Decentralized autonomous organizations (DAOs) are a novel type of entity – with profound differences from traditional structures like LLCs. Lately, DAOs are experiencing a surge of interest. According to one estimate, the market capitalization of DAOs was already around $21 billion in January 2022.
What Are DAOs?
Thankfully, despite their novelty, DAOs are not completely unrecognizable. For example, the New York Times once described a DAO as a “group chat with a bank account.” DAOs share some similarities to traditional business structures. For one, both enable the collection and mobilization of capital. And both divide up ownership into tradeable chunks. Specifically, where traditional structures have “shares” owned by shareholders, DAOs have “tokens” owned by its members, called “token holders.”1
But the similarities largely end there. Differences include:
first, that DAOs are not governed by physical (or digital) documents like charters or bylaws. Instead, DAOs are governed by rules encoded into a blockchain’s software;2
second, while traditional structures are run by centralized management, DAOs are run by smart contracts – code that automatically executes when certain conditions are met.3 Thus, day-to-day operations of DAOs (like making transactions) are taken care of without human involvement; and
third, in traditional structures, a centralized authority – like a board of directors – is charged with making major decisions. But with DAOs, power is directly vested with the DAO’s owners who vote themselves.
Andrew G. Gunem, U.W. Law School Class of 2023, is a law clerk and incoming associate attorney with Turke & Strauss LLP, Madison, where he will focus on complex litigation in state and federal courts across the country.
Purpose and Possibilities
Like any entity, DAOs can be used in many ways. Some investors and attorneys have even suggested that DAOs may be “the new LLCs.”4
For example, Constitution DAO was created to crowdfund the purchase of an original copy of the U.S. Constitution – one of 13 remaining – at a Sotheby’s auction. Ultimately, the DAO was outbid by a private party. Still, Constitution DAO demonstrated the breathtaking potential of DAOs to pool and mobilize capital. According to its Twitter account, it raised more than $40 million from 17,437 investors – all within a handful of days.
Meanwhile, Fintech Fraud DAO locates and combats fraud in the financial technology (fintech) space.5 This DAO allows member organizations – like digital bank Chime – to pool encrypted user data to better identify suspicious and potentially fraudulent activity. Already, this DAO processes the data of 20 million digital bank customers.
Liability and Litigation
Today, the legal status of DAOs is unclear. For example, it is unclear how DAOs will be treated under securities, tax, antitrust, and bankruptcy laws. The decentralized nature of DAOs and their lack of formal incorporation will surely raise challenging questions relating to jurisdiction and service of process.
But perhaps the most important unknown is whether members of a DAO can be held personally liable for the DAO’s liabilities. In other words, will a DAO shield its members from liability like an LLC? Or will a DAO expose its members like a general partnership?6
Recently, one DAO ran into a regulatory buzzsaw. In September, the Commodity Futures Trading Commission (CFTC) simultaneously filed and settled charges against one DAO because its two founders violated the Commodity Exchange Act.
There, the CFTC argued that the DAO was an “unincorporated association.” Thus, the CFTC claimed that the DAO’s individual members may be liable for the debts of the DAO itself. This controversy is still ongoing and multiple amicus briefs have been filed.
Conclusion: Time Will Tell
Perhaps DAOs will soon dominate the legal landscape and replace LLCs as the go-to legal entity. Or perhaps DAOs will fail to gain traction and fade into obscurity.
But regardless of the fate of DAOs, further entity experimentation is likely. Attorneys will benefit by keeping an eye on these developing areas.
This article was originally published on the State Bar of Wisconsin’s Litigation Section Blog. Visit the State Bar sections or the Litigation Section webpages to learn more about the benefits of section membership.
1 For more reading about DAOs, see Andrew Gilbert, “Decentralized Autonomous Organizations: The New LLCs?”, Bloomberg Law, Aug. 2, 2022; William K. Pao, et al., “SOS! DAO in Distress!” O’Melveny & Myers Alerts and Publications, Oct. 13, 2022; and Eric Sibbett, et al., “Voter Beware! Personal Liability for DAO Token Holders for Voting?” Paul Hastings, Client Alerts, Sept. 28, 2022.
2 Zack Smith and David Swegle, “The Legal Status of Decentralized Autonomous Organizations: Do DAOs Require New Business Structures? Some States Think So.,” The Heritage Foundation, June 1, 2022.
4 See Gilbert, “Decentralized Autonomous Organizations,” and Weinstein, “A Primer on DAOs.”
5 “Unit21 Launches Fintech Fraud DAO to Combat Financial Crime With Brex, Chime and PrimeTrust as Early Customers,” Businesswire, Oct. 19, 2022.
6 See Smith and Swegle, “The Legal Status of Decentralized Autonomous Organizations.”