A “decentralized autonomous organization” (DAO) is a developing concept that generally refers to blockchain-based tools that allow people to assemble and coordinate online in new ways. DAOs can be assembled for any purpose imaginable, and they are important elements of certain DeFi protocols.
DeFi protocols function through software programs called smart contracts. When they are deployed on a distributed ledger, those smart contracts can include (but do not always include) mechanisms to change how they function. The functions of a smart contract that can be changed depends on a smart contract’s original design. Regardless, those changes must be initiated by humans, and some protocol designs democratize this process of change by decentralizing decision-making authority among a broad group of participants.
Setting aside the still-developing concept of DAOs, what is clear is that our existing legal system did not envision the novel form of online coordination they allow for. Thus, applying existing legal frameworks to DAOs can discourage innovation and hinder their development. For example, there is significant debate as to whether DAOs are “entities” in the traditional sense at all, and if they are, whether they could fit into existing legal structures.
So far, the US Federal Government has yet to directly address these questions. The “Lummis-Gillibrand Responsible Financial Innovation Act” is the only proposed piece of federal legislation that squarely covers DAOs. Namely, Section 204 designates DAOs as taxable entities and mandates them to be registered as limited liability companies (LLCs), corporations, partnerships, or other similar entities.
Unlike the Federal Government, states are experimenting with more direct solutions. These early and encouraging efforts in legislative innovation evidence momentum in answering questions about whether and how DAOs fit into existing legal structures. A brief overview of what states are doing can be found below.
In July 2021, the State of Wyoming passed a law allowing DAOs to register as “DAO LLCs.” To be granted the DAO LLC status, an organization must satisfy the requirements delineated in the “Wyoming Decentralized Autonomous Organization Supplement.”
Anyone can form a DAO LLC, whether that person is a member of the organization or not. A registered organization must maintain a registered agent and abide by the already established laws for registered agents in Wyoming.
Each registered organization must provide articles of organization that explain how decision-making authority is allocated between the DAO participants and associated smart contracts. The articles must include public identifiers (public addresses) of those smart contracts, and if the smart contracts are updated, the articles must be changed accordingly. The structure also requires that DAO LLC smart contracts are upgradeable.
The articles of organization and smart contracts must govern important aspects of a DAO, including: rights and duties of members, activities of the organization, procedures for modifying smart contracts, and dispute resolution processes. Whenever the articles of organization and smart contracts do not cover the obligations of members, they can be supplemented by an operating agreement.
In addition, when the articles of organization, smart contracts, and the operating agreement do not specify the process of becoming a member, a person can be considered a member if they purchase or otherwise gain a right of ownership of a membership interest (e.g., when a person buys governance tokens). Additionally, while the law does not automatically designate DAO participants as fiduciaries, a DAO can impose fiduciary duties on certain members through its articles of organization.
For those DAOs in which participation is not associated with some kind of digital asset, each member will have one vote. Also, under this framework, DAOs can set individual quorum requirements for voting.
Finally, the law sets a maximum period of inactivity for DAOs at one year. In other words, if a DAO LLC fails to approve any proposals or take other actions for one year, it will be automatically dissolved.
In April 2022, Tennessee became the second state to enact a DAO-specific framework. The text of the bill excludes the word “autonomous” and defines the rules for “Decentralized Organizations” or DOs. The important provisions regarding the registration process, amending a smart contract, fiduciary duties, and dissolution period are the same as Wyoming’s law. However, there are two notable differences.
First, the statute sets a quorum of 50% for a vote to be valid. Second, unlike the Wyoming law, Tennessee’s law requires organizations to choose between “member-managed” and “smart contract-managed” structures. In practice, however, DAOs are rarely either totally “member-managed” or exclusively “smart-contract-managed” and generally include elements of both.
While Vermont does not have DAO-tailored rules, the state offers the option to register as a blockchain-based limited liability company (BBLLC). The legislation, which was enacted in 2018, applies to any company “that utilizes blockchain technology for a material portion of its business activities.” Because DAOs primarily operate on-chain, they fall under the definition of a BBLLC.
To register as a BBLLC, a company must provide an operating agreement that includes information about the mission or purpose of the BBLLC, information on the blockchain(s) with which they interact, voting procedures, security protocols, and participation obligations.