Tennessee DAO Series Part I: The Fundamentals of DAO
The blockchain revolution is in full swing, and it’s disrupting every industry imaginable. Add to this a post-COVID virtualized economy, and the traditional notions of team, collective, and business are in full tilt. Decentralized autonomous organizations (DAO) are an interesting byproduct of blockchain and the virtual economy, allowing groups of people to organize around shared resources and common goals much the way that businesses operate. The demand for decentralized, virtual businesses of sorts have prompted a growing number of states to authorize DAOs as formal business models, akin to corporations and LLC’s, though the securities and tax implications of DAOs are evolving.
What is a DAO?
While DAO have in some circles existed for half a generation, many people still don’t even quite understand what blockchain is. Essentially, a DAO is an organization that exists as a set of smart contracts and uses blockchain technology to carry out more often quantitative but also qualitative transactions (and yes, we agree that they’ll soon replace SOME legal functions). A DAO has no central management structure or authority figures; instead, token holders have total control over it. A DAO can take many forms, ranging from business enterprises to nonprofits—there are even applications for distributed global projects that would otherwise be impossible or impractical in a traditional company setting. There are highly scrutinized historical examples of DAOs (e.g., see the introduction of Slock.it and lessons learned) that are leading to better, more sustainable iterations. In fact, there was recently a proposal for a project called Ujo Music that raised $5 million through Ethereum-based tokens. Although it’s still early days for these types of companies, token sales seem poised to become one of the most significant trends in cryptocurrency moving forward.
Is a DAO a company?
The precise legal definition of a DAO is hazy. It can be thought of as a digital version of an LLC or partnership, but that’s not entirely accurate—it’s more complex than that. Also, an LLC is vastly different from a corporation, just as a Tennessee corporation is from a Delaware corporation. Also, formalizing as a DAO does not make you legally exempt from paying federal taxes—there is currently no federal law addressing how these kinds of organizations should be taxed. I’ll cover this at greater length later in this series. While states like Tennessee have made plenty of splash in economic development terms for enacting DAO laws, we still have a LONG way to go before any Tennessee lawyer, judge or professor can confidently say what a DAO is exactly in terms of state securities, contract, and business law.
How does a DAO work?
A DAO is basically a governance or management system based on rules encoded as computer programs called smart contracts. Its power comes from its ability to execute decisions using pooled resources it is authorized to manage through agreement among its constituent members in a transparent, conflict-free way. A DAO is formed when it has funding from some source, which allows it to create proposals that will be voted on by those who have invested in it. If voters approve of a proposal, then the smart contract that executes it automatically gets executed and any profits are then distributed back to investors according to how much they invested. This allows for a completely democratic form of investment because anyone can invest at any time and only what each person has invested gets returned to them – nothing more, nothing less. Read more on establishing a DAO through an ICO.
Advantages of a well-designed DAO
There are a number of benefits to incorporating as a DAO. First, in addition to being ostensibly a statutory corporate entity (and thus to a certain extent legitimized), it could operate as an investment organization, business trust or unincorporated association depending on its legal features. It can be made to have a flexible management structure, e.g. a voting system that gives certain tokens holders more power than just their number of tokens. While voting authorities may be weighted, a well-designed DAO will nevertheless incorporate broad voting rights into its framework from Day 1; failing to give stakeholders a voice is one common mistake that leads to unhappy token holders who won’t want anything to do with your project moving forward.
What states have approved DAO?
At present, Wyoming and Tennessee are key states that have recently approved DAOs. Legislators in several other states have also proposed bills that would create a framework for approval of DAO, and will closely monitor the pros and cons of the Wyoming and Tennessee rollouts. Do the DAO laws actually fulfill their economic development promise for attracting the tech industry? Do they create headaches for courts and administrative bodies? While the average state legislator may be vaguely aware of blockchain, many legislators remain uncertain as to how blockchain technology works and what it can do, much less what a DAO is. For now, companies operating in states with laws specifically allowing blockchain-based organizations are likely safest from legal issues.
Can DAOs raise money from investors?
Currently, there is no federal legislation specifically addressing whether DAOs can or cannot raise money; however, as they continue to grow in popularity, regulators will likely address how these organizations should be treated under existing securities laws.
For more on the investor’s perspective, see a16z’s A Legal Framework for Decentralized Autonomous Organizations. We’ll also cover this at greater length later in this series. Stay tuned for more!
About Kevin Christopher
Kevin Christopher is the founder of Rockridge Venture Law®, and co-founder of ResoluteTherapeutics, a CARB-X funded antibiotic innovator, and Calliope Bio, a Yale launched synthetic biology startup and recent participant in the Nucleate Activator and Berkeley Skydeck accelerators. Kevin is a 2050 Fellow at the Center for Business and Environment (CBEY) under Vincent Stanley, a global leader in sustainability and Director of Philosophy at Patagonia. Kevin has led Rockridge® to become a B Corp Best For The World and Real Leaders Top 150 global impact company has been recognized as a SuperLawyer and Conscious Company Magazine’s Top Business Leader.
Kevin’s corporate and IP practice focuses on the crossover of innovation + impact in venture ecosystems. He is a registered patent attorney and published poet, uniquely combining creativity and technological acumen in registration of intellectual property, business transactions, and litigation. Kevin’s practice areas including: patent and trademark prosecution, licensing and litigation; corporate law, with an emphasis on benefit corporations, socially responsible businesses and high-growth emergent companies; government contracts, with an emphasis on innovation funding; corporate and investor financing; and, technology commercialization.
As an entrepreneur, Kevin has founded companies in biotech, renewables, and consumer product industries, all active and growing. Kevin is a leader within the B Corp community, having founded Tennessee’s local B Corp network B Tennessee and serving as pro bono counsel to B Academics. Kevin mentors entrepreneurs as program advisor with Bethesda Green Hub, First Flight Venture Center, Nashville Entrepreneur Center, University of California Venture Catalyst, and Yale Tsai CITY. With a background in public-private partnerships, Kevin is also a National Institutes of Health (NIH) RadX faculty member, and National Science Foundation (NSF) Center for Bioplastics and Biocomposites program evaluator.
To discuss Tennessee Benefit Corporations with Kevin Christopher, schedule an appointment through Calendly or email him directly at firstname.lastname@example.org.