DAOs

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Unlike traditional corporate entities with a typical hierarchical structure, a decentralized autonomous organization (“DAO”) – a management structure that uses blockchain technology – functions as a leaderless entity. Without a formal corporate structure, DAOs instead operate by distributing governance rights among persons who hold a specific governance token. Consequently, federal and state courts have been grappling with how to consider a DAO under existing laws that were traditionally interpreted against long-standing corporate entities.

As discussed in a prior post, DAOs allow individuals to organize and coordinate at arms-length, and rely on code (a “protocol”) to govern and execute functions traditionally determined by governing documents, like operating agreements and articles of formation, and undertaken by executives. A DAO’s protocol is committed to a public ledger on a blockchain, which guarantees accessibility and transparency. Each member is granted governance rights – the ability to propose and approve initiatives, called proposals – through a governance token. In light of their unique makeup, DAOs lack centralized leadership and a typical top-down management structure.

Accordingly, parties have debated whether a DAO should be recognized as a general partnership under state corporation laws (i.e., N.Y. P’ship Law §10: “an association of two or more persons to carry on as co-owners a business for profit….”) or, in the case of the Commodity Futures Trading Commission’s (“CFTC”) Ooki DAO enforcement, whether a DAO could be deemed an “unincorporated association” under the Commodity Exchange Act (“CEA”). Following the filing of the CFTC’s enforcement action, it is not surprising that the structure of the Ooki DAO, and the CFTC’s enforcement action against the DAO itself, has garnered a lot of media attention and industry reaction, and has raised novel legal issues.

Several questions have arisen in recent years regarding the potential liability of DAO members:

  • While DAOs are emerging as a viable structure in the DeFi space, does their non-traditional makeup necessarily shield them from real world liability?
  • Does a DAO’s structure render its activities “enforcement proof” or, at the very least, difficult to effect traditional service of process upon?
  • Can a DAO be an “unincorporated association” under federal or state law?
  • Who should be liable for the decisions made by a DAO?
  • Because token holders participate in the DAO’s governance, can they be deemed personally liable for its actions (akin to the general partners in a general partnership), even if each governance token holder is essentially unknown to the other DAO members, who likely reside in multiple jurisdictions?

As discussed in Part I of this series, state DAO LLC laws have been enacted in the last several years and have become one option for decentralized autonomous organizations (or DAOs) to create a so-called “legal wrapper” or real-world corporate entity to shield individual members from liability.

In Part II we will look at some of the standout features of the United States’ DAO laws.[1]

DAOs as LLCs, or LLDs. As discussed below, the Wyoming (SF0038, codified at W.S. §17‑31‑101 through §17‑31‑116; Wyoming Governor Mark Gordon signed an amendment to the DAO Supplement into law (SF0068) (the DAO Supplement and its 2022 amendments) (collectively, the “WY Law”)  and Tennessee (HB2645/SB2854, to be codified at Tenn. Code Ann. §48-250-101 through 48-250-115) (the “TN Law”), DAO LLC laws opt for the “wrapper” approach by “wrapping” DAOs within an LLC. Utah, however, goes further. Under the “Utah Decentralized Autonomous Organizations Act” (HB 357) (codified at Utah Code Ann. §48-5-101 – 406) (the “Utah Law”), rather than being wrapped by an LLC, limited liability decentralized autonomous organizations (or “LLDs”) are the legal entity formed under the Utah Law. (Utah Code Ann. §48-5-104). Under the Utah Law, LLD members enjoy limited liability and are only liable for the on-chain contributions that the member has committed to the DAO. (Utah Code Ann. §48-5-202). Further, members cannot be held personally liable for any excess liability after the DAO assets have been exhausted. (Utah Code Ann. §48-5-202(1)(b)). Utah further covers situations when a DAO refuses to comply with an enforceable judgment or order against the DAO by stating that members who voted against using the DAO’s treasury to satisfy a judgment may be liable for any monetary payments in the judgment or order “in proportion to the member’s share of governance rights in the [DAO].” (Utah Code Ann. §48-5-202(d)(2)).  The Utah Law, in another effort to foreclose certain theories of liability, also explicitly states that a developer, member, participant or legal representative of a DAO may not be imputed to have fiduciary duties toward each other or third parties solely on account on their role, absent certain express actions or statements. (Utah Code Ann. §48-5-307).  These questions have been more salient for DAO members, given the ongoing CFTC enforcement against the Ooki DAO and the recent California district court ruling that various governance token holders in a DAO could be deemed to be members of a “general partnership” under California law and thus potentially joint and severally liable in the suit.

Little-known legal trivia: In 1977 Wyoming was the first state to pioneer the LLC, which is now a commonly applied legal innovation.  Fast forward more than forty years…in July 2021, Wyoming again tried to be at the vanguard of new corporate formations and passed legislation that recognized decentralized autonomous organizations, or DAOs, as legally distinct business entities, with protections for token holders similar to those offered to corporation stockholders or limited liability company members. Wyoming may have jumped off the blocks first, but Tennessee and Utah are not far behind. Recently, on March 1, 2023, the Utah Legislature passed HB 357 (codified at Utah Code Ann. §48-5-101-406), the “Utah Decentralized Autonomous Organizations Act” (the “Utah Law”).

This article is Part I of a two-part article on developments in state DAO LLC laws. In this part, we will briefly outline the basics of a DAO and the latest state enactments in the area, as well as explain why real-world corporate formations may be attractive for some DAO members. In Part II, we will do a deep dive into the more notable aspects of the new crop of state DAO LLC laws and offer some final thoughts.

This blog post summarizes recent federal bills that have been introduced (but not yet passed), proposals by the Biden Administration, and guidance issued by the Internal Revenue Service with respect to the taxation of digital assets.

Read the full post on our Tax Talks blog.

In what appears to be an issue of first impression, a California district court ruled that various defendants allegedly holding governance tokens to the bZx DAO (or “Decentralized Autonomous Organization”), a protocol for tokenized margin trading and lending, could be deemed to be members of a “general partnership” under California law under the facts outlined in Plaintiffs’ complaint, and thus potentially joint and severally liable for negligence related to a phishing attack that resulted in the loss of users’ cryptocurrency. (Sarcuni v. bZx DAO, No. 22-618 (S.D. Cal. Mar. 27, 2023)). The ruling is significant given that this is purportedly the first court to substantively consider the legal status of a DAO under state law (albeit in a ruling on a motion to dismiss); interestingly, in a prior settlement the defendant bZeroX, LLC and its founders reached with the Commodity Futures Trading Commission (CFTC) in 2022 over claims that bZeroX and its founders unlawfully offered leveraged and margined retail commodity transactions in digital assets, the order expressly considered the bZx DAO (and its successor Ooki DAO, which is co-defendant in the instant action) as an “unincorporated association” under federal law. (In re bZeroX, LLC, CFTC No. 22-31 (Sept. 22, 2022)).

A DAO is a decentralized autonomous organization where token holders can vote on governance decisions of the DAO. DAOs don’t typically operate within a formal corporate structure, opting instead to distribute governance rights among persons who hold a specific governance token. The entire raison d’être of a DAO is to take advantage of web3 technologies and operate without a traditional corporate formation to make decisions without a central authority or usual top-down management structure. While DAOs are emerging as a viable structure in DeFi space, this ruling shows that their non-traditional makeup may not necessarily be a shield from real world liability.  Plaintiffs’ theory that the DAO members are part of a general partnership means that anyone holding governance tokens at the relevant time would be jointly and severally liable for the torts of the DAO.  To be sure, even though existing structures do not fit the novel web3 organizational primitive that is a DAO, nothing prevented the bZx DAO (or its successor Ooki DAO), from creating a so-called “legal wrapper” or real-world corporate entity to shield individual members from liability and limit potential creditors to monetary recovery from the DAO’s treasury only.

On September 22, 2022, the CFTC announced an order simultaneously filing and settling charges against bZeroX, LLC (“bZeroX”) and its creators for illegally offering leveraged and margined retail commodity transactions in digital assets, operating as an unregistered futures commission merchant and failing to conduct KYC on its customers. According to the CFTC, a month prior to this settlement announcement, bZeroX transferred control of the bZx Protocol to the bZx DAO, a decentralized autonomous organization (“DAO”), which later renamed itself as the Ooki DAO.  On the same day as the bZeroX settlement was announced, the CFTC filed an enforcement action against the Ooki DAO (successor to bZeroX) for violating those same regulations.  The CFTC stated that bZeroX and its creators engaged in this unlawful activity in connection with their decentralized blockchain-based software protocol that functioned in a manner similar to a trading platform.  The transactions executed on bZeroX, and subsequently on the Ooki DAO, were required to take place on a registered designated contract market.  Additionally, the complaint asserted that bZeroX and Ooki DAO were operating as unregistered futures commission merchants by soliciting and accepting orders from customers, accepting money or property as margin and extending credit.

The structure of Ooki DAO, and the CFTC’s enforcement action against the DAO itself, has garnered a lot of media attention (and industry reaction) and raised novel legal issues.

Back in 2013, the first cryptocurrency matter hit our desks. That was the beginning of the exponential growth of our digital assets practice. Recognizing the importance of the area, we launched this blog, Blockchain and the Law. In our first cluster of posts, we covered topics such as cryptocurrency taxation, blockchain and privacy, and issues surrounding initial coin offerings (or ICOs), one of the hottest issues at that time and a practice that still garners SEC scrutiny in 2022 (interestingly, there is still no consensus around when a digital asset, outside of Bitcoin, which is considered a commodity, is a “security”).

Today, blockchain-based innovations continue apace, continuously offering new opportunities (and raising challenges). In the push toward Web3 – with its decentralized, permissionless, tokenized core – there are a variety of new technologies and innovations, from DeFi to DAOs to NFTs to fan tokens to the Merge to the metaverse.  We have been privileged to work with many of the most dynamic clients in helping them build businesses around these advances.

We were thrilled to host a three-day symposium from September 19-21, 2022 to highlight some of the hottest legal and business issues affecting digital assets, featuring a full slate of discussions among our attorneys and guests from the industry.  At the symposium, we programmed virtual panels across a range of topics: SEC enforcement and securities regulation of digital assets, asset manager considerations surrounding digital assets, employee compensation and benefits issues, cryptocurrency AML considerations, digital assets in bankruptcy, decentralized autonomous organizations (DAOs), and sports and media trends and issues in Web3.  The final day of the event culminated in an in-person reception and a “Voices from the Industry” panel featuring an eclectic group of executives from across the digital asset space talking about issues that are top of mind.  In the span of a few days, we learned a lot.

On November 10, 2021, the SEC announced that it had instituted proceedings against a Wyoming-based decentralized autonomous organization (DAO) to halt its registration of two digital tokens, alleging that disclosure in the organization’s registration statement was deficient and contained materially misleading statements. (In the Matter of American CryptoFed DAO LLC, No. 3-20650 (SEC Order Nov. 10, 2021)).  Without the SEC’s latest action, the issuer’s Form 10 filing was scheduled to become effective on November 15, 2021 (sixty days from the initial filing date).  The action against American CryptoFed DAO LLC (“CryptoFed”) serves as a clear reminder that cryptocurrency remains in the SEC’s crosshairs, and token issuers must carefully consider regulatory risk when launching new products.