Recent Developments in the Legal Treatment of Decentralised Autonomous Organisations (DAOs): Vermont and Wyoming

Introduction and Context: What are DAOs?

1. Decentralised autonomous organisations, known by their acronym “DAOs”, have been a constant source of head-scratching for blockchain enthusiasts and market actors, as well as for legal scholars, at least since 2016[1]. Variably described as “crypto-companies”, “crypto-funds” or “crypto-partnerships”, their exact definition and architecture has been a source of debate within the community and external observes as well.
2. While this text does not aim at describing or providing a definitive answer, it is important to clarify readers what we are talking about and provide some general references.
3. The original definition of a DAO was put forth by Vitalik Buterin in 2014[2] – an entity that lives on the internet and exists autonomously, but also heavily relies on hiring individuals to perform certain tasks that the automaton itself cannot do. This is a broad definition that can potentially encompass the majority of blockchains.
4. In any case, especially in light of practical experience such as the much publicised 2016 DAO project[3], a narrower definition, which focuses on DAOs closer to real-life organisations such as companies, has become widespread.
5. In 2019, the Author of this text provided one of such narrow definitions: a DAO is a smart contract conceptualised as a relatively autonomous and self-sufficient for-profit organisation, which is jointly held by tokenholders who provide funding with cryptoassets and directly or indirectly share in its earnings[4].
6. I am fully aware of the limitations of this definition and that every DAO is a different DAO, and might retain some of the characteristics outlined in the preceding paragraph while discarding others. However, it still makes sense to include a considerable number of self-anointed DAOs[5] in this definition, minor deviations notwithstanding.
7. However, for the purposes of the legal challenges brought about by DAOs, the idea of autonomy and self-sufficiency must be kept in mind. Indeed, a DAO is supposed to work without managers or employees taking decisions, and it operates automatically through the deployment of a self-functioning software (such as a smart contract) with pre-set rules imbedded in the code, such rules concerning the internal “corporate” governance of the DAO (for instance, how to vote proposals)[6].
8. The objective is precisely to mitigate the agency problems arising from the relationship between ownership and management through the elimination or minimisation of the latter, replaced by a self-executing code and/or the owners (usually tokenholders) themselves. The governance structure of a DAO places member-owners at the centre.
9. This short text will focus on this narrower understanding of DAOs, usually perceived as a sort of “crypto-company”. After some brief remarks on the status quo in the legal status of DAOs in most jurisdictions, which will lead us to conclude that DAOs would be considered an unincorporated partnership in many jurisdictions, we will take a look at recent developments in jurisdictions that have directly tried to address the issue: the U.S. States of Vermont and Wyoming.

 

DAOs as Unincorporated Partnerships and Challenges in Regulating Them

10. As explained in more depth elsewhere[7], DAOs, in most jurisdictions, would not be qualified as companies (especially because they are not registered, an almost universal prerequisite) but rather as unincorporated partnerships[8].
11. In most jurisdictions, the qualification of a certain set of human relationships as an unincorporated partnership is the result of two or more people pooling assets with a joint purpose to carry out some activity, collectively deciding on the fate of such assets and receiving some kind of earnings therefrom. Most DAOs would fulfil these extremely broad prerequisites.
12. In most cases, with some minor differences, the unincorporated partnership would not have legal personality nor enjoy entity shielding, with its members or partners being jointly and severally liable for the debts arising from the partnership’s activity[9].
13. This is a highly undesirable situation, although some DAOs have been known to use various ways to mitigate such consequences by using companies as representatives[10], which is an ironic outcome considering DAOs’ objectives of mitigating or eliminating agency problems.
14. The question is – how to deal with DAOs? Leaving them as partnerships might be an interim solution because it avoids any legal void, but it is untenable. Partnership law was designed to provide flexible but safe solutions to small business owners, not to blockchain-based operations spread across borders and with a large number of members.
15. As explained better elsewhere[11], to simply allow DAOs to register as “normal” companies can present various obstacles. While the bestowment of legal personality and limited liability is not a problem in itself, most jurisdictions require corporate forms with both such characteristics to have delegated management, which is anathema to the whole idea of DAOs. Such requirement would have to be discarded, at least for DAOs.
16. Legal personality and the consequent limited liability would better protect the position of members or tokenholders. In most jurisdictions, legal personality grants the constituents of a legal person (especially companies) shielding from the legal person’s creditors, limited liability and the possibility of the legal person itself being a party to contracts autonomously.
17. However, State authorities usually demand a trade-off: the State grants or recognises legal personality and limited liability if the beneficiary thereof registers in some public record (such as a commercial register) and discloses some basic information. Some market actors might be reluctant to do so, but it is a much less intrusive requirement than requiring delegated management. And likely a necessary one.
18. As such, any recognition of DAOs as legal persons with a degree of limited liability would have to solve this fundamental problem – allow legal personality and limited liability through registry in a public record but without requiring a fixed/traditional management structure.
19. Other problematic issues to look out for when regulating DAOs are capital requirements (if any), purpose, certifying ownership, applicable law, criminal liability, AML issues and, of course, tax status.
20. Without prejudice to existing legal frameworks – such as the Innovative Technology Arrangement Act of Malta of 2018[12] – which could theoretically be applicable to DAOs, we will look today at two recent, more explicit, attempts to do so in two U.S. States – Vermont and Wyoming – and see how they approached their recognition and regulation of DAOs.

 

Vermont and the Blockchain-Based Limited Liability Company (BBLLC)

21. The U.S. State of Vermont was, as far as the Author knows, the first jurisdiction to explicitly and officially provide a framework for DAOs. In 2018, Section 7 of Vermont Bill 205 of 2018 (Act relating to blockchain business development) introduced a new type of company – the “Blockchain-Based Limited Liability Company” (“BBLLC”) in State law (11 V.S.A §§ 4171 – 4176).
22. The new framework allows for “regular” LLCs incorporated in Vermont that operate a business using blockchain technology for “a material portion of its business activities” to choose to become a BBLLC if it expresses such intent on its articles of organisation and if it meets the following prerequisites[13]: (i) its operating agreement indicates the BBLLC’s purpose, technology used, voting procedures, security protocols and members’ rights; and (ii) members are free to interact with the BBLLC in multiple roles.
23. As for the nature of the underlying technology, the BBLLC’s operating agreement must specify whether the decentralised consensus ledger used is fully decentralised or partially decentralised and whether it is fully public, partially public or private[14].
24. In what concerns governance, a BBLLC may adopt “any reasonable algorithmic means” for accomplishing the consensus process to validate records, to conduct operations or make organisational decisions[15].
25. Voting procedures may vary, and the law explicitly allows for them to include smart contracts that can address proposals from members or other participants, changes to the operating agreement or any general matter of governance or activities of the BBLLC[16].
26. BBLLCs seem to also have wide discretion on how to regulate membership. The law indicates that the operating agreement must specify how a person becomes a member of the BBLLC and what the membership interest will be, which can be denominated in the form of units, shares or capital stock.
27. Save for these BBLLC-specific provision, the BBLLC is subject to the general rules applicable to LLCs[17], which means it has legal personality, legal liability and its members are shielded from creditors in the same fashion as LLC members. Most importantly, no partnership would exist among them.
28. This minimalist approach has some appeal and is aligned with the suggestions laid out above – it maintains legal personality and limited liability, with the same framework applicable to LLCs being applicable to BBLLCs, but it leaves plenty of room for the BBLLC to define its internal organisation, in issues such as voting procedures and membership status.
29. dOrg, a “blockchain development shop” was the first entity to be registered as a BBLLC under Vermont law[18]. Its publicly available operating agreement[19], for instance, indicates its purpose, that its governance is carried out exclusively through blockchain technology, that it will use a fully decentralised, publicly-available ledger and that its membership interests is composed of a certain number of “Units”. It clearly states that the business, operation and affairs of the DAO are to be managed under the direction of the members (however, out of reasons of convenience, it provides for the existence of administrative members to interact with third parties).
30. It remains to be seen how this experiment will work, and it is all but certain that fine-tuning and amendments will be needed in the future.

 

Wyoming and the DAO LLC

31. Very recently, on 22 April 2021, the U.S. State of Wyoming became the second jurisdiction to officially recognise DAOs (and this time, by name), having enacted the Wyoming DAO Act[20], whose provisions will be applicable from July 1.
32. The Act defines a DAO as an LLC whose articles of organisation contain a statement that the company is a DAO[21], and that its registered name can include “DAO”, “LAO”, or “DAO LLC”[22].
33. For that purpose, Wyoming DAO LLCs are required to add a “notice of restrictions on duties and transfers” in their articles of organisation or operating agreement, indicating that: (i) the rights of members in a DAO may differ materially from the rights of members in other limited liability companies and (ii) the Wyoming DAO Act, underlying smart contracts, articles of organisation and operating agreement, if applicable, of a DAO may define, reduce or eliminate fiduciary duties and may restrict transfer of ownership interests, withdrawal or resignation from the DAO, return of capital contributions and dissolution of the DAO[23].
34. This interesting obligation to introduce such notice seems to aim at notifying potentially interested members that DAOs, though partially subject to the LLC framework, do not operate within traditional norms and should be treated with caution.
35. A Wyoming DAO can have any lawful purpose, whether or not for profit[24].
36. Its articles of organisation must include a publicly available identifier of the smart contract used to manage, facilitate and operate the DAO and must reflect any amendments thereto[25].
37. The Act provides some minimum content for the articles of organisation, such as relations among members and between members and the DAO, rights and duties of members, activities of the DAO, means and conditions for amending the operating agreement, voting rights of members, transferability of membership interests, withdrawal of membership, distributions, amendments to the articles of organisation or applicable smart contracts[26].
38. Besides the usual references to provisions in the articles of organisation and, if applicable, the operating agreement, please note that there are several references, throughout the act, to “provisions in the smart contract”, which is significant.
39. In what concerns the DAO’s management, it can either be vested in its members or in a smart contract. Such bestowment results in the definition of the DAO, by its articles or organisation, as either a “member-managed DAO” or an “algorithmically-managed DAO”[27]. For the latter, the law requires that the underlying smart contract must be able to be updated, modified or upgraded[28] (though it is not clear who can do so).
40. Membership interests in member-managed DAOs have no particular designation (such as unit or share) and are calculated by dividing the member’s contribution of digital assets to the organisation and as such seems to assume that the DAO’s membership interests are cryptoassets or tokens[29]. It opens up the possibility of not contributing digital assets as a prerequisite for being a member, in which case each member has one membership interest and one vote[30].
41. Members have no right to information if the information looked for is available on an open blockchain[31] and, by becoming members, waive any fiduciary duty towards the organisation or any other member, save for good faith and fair dealing[32]. They can also withdraw from the DAO in accordance with the terms set forth in the articles of organisation, the smart contract or the operating agreement[33].
42. The Wyoming DAO may dissolve either through expiration of the period fixed for duration, by vote of a majority of members of a member-managed DAO, at the time of events specified in the underlying smart contract, articles of organisation or operating agreement, inactivity for one year or by public order[34].
43. Wyoming’s approach seems to have been slightly more hands-on than Vermont’s, but marginally so and the two are very much in line in approach. The law is very recent and there are no reports of DAOs registering in Wyoming as DAO LLCs.

 

Brief Final Remarks

44. Besides minor differences, both U.S. States recognise DAOs as a special type of LLCs (thereby recognising their legal personality and limited liability) but do not intrude forcefully in management or require a delegated management at all times, allowing the inclusion of smart contracts in governance and also leaving membership largely for the articles of organisation of operating agreements to decide.
45. Naturally, as said above, the trade-off for legal personality and limited liability is of course registration and subjection to some rules. That is a fair compromise that avoids DAOs registered in those States to live dangerously as partnerships and gives them the legal benefits of the corporate form. That was the most urgent issue and its resolution was quite simple.
46. Let us not forget that legal personality is not natural personality – there is no natural existence of legal persons nor of limited liability, they are a fiction created and granted by the State. Any expectation of having the best of both worlds – not needing to register but having limited liability – were naïve, to say the least.
47. It remains to be seen when European countries will follow the same steps and try to attract DAOs by offering them legal security, legal personality and limited liability, as well as flexible management rules, in exchange for registration and some light public oversight, instead of letting them roam as unincorporated partnerships. DAOs will operate anyway, so one might as well give them legal coverage and increase oversight. This minimal regulation can even be a springboard for more regulation in the future.
48. The law does adapt, and these two experiments are a step in the right direction, elegantly giving DAOs plenty of room in defining how they are governed and who is to be a member while requiring registration and subjection to simple rules.
49. However, the DAO story is still in the beginning. Now, tougher challenges will be faced. Criminal liability, international recognition, application of tax rules, application of AML rules is still terra incognita. Not for long, one would hope.

 

[1] For an in-depth legal analysis of the phenomenon, cfr., inter alia António Garcia Rolo, “Challenges in the legal qualification of Decentralised Autonomous Organisations (DAOs): the rise of the crypto-partnership?”, in Revista de Direito e Tecnologia 1 (2019), 33-87, available in https://blook.pt/publications/publication/168e81e05a8b/ ; Laila Metjahic, “Deconstructing the DAO: the Need for Legal Recognition and the Application of Securities Laws to Decentralized Organizations”, in Cardozo Law Review 39-4 (2020) 1533, available in http://cardozolawreview.com/wp-content/uploads/2018/07/METJAHIC.39.4.pdf ; Max Ganado / Joshua Ellul / Gordon Pace / Steve Tendon / Bryan Wilson, “Mapping the Future of Legal Personality”, MIT Computational Law Report (2020), available in https://law.mit.edu/pub/mappingthefutureoflegalpersonality/release/1 ; or Usman Chohan, The Decentralized Autonomous Organization and Governance Issues (04.12.2017), available in https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3082055 ; Ori Oren, “ICOs, DAOs and the SEC: a Partnership Solution”, 2 Columbia Business Law Review (2018), 637-650, available in https://journals.library.columbia.edu/index.php/CBLR/article/view/1702.

[2] Vitalik Buterin, in DAOs, DACs, Das and More: an Incomplete Terminology Guide (06.05.2014), in https://blog.ethereum.org/2014/05/06/daos-dacs-das-and-more-an-incomplete-terminology-guide/ , where the author, while recognising a “murky” definition was possible at best, proposed that a DAO is a an entity that lives on the internet and exists autonomously, but also heavily relies on hiring individuals to perform certain tasks that the automaton itself cannot do, with internal capital and property and that would rely on decisions made by itself with little human interaction, further breaking down the concept into a sub-category of “decentralised autonomous corporation”, with the main difference that the latter pay dividends, have some sort of purchasable and tradable shares and are for-profit entities.

[3] You can check the 2016 DAO’s white paper in https://github.com/the-dao/whitepaper. As it is widely known, the 2016 DAO, after an ICO in which it gathered USD 150 million in Ether, was “hacked” and subsequent actions were controversial. For more details, cfr. António Garcia Rolo, Challenges in the legal qualification of Decentralised Autonomous Organisations, 48–52.

[4] For more details on the definition, cfr. António Garcia Rolo, Challenges in the legal qualification of Decentralised Autonomous Organisations, 54-62.

[5] The 2016 DAO, DigixDao, MolochDAO or MakerDAO, for instance. Dash, which considers itself a DAO, would be more in line with a broader concept of DAOs. For more details on the difficulty of including Dash within the narrower concept of DAO, cfr. António Garcia Rolo, Challenges in the legal qualification of Decentralised Autonomous Organisations, 62.

[6] António Garcia Rolo, Challenges in the legal qualification of Decentralised Autonomous Organisations, 57-59.

[7] António Garcia Rolo, Challenges in the legal qualification of Decentralised Autonomous Organisations, 63-72.

[8] In the United States, most DAOs would fall into the US law definition of partnership; in English law, most DAOs would also be considered partnerships; in France, DAOs would be considered de facto partnerships (société créée de fait), with application of the rules of the société en participation and the société en nom collectif; in Germany, a DAO would likely be a civil partnership (Gesellschaft bürgerlichen Rechts) or a general partnership (Offene Handelsgesellschaft); in Portuguese law, most DAOs would either be considered a pre-contract company (sociedade pré-contrato) under Article 36(2) of the Portuguese Companies Code or a civil partnership under Article 980 of the Civil Code, with both situations leading to a similar outcome in what concerns applicable rules. For the confirmation of these understandings, cfr., inter alia, Leila Metjahic, “Desconstructing the DAO”, 1558-1565 and Ori Oren, “ICOs, DAOs and the SEC”, 651 (for the United States); Anne Maudouit-Ridde, “L’organisation autonome décentralisée (DAO)”, 117/4 Bulletin Joly Bourse (2018) 177, 180 and Thibaut Verbiest, Les organisations distribuées autonomes: quell statut juridique? (26.10.2016), available in https://finance-innovation.org/organisations-distribuees-autonomes-statut-juridique-thibverbiest-de-gaulle-fleurance-associes/ (for France); and Maximilian Mann, “Die Decentralized Autonomous Organization – ein neuer Gesellschaftstyp?”, Neue Zeitschrift für Gesellschaftrecht 20 1014-1020 (for Germany).

[9] António Garcia Rolo, Challenges in the legal qualification of Decentralised Autonomous Organisations, 69, 71-72.

[10] The 2016 DAO planned to act through a company incorporated in Switzerland, the LAO uses a Delaware LLC and NexusMutual seems to be a “real company”.

[11] António Garcia Rolo, Challenges in the legal qualification of Decentralised Autonomous Organisations, 72-77

[12]  Cfr. an English version in  https://legislation.mt/eli/cap/592/eng/pdf. For more details, cfr. Max Ganado / Joshua Ellul / Gordon Pace / Steve Tendon / Bryan Wilson, “Mapping the Future of Legal Personality”.

[13] § 4172 11 V.S.A.

[14] § 4173(2)(B) 11 V.S.A.

[15] § 4175(1) 11 V.S.A.

[16] § 4173(2)(C) 11 V.S.A.

[17] § 4176 11 V.S.A.

[18] https://vermonttechlaw.com/2019/06/11/dorg-launches-first-limited-liability-dao/

[19] https://lib.openlaw.io/web/default/template/bbllc-dao%20-%20vermont

[20] An Act relating to corporations; providing for the formation and management of decentralized autonomous organizations; providing definitions; and providing for an effective date (SF0038), introducing W.S. 17-31-101 through 17-31-116. Available in https://www.wyoleg.gov/Legislation/2021/SF0038

[21] W.S. 17-31-104(A).

[22] W.S. 17-31-104(D).

[23] W.S. 17-31-104(C).

[24] W.S. 17-31-105(C).

[25] W.S. 17-31-106(B).

[26] W.S. 17-31-106(C).

[27] W.S. 17-31-109.

[28] W.S. 17-31-105(D).

[29] W.S. 17-31-111(A)(i).

[30] W.S. 17-31-111(A)(ii).

[31] W.S. 17-31-112.

[32] W.S. 17-31-110.

[33] W.S. 17-31-113.

[34] W.S. 17-31-114.