Decentralized Autonomous Organizations: Legal Issues in Structuring DAOs

Harris Bricken attorneys Jonathan Bench and Robert Lamb sat down again to discuss Decentralized Autonomous Organizations (DAOs) and the legal issues in structuring them across borders. Check out the last conversation HERE. A transcription of this talk can be found below.

In most jurisdictions, an organization of two or more people for a purpose, without corporate formalities, is a general partnership. A general partnership has no liability protection, and organization liabilities flow “jointly and severally” to each of the participants. This is an ominous legal reality for Decentralized Autonomous Organizations (DAOs) and their members.

What should DAO participants do?

Do Nothing

By doing nothing, all DAO participants risk joint and several liability on all DAO activities by all participants across the world. This is obviously ill-advised from a legal perspective.

Go to Wyoming

In July 2021 Wyoming applied its limited liability code to DAOs. But that limited liability code does not completely apply to a decentralized organization. Wyoming addresses this tension by allowing smart contracts to act like operating agreements.

Go Offshore

“Offshore” refers to countries that welcome web3 innovations outside the U.S. Cayman Islands, British Virgin Islands, El Salvador, Singapore, and Gibraltar are the current frontrunners.

We put our clients in a DAO-friendly jurisdiction. Then we overlay principles of decentralization (i.e. smart contracts as a basis for governance). The smart contract algorithms can play their role, the autonomous group can have some level of liability protection, and the DAO is attached to a maturing regulatory environment.

DAOs are the beginning of a new global restructuring, furthered by jurisdictions with visionary regulatory schemes and creative international practitioners.

Jonathan Bench 0:05
Rob, really happy to have you here again with us this week, I had a lot of fun talking last week about some principles of DAOs and corporate governance. Today, we’re going to dive in a little bit deeper.

Rob Lamb 0:16
Thanks for having me back, we’ll get right into it.

Jonathan Bench 0:18
So let’s talk about the components of traditional entities like corporations, what makes a corporation a corporation? Why did DAOs not fit into that traditional structure?

Rob Lamb 0:27
So in some ways they do. But mostly they don’t we’ll go go through it. legal personality, which a Dao, I think, ultimately is it just may be the wrong personality to the wrong thing. Limited Liability, which is a big glaring paradox, it just ultimately doesn’t have limited liability or could depending on how what how you ultimately structured it transferability of shares, I actually think this is one place where a DAO shines, I think that a Dao does really well, in a token, in a token economics on on the chain, you’ll have tokens that that function and operate really a lot like shares do, and and there’s actually a better platform to exchange those shares than there isn’t a private company generally. So that’s one place where I think there’s some commonality, central management, traditionally, a traditional corporation has central management through officers and directors, this is exactly the opposite of what Adele wants to achieve. They want decentralization. And so that’s probably where the paradox, I think, glares the most. But I think it’s we could manage through it. And that’s the those are sort of the components. And, and, and, and the opportunity, I think, ultimately, a Dao is lending itself and the popularity of dowser, lending themselves to innovation, and an opportunity, I think, for lawyers to jump in, and to help innovate and create structures that ultimately work.

Jonathan Bench 1:57
I think that’s the key right, is you and I have kicked around these ideas, working with companies all over the world groups of people trying to form these DAOs. So they’re not like traditional companies, and they function like real downs. And that’s been a real key thing is figuring out the structure. And I think giving them hope that there is a way forward to do this. Right. And that’s ultimately what we want to talk about today is what you know, when you have a traditional entity, traditional contracts, how do you marry those and still preserve the DAOs, you know, those those things that make DAOs special?

Rob Lamb 2:27
We talked last time, and we’ll just cover it really quickly, that that both sides need a paradigm shift a bit. Lawyers, I think have a hard time fitting it fitting into this this new thing, this new decentralization because it goes so much in opposition to what we were ultimately trying to create with corporations. But I do believe that there’s a path forward.

Jonathan Bench 2:51
So what about smart contracts? We that term is very, very much kicked around. I’ve heard very smart people say smart contracts are neither smart nor contracts. Would you care to comment on that?

Rob Lamb 3:03
Yes. So so. So again, this there’s there’s some innovation opportunity here. And there’s also some, some challenge, of course, and a smart contract is is an essence, a computable contract. It is it is really artificial intelligence, it’s aI contracting. And they’re not all the same. And, and there is sort of a model that I think a lot of the DAOs are following. But ultimately, a smart contract is going to have different degrees of autonomy built into it, you’re going to have high, high level of autonomy, and you’re going to have absolutely zero autonomy. And it’s all built based on the developers and how they how they contrived this the smart contract. What I think what I think is a challenge for lawyers is This is in essence, artificial intelligence contracting. And so if somebody is out there asking the question, Will artificial intelligence ultimately take over lawyers, this is where this is where this is, I think, is playing out to a certain to a certain extent. And these are bots. I mean, in essence, they are designed bots. And they are self creating self define self outlined self executing, self enforced without any level of discretion of enforcement and self accepting. And so let matters ultimately, where you’re where you’re where the DAO was at with respect to autonomy, high degree of autonomy, low degree of autonomy, and what sort of human participation is ultimately going to be allowed. And now that I’m in this space and been in the space for a while, we’re seeing both and we’re seeing challenges and problems with both because ultimately, ultimately, if you have a contract that is self accepting self executing there is no human component within that that can sort of deal with problems that may arise. And we all know that problems arise.

Jonathan Bench 5:09
Absolutely. And I think one of the things that’s interesting to think about is how you and I draft contracts all the time, the thought of putting together a contract so perfectly at the onset, that, you know, it’s going to work flawlessly, right. And and every time I had a partner asked me early in my career, he said, I said, I spent a ton of time in his contract. He said, Is it perfect? I said, not in your life. And so getting, you know, getting to that point where we’re revising, and really, that’s what we do as lawyers, right? We’re writing legal code. And that actually has to be baked into real computer code. So that can execute you know, the terms and really this, you know, getting a lot of the eventualities into a smart contract is, that’s that’s a tough order.

Rob Lamb 5:50
It is that the technology is getting better. I think that they’ll advance as you go. I mean, I think that those that really believe in the ultimate autonomy, having these AI’s drive the transactions and drive the party relationships and drive the investments or whatever these participants are doing within a DAO, I think I think those there’s, there’s technology that is advancing that ultimately may perhaps get close. But But ultimately, you’re going to need lawyers to be involved somehow, in some way in sort of forming and frankly, I’m seeing that already, in a couple of the DAOs that are that that were generic, that is there smart contracts were generic. And, and something goes wrong, a market twists and turns. Those Those are not thought through. And so all sudden, you need centralized management to step in and to deal with help with and sort out whatever problems may arise. So So anyway, it’s impossible ultimately, I think, to your point, to pre draft, all eventuality but the technology, the bot technology, the AI technology is sure trying. And ultimately, that matters with respect to corporate form.

Jonathan Bench 7:09
And that’s really what where I wanted to go next is talking about it. So in a perfect world, we have great smart contracts on top, we have great legal structure underneath. What does that underneath legal structure look like? And can we do it all domestically in the US will have to be international and some component of what’s the what’s the the magic formula? I mean, and we’re not like you said, we’re not giving away the secret sauce. But tell us a little bit about the ingredients to secret sauce?

Rob Lamb 7:32
Yeah. So so let me let me go through options. Okay, I in my article that is out there on the internet, it, I basically outline what I think some of the options are, let me nuance those just a bit. First option is to do nothing. This actually may work in a perfect world, it may work in a highly controlled, developed, artificial intelligence smart contract, it may actually it may work in that scenario where the doubt participant comes in, everything is automated, and it just processes one after another. There, there would be no limited liability in that case, and you would definitely not have centralized any level of centralized leadership to make specific decisions around hiring, paying taxes or what have you. But But for the for those that are true to decentralization, that’s an option, right? So so sort of do nothing is one option. The next thing is is to if you’re a US based company is to domesticate here to do what you normally do, go to whatever state you’re in, or wherever your activity is, and file as a limited liability company, or file as a corporation and go through the regular process of deciding and choosing. In that case, what you could what we’re doing and sort of crafting is a nexus between the entity, the organization itself, and, and the protocols. So we basically create treasury and create corporate function around treasury, hiring, firing, develop getting developers on board, making sort of normal corporate decisions, and housing that in an entity structure. And then at the same time, creating contractual nexus between the protocol platforms, and the smart contracts and allowing them to function on their own in decentralization. And this is kind of my puppet model where, where the, this is all thought out smart contracts basically dictate what sort of things the entity itself will do basic corporate things, but ultimately, there is no decentralized management. Excuse me, there’s no centralized management, it stays decentralized and they become ultimate puppets of the decentralized organization or the or the Dao. And that’s that’s that’s An option and I’m seeing that sort of pop up and play out. A couple of states are trying to be more specific and nuance with their approach. Wyoming is one of them, they’ve taken their limited liability code and wrapped it around any doubt. And so it’s working and not working at the same time. It’s working in the sense that it’s attracting a lot of these doubts that are trying to be true to decentralization to have the override of a limited liability and company. So what we’re seeing is, there’s a trend that’s flowing into Wyoming right now, because of that. There’s other states that are doing the same thing I just read the other day where Texas is trying to do some things. It’s not working in the sense that there are nuances to the structures that that don’t thoroughly fit into a limited liability structure. There are things that haven’t been fully thought through like UCC code application, and some other things, currency codes that are new. And so there’s marrying and synthesizing all of those different things. And Wyoming, again, should be commended for what they’re doing. But it’s not, it’s not a perfect fit. And a couple of states, Texas, I think, Vermont, and a couple other taking the learnings from that and trying to make adjustments. The other thing that I don’t love about about that structure is that you still have a certain degree of uncertainty with respect to a federal government overlay. Again, as you know, state to state the corporations, and corporate selection is a state issue, but you’re gonna have tax issue, you’re gonna have FCC issues you’re gonna have, you have SEC issues. And there’s still a lot of uncertainty and subject being subject to both the state and federal government, I think is it can be a challenge.

The other the other model that we like is to, quote unquote, offshore. And what I mean by that is something that is one jurisdiction, that’s not the United States, so British Virgin Islands, Cayman Islands, we like Singapore, and I’ll talk about this in just a second about Singapore and some of these others. Gibraltar, I think I mentioned before, and, you know, there’s some other jurisdictions that are doing a nice job of attracting, attracting DAOs potentially applying their power, whatever corporate form, they have to adapt. And then you have one centralized jurisdiction that you’re that you’re dealing with. I like that, because DAOs tend to be very international anyway, most of the participants are global. And, and in development, too, a lot of the smart contract developers now are not in the United States. And so it makes sense to be truly global. And International. There’s another form that is that’s becoming more and more popular, and that is what I call a foundation form. It is it is to look at the two functions of a DAO look at Treasury, and then look at the protocol participation. Treasury really is everything that we would consider traditionally corporate, and to make that a true cost center only, not a profit center True Cost Center, and then overlay that as a foundation 501 C three, or whatever the local jurisdiction foundation is, Singapore is applying foundation, their foundation law to DAOs, allowing that bifurcation and then you create something of a contractual nexus between now that may work for some it may not work for others. But anyway, that’s that’s that’s a trend there is another trend that’s interesting, is that you have on chain, corporations or on chain companies, that event that are now looking at the DAO space and wanting to participate in the DAO in a DAO they’re sponsoring a DAOand they’re migrating that functionality into a separate foundation. For whatever reason, there’s a lot of there’s a lot of altruistic reasons to be doing different things with dads. So that’s another structure. What I like is if I can end this on what my recommendation is, is to go is to go offshore to bifurcate those two functions, sometimes we could we could, we could attach a cost center only foundation component and create the foundation with all things treasury and then create contractual nexus with the actual down participants. That’s, that’s sort of that’s sort of the ideal. Now, it doesn’t always work because it’s it’s these are complex organizations with complex objectives and goals and creating the straight cost center aspect of it. Just ultimately, I don’t think works, but you can still create a puppet relationship between an organization the Treasury components, corporate treasury components, that ultimately become the contractual components to the DAO bass participants and doing those offshore, I think is the entity that we’re landing on and the one that we’re executing on right now the most.

Jonathan Bench 15:06
Excellent. Thanks, Rob. That’s all the time we got today. We’ll catch back on the next episode and we’ll keep talking.

Rob Lamb 15:11
Thanks for the time.

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