The rise of Decentralized Autonomous Organizations (DAOs) has brought about a paradigm shift, offering the promise of transparent and inclusive decision-making. These innovative structures, fueled by blockchain technology and smart contracts, have captivated the imaginations of entrepreneurs and innovators worldwide. DAOs present a disruptive alternative to traditional hierarchical models, empowering participants to collaborate and govern without intermediaries.
This decentralized approach holds immense potential for industry transformation, redefining organizational operations and facilitating self-organization and self-governance.
However, as the popularity of DAOs grows, they encounter a multitude of legal and regulatory challenges, particularly due to their decentralized nature. Navigating these challenges can get convoluted, given the absence of a centralized entity or a specific jurisdiction associated with DAOs. One of the primary hurdles faced by DAOs, their founders, and their communities revolves around comprehending the legal and compliance complexities tied to their projects. The decentralized nature of DAOs present a distinctive regulatory dilemma, assuming the lack of a singular entity or jurisdiction entwined with the project. This intricate landscape complicates the determination of legal implications and compliance requirements for DAOs. While the absence of an established jurisdiction may seem like a means to evade regulations, the reality proves otherwise.
Given that DAOs lack formal and global recognition as legal structures, they are often confused with general partnerships, resulting in a myriad of potential legal complications for those involved in a project.
What Is a General Partnership?
General partnerships have long been a prevalent business structure that brings individuals together to pursue common goals and share profits and losses. This type of partnership typically involves two or more partners who pool their resources, skills, and expertise to establish and operate a business. Unlike other business structures, such as corporations or limited liability companies (LLCs), general partnerships are relatively easy to form and require minimal formalities. This accessibility has made them a popular choice for entrepreneurs and professionals seeking to collaborate closely and leverage their collective strengths.
In contrast to DAOs where the decision-making power is with the community, in a general partnership, partners share management responsibilities, and key business decisions are made based on the consensus among partners.
Moreover, general partnerships bring forth the burden of joint and several liability. In general partnership, there is no limitation of liabilities meaning that each partner is personally liable for the partnership's debts and obligations. This liability extends to the partners' personal assets, potentially exposing them to significant financial risks.
Additionally, general partnerships are subject to legal frameworks and regulations specific to the jurisdictions in which they operate. Compliance with laws regarding taxation, labor, contracts, and other aspects is essential for their functioning and protection.
How General Partnerships Undermine DAOs' Decentralized Vision.
In recent times, regulators have engaged in discussions regarding the classification of DAOs as either general partnerships or unincorporated associations. This arises from the understanding that DAOs, in essence, can be viewed as an association of individuals collaborating as co-owners to conduct a profit-oriented business. Consequently, the formation of a partnership may occur regardless of whether the individuals had the intention to establish one or not.
Classifying DAOs as general partnerships does more harm than good for the following reasons:
They cannot enter into contracts because there is no separate legal entity from the partners, meaning they are legally unable to enter into a contractual relationship.
If the partnership happens to go bankrupt, the partners (members) are also declared bankrupt. In case of a DAO, this could present a risk if a project goes bankrupt or suffers any losses, members may suffer similar consequences.
There is no limitation of liability. Simply put, if there is one bad actor within a DAO, any other member can be deemed liable personally, with their personal assets. This is extremely risky as DAOs are by nature decentralized projects and members do not know each other.
General partnerships are built on trust among partners and are highly human dependent, while DAOs use smart contracts to eliminate that need for trust and reliance on other humans
One of the partner's death can result in the dissociation of the entire partnership, which defies the nature of DAOs that is not dependent on an individual.
The agreement of other partners is needed for any partner to sell or give away their stakes, while in a DAO, holders can sell their holdings without any approval.
Further, in partnerships, every decision is taken unanimously, as opposed to DAOs where usually the majority or the needed quorum decides what action is to be taken.
Furthermore, the legal landscape surrounding DAOs adds another layer of complexity. General partnerships operate within established legal frameworks, benefiting from clear guidelines and legal protections. On the other hand, DAOs exist in a rapidly evolving and often uncertain regulatory environment. This ambiguity presents legal challenges that require careful navigation to ensure compliance while preserving the decentralized nature of DAOs.
In order to limit the liabilities and protect those involved, many projects opt to incorporate as limited liability companies (LLCs), or they choose one of DAO and crypto friendly jurisdictions such as Switzerland, Panama, BVI and Cayman islands.
Is There a Real Threat of DAOs Being Seen as General Partnerships?
The recent case involving Ooki DAO and the Commodity Futures Trading Commission (CFTC) brings attention to the intricate issue of legal liability within DAOs.
The CFTC contended that Ooki DAO, functioning as an unincorporated association, consisted of token holders who utilized tokens for governing the Ooki protocol. As a result, the CFTC sought to hold the token holders accountable for their actions on behalf of the DAO.
The movants argued against suing Ooki DAO as an unincorporated association, asserting that it did not fall under that legal classification. However, the court disagreed, citing several factors that indicated Ooki DAO's status as an unincorporated association under state law. These factors included the presence of two or more persons (the token holders) who joined the DAO through mutual consent, shared a common lawful purpose of governing the DAO, and functioned under a common name.
This legal dispute highlights the complexities surrounding the legal framework of DAOs and the challenges faced in assigning liability, and emphasizes the need for the limitation of liabilities for people who are involved in a project.
In the last two years, there have been notable advancements in establishing a regulatory framework for DAOs. This recognition by regulators highlights the growing importance of DAOs as organizational structures. However, it is essential to acknowledge that these regulatory frameworks are still in the nascent stage of development and may not fully cater to the specific needs and nuances of DAOs. There is still progress to be made in creating a regulatory environment that is truly conducive to the growth and flourishing of DAOs.
Wyoming: The First State to Regulate DAOs.
In 2021, Wyoming made history by becoming the first state to officially recognize Decentralized Autonomous Organizations (DAOs) as decentralized autonomous organizations and allowing their incorporation as limited liability companies (LLCs). This groundbreaking regulatory framework brought uniformity and provided a sense of authenticity to DAO members, enabling the growth and development of these innovative organizations. However, despite its forward-thinking approach, the Wyoming DAO LLC law framework may require future amendments due to certain loopholes.
Notably, the Wyoming LLC Law allows DAOs to register as LLCs without undergoing Know Your Customer (KYC) procedures, offering the advantage of anonymous filing. However, it also mandates the disclosure of the registered agent's name, contact information, and address, as well as the managers' details for registration, creating a potential contradiction.
Wyoming's pioneering step in regulating DAOs has paved the way for other jurisdictions to follow suit. Notably, the Marshall Islands has followed in Wyoming's footsteps, embracing and formalizing the recognition of DAOs in its legal landscape.
The Marshall Islands Give Legal Status to DAOs.
In a significant move in February 2022, the Marshall Islands officially recognized Decentralized Autonomous Organizations (DAOs) as legal entities, granting them non-profit status.
Building on this milestone, in December 2022, they enacted the Decentralized Autonomous Organization Act of 2022, commonly known as the DAO Act, which governs the status of DAOs. This groundbreaking legislation not only permits DAOs to register as for-profit organizations but also distinguishes between those operating for profit and those with non-profit objectives. As a result, DAOs obtain the legal standing of a resident domestic limited liability company, subject to the regulations outlined in the Limited Liability Company Act.
Moreover, the DAO Act facilitates the conversion of a resident LLC into a DAO through amendments to its certificate of formation or company agreement, effectively fostering the establishment of more DAOs and enhancing the adaptability of decentralized structures. The Marshall Islands' proactive approach sets an influential precedent, propelling the recognition and regulation of DAOs to new heights.
Tennessee's Legislation for DAO LLCs: Facilitating Registration and Governance.
Tennessee has recently introduced a new legislation that enables Decentralized Autonomous Organization (DAO) LLCs to register within the state. The key provisions of this legislation are as follows:
Denoting DAO Status: Any DAO wishing to register as an LLC in Tennessee must include specific abbreviations in its business name, such as DO, DAO, DO LLC, or DAO LLC. These abbreviations serve to indicate the organization's DAO status.
Governance Options: Tennessee DAO LLCs have the flexibility to choose between member-managed or smart-contract managed structures. However, it is crucial to specify the chosen governance model in the articles of organization. In the absence of such specification, the DAO LLC will be automatically considered member-managed, operating similarly to any other LLC.
Registered Agent Requirement: If a DAO LLC does not operate within Tennessee, it must appoint a registered agent within the state. This registered agent serves as the point of contact for official communications and ensures compliance with state regulations.
Amendments for Smart Contract Changes: In the event of any modifications or updates to the DAO's smart contracts, appropriate amendments must be made to reflect these changes in the articles of organization. This requirement ensures transparency and accountability in the governance of Tennessee DAO LLCs.
By enacting this legislation, Tennessee aims to facilitate the registration and governance of DAO LLCs, providing a supportive environment for decentralized organizations to operate and thrive within the state.
Utah Recognizes Limited Liability Decentralized Autonomous Organizations (LLDs).
Utah has taken a pioneering step in recognizing DAOs as a distinct legal entity, introducing the concept of Limited Liability Decentralized Autonomous Organizations (LLDs) through the Utah DAO Act. The key provisions of this act provide important guidelines for LLDs. This act will be in force starting January 2024.
Under the Utah DAO Act, LLDs are defined as organizations that exist as sets of rules encoded on a permissionless blockchain, typically through the use of smart contracts. While LLDs may have various classes of members, the formation of an LLD requires at least one natural person.
What sets the Utah DAO Act apart is its focus on safeguarding the software operations of LLDs. The act includes provisions that mandate each LLD to furnish evidence of their software code undergoing quality assurance to the Utah Division of Corporations. Additionally, LLDs are required to have a graphical user interface that allows monitoring of transactions originating from or directed towards their smart contracts.
Liability within LLDs is clearly defined. Members are personally liable only for their on-chain contributions to the LLD. They are not held accountable for the actions of other members or for any obligations of the LLD beyond its assets. However, members who vote against complying with a court-ordered remedy may face personal liability proportionate to their shares of governance rights.
The Utah DAO Act also addresses proxy voting, granting any DAO member the ability to be represented by a proxy with full voting rights. However, the extent of a proxy's power can be limited by the bylaws of the LLD.
What’s Does the Future Hold for DAOs?
The emergence of Decentralized Autonomous Organizations (DAOs) has sparked a wave of innovation and potential in decentralized governance. Governments and jurisdictions worldwide have made strides in recognizing and regulating DAOs, providing legal frameworks to accommodate their unique characteristics.
While DAOs offer exciting opportunities, they also face challenges, particularly in navigating legal and regulatory landscapes. One notable concern is the confusion between DAOs and general partnerships, which can lead to potential legal issues for those involved in DAO projects.
To foster the growth of DAOs and ensure their long-term success, it is crucial for regulators, industry participants, and DAO communities to collaborate in developing comprehensive and adaptable frameworks. These frameworks should address the legal implications, compliance requirements, and potential liabilities associated with DAOs, while also promoting innovation and transparency.
As DAOs continue to reshape traditional organizational structures, it is important for stakeholders to stay informed about the evolving regulatory landscape and best practices. By striking a balance between regulatory oversight and DAO-friendly frameworks, we can embrace the transformative potential of DAOs and unlock new possibilities for decentralized decision-making and community-driven governance.
Embrace the Rise of DAOs with me and embark on a journey into the intricate realms of DAOs, Web3, and decentralization. To delve deeper into this remarkable space, I invite you to listen to my podcast, DAO Today, where we passionately explore its inner workings, challenges, and potential. Tune in to engage with insightful discussions that navigate various aspects, with a particular focus on the legal and regulatory challenges shaping this industry. Listen now!
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