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.

Crypto firm bankruptcies and resulting disruption in the crypto ecosystem will continue to exacerbate liquidity and regulatory concerns in this space.  Since all participants supporting the crypto ecosystem are at risk, managing that risk is critical.

Fund managers should be prepared on multiple fronts.

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Binance is the latest major crypto industry player to be sued by a U.S. regulator.  On March 27, 2023, the CFTC announced that it had filed a civil enforcement action against Binance Holdings Limited (and related legal entities) (collectively, “Binance”), its CEO, Changpeng Zhao (“Zhao”), and its former chief compliance officer, Samuel Lim (“Lim”), for violating the Commodity Exchange Act and CFTC regulations. (CFTC v. Zhao, No. 23-01887 (N.D. Ill. Filed Mar. 27, 2023)).  The CFTC, among other things, alleges that Binance allowed U.S. customers to make use of their centralized digital asset trading platform without Binance first properly registering with the CFTC and also allegedly failed to implement an effective anti-money laundering (“AML”) program as required under applicable law. The complaint states that Binance has “never been registered with the CFTC in any capacity.” The CFTC is seeking disgorgement, civil monetary penalties, permanent trading and registration bans, and a permanent injunction against further violations of the Commodity Exchange Act and CFTC regulations.

As discussed in Part I of this series, Ordinals are a pioneering new method of utilizing the Bitcoin blockchain that will usher in new and innovative use cases on Bitcoin. As promised, in Part II we will discuss the implications for creators and owners.

Implications of Ordinal NFTs for Creators and Owners

As with most crypto innovation, capable users quickly flocked to the shiny new object. Copies of popular Ethereum NFT projects began appearing on the Bitcoin blockchain after the Ordinals launch. For example, a clone of CryptoPunks, named Ordinal Punks, popped up and is reportedly gaining traction. Further, the owner of Bored Ape Yacht Club (“BAYC”) #1626 permanently removed the NFT from its spot as one of the most valuable in the space by “burning” it, then inscribing the NFT on Bitcoin using Ordinals.  While the owner of BAYC #1626 effectively deleted – or symbolically transferred – the NFT, it appears that some NFT creators are not purists and are willing to experiment on Bitcoin. For example, Yuga Labs, the creator behind the Bored Ape Yacht Club Ethereum-based NFT phenomenon, announced that it would release a NFT project called TwelveFold on the Bitcoin blockchain.

In our December article we asked: what do hard forks mean for my NFTs? In this article we ask a similar question: how does a copy of an NFT on completely different chain (Bitcoin, not Ethereum), affect value and licenses?

A number of questions arise. Does the holder of the copycat Ordinal on Bitcoin require a license corresponding to the Ethereum NFT? What happens to the Ethereum NFT purchaser’s rights granted to it under the license, which may or may not include a commercial right to exploit and sublicense? Does an Ordinal inscription of an Ethereum NFT fall under a purchaser’s general non-commercial use and public display rights that are generally given to purchasers on NFT marketplaces? Does the original Ethereum NFT holder hold one set of rights and the holder of the copycat on Ordinals possess any rights that may be in conflict with the original NFT holder’s? Generally speaking, would the value of the NFT be affected if two identical copies exist on two different blockchains? Does the NFT owner or project have a say in which blockchain to recognize? Has any IP infringement occurred?