
- Contribute tokens to LLC.
Another option is to use a Swiss or Austrian varein. I won't dig into that here, but, basically, tokenholders can opt into a varein through a front end solely for purposes of casting their votes.
WHY NOT JUST "WRAP THE DAO"?
That's an option too, but I don't think everyone calling for wrappers fully appreciates what they are suggesting.
Wrapping means conceding that governance tokens are equity in an entity, and that the entity owns the protocol admin keys (and the onchain treasury, if any). To prove the entity owns the admin keys (instead of the keys sitting outside the entity), you'd typically need to sacrifice decentralization by having one or more officers or directors own those keys through a multisig on behalf of the entity. That increases rugging risk.
Moreover, most entities have tax filing, payment, withholding, and reporting obligations. I've already talked about that for DUNAs. Basically, as US tax corps, DUNAs need to pay corp tax and can't stream fees without KYCing everyone first.
In an effort to imitate tax law, cryptolaw introduced two new acronyms over the last week:
- DUNAs, or decentralized unincorporated nonprofit associations; and
- BORGs, or cybernetic organizations.
Some US tax musings on both, a
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Finally, it's not even clear "wrapping the DAO" would fully derisk either. As I mentioned above, Judge Chhabria left open the question of who the "members" of the "Lido entity" are. It's not hard to imagine him finding a partnership among a wrapped DAO and other people.
All that said, I'm not saying that "wrapping a DAO" is per se bad. In some situations, an entity might just be unavoidable. But then drop the charade and call the governance tokens what they are: tokenized corporate stock.
