Decentralized Autonomous Organizations (DAOs) sound like something out of the future. And in a way, they are. It’s a new organizational structure that, in theory, allows for decentralized decision making using blockchains and token-voting mechanisms.
If those terms aren’t familiar to you, you’re not alone. Suffice it to say that there are no CEOs, boards of directors, or many of the other hierarchical structures found in traditional business entities.
The New York Times recently described a DAO as a “group chat with a bank account.”
But far from being on the fringes of the ever-growing crypto economy, DAOs, after a rocky start, are increasingly seen as playing a central role in it—and potentially in the wider non-crypto economy too. One DAO made the news last year by raising $40 million to bid on a rare copy of the U.S. Constitution. Another grabbed headlines more recently for helping to raise funds for war-torn Ukraine. Some DAOs plan to purchase (or attempt to purchase) a professional sports franchise. And one of the highest-profile crypto exchanges even transformed itself into a DAO.
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But as DAOs become increasingly prominent by funding projects, investing in companies, and employing people or organizations, some mundane yet vitally important questions must be answered.
If someone wants to sue a DAO, whom do they serve process on? Where is a DAO, which is decentralized and exists solely on a blockchain with potentially thousands of members spread across the globe, domiciled? Are a DAO’s members personally responsible for a DAO’s liabilities? How does a DAO enter a legally binding contract?
There are many more questions, and the answers are often unclear at best.
Some lawyers think there “is a risk [a] DAO could be considered a general partnership or unincorporated association,” which “might expose its members to personal liability for any of the DAO’s actions and obligations, and discourage businesses, institutional investors, or other vulnerable or regulated entities from participating in DAOs.”
It’s unlikely that any one of a DAO’s potentially thousands of investors would intend to be jointly-and-severally liable for what could be millions-upon-millions of dollars in liabilities.
To get around this problem, some DAOs have adopted a “LLC Wrapper.” A limited liability company is a well-known business structure that shields its owners from personal liability and combines certain characteristics of corporations and partnerships. It tries to be the best of both worlds.
One observer said that with “many DAOs, a Delaware-based LLC holds all the ownership rights and serves as the beneficiary of funds—or part of them—raised . . . by a DAO.”
Still, not all DAOs adopt this structure. Some worry that forming an LLC takes away the decentralization that is a key element of a DAO. And uncertainty can remain, which can stymie innovation. So lawmakers in several states have stepped in to fill this void.
Last year, Wyoming enacted a statute allowing a new legal entity—a DAO LLC—to be formed. One Wyoming state senator said that the “law doesn’t do what a tech-savvy contract attorney couldn’t have already done . . . but it does make the process of a DAO becoming an LLC easier and cheaper.” The state even recently updated its law in the hopes of attracting more such entities to Wyoming.
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Tennessee passed a similar law recently in an effort to make “Tennessee the Delaware of DAOs.”
And Vermont earlier had enacted a law which, while not specific to DAOs, allows the creation and registration of a blockchain-based limited liability company, a “BBLLC.”
Other nations too, such as Australia and the Marshall Islands, are considering creating, or have created, new legal entities to accommodate the new business structure implemented by a DAO.
Needless to say, it’s still relatively early in the legal lifecycle of DAOs. The structures, uses, and functions of DAOs may change in ways no one has yet thought about.
But as more people and money flock to DAOs, it will be important to resolve lingering questions about the legal rights and responsibilities of these entities and their members. So far, the states are leading the way, and federal regulators should let that innovation continue.
This piece originally appeared in The Federalist Society