Decentralized autonomous organizations (DAOs) employ smart contracts to establish their governing rules, which a core group of community members determines. These smart contracts provide a transparent, verifiable, and publicly auditable foundation for the DAO's operations, allowing any potential participant to understand how the protocol functions at all times.
After inscribing these rules onto the blockchain, the DAO must determine how to secure funding and distribute governance powers. Typically, this is achieved through a token issuance, where the protocol distributes tokens to raise capital and fill the DAO's treasury. In return for their investment, token holders receive voting rights, usually proportional to their holdings. Once the funding process is complete, the DAO is ready for deployment.
DAO code is activated upon deployment on the Ethereum blockchain.
After the code is deployed, it can only be modified by achieving consensus through member votes. In other words, no single authority can alter the DAO's rules – the power lies entirely in the hands of the DAO's token holders.
A few thoughts on how to create a DAO
Begin by discussing with your peers the purpose of the DAO, its intended role, and operational structure. Human decision-making is required initially to identify opportunities, recruit collaborators, validate the need, and outline the processes to be automated through smart contracts. It is crucial to clarify the DAO's objectives with other enthusiasts to minimize the risk of disagreement over the governance structure. You will need an encrypted wallet for transactions and storage.
Ownership in a DAO is usually tokenized and can be transferred to members in various ways. Standard methods include "airdrops" and "rewards." Airdrops distribute tokens to members based on their contributions and community behavior. Rewards are bonuses given to members who accomplish tasks and goals. Members can gain ownership by earning native token-based rewards or purchasing tokens through decentralized exchanges.
Decide how decisions will be made once the DAO is established. The most common method is "token-weighted voting," where token holders vote, with each token representing one vote. Members submit ideas using tools like Snapshot, then vote based on other members' preferences, with outcomes that may be (or may not) executed automatically via smart contracts.
Developing rewards and incentives for DAO members and contributors foster trust. Native governance tokens may be distributed to members and contributors using DeFi protocols. DAOs may also reward contributions with cryptocurrencies or even with titles and ranks. After the DAO conceptualization phase ends, the reward structure can be further refined.
There may be different types of DAOs, for example:
Protocol DAOs: governance structures where tokens serve as a voting metric for implementing protocol changes.
Collector DAOs: for artists using NFTs to establish art ownership.
Operating systems: standalone platforms for organizations to create their DAOs.
Service DAOs: talent hunting and support acquisition models.
Investment DAOs: pool capital for democratized investing.
Grant DAOs: community-contributed grant pools for funding innovative projects.
Entertainment DAOs: decentralized entertainment where creators maintain governance control.
Media DAOs: allow content owners to contribute directly for native token rewards.
Social DAOs: collaboration platforms for crypto-based social networking.
The DAO tension triangle represents a delicate equilibrium among three essential components: voice, exit, and loyalty. The ability of a DAO to respect an individual's sovereignty is reflected in the freedom to leave.
Voice refers to the freedom for individuals to participate in decision-making, including joining, exiting, and voting on DAO choices. The governance mechanism is the DAO-specific design space associated with voice, focusing on protocol-related decisions and DAO improvement. Enhancing governance requires strengthening the voice and reducing exit incentives.
Governance encompasses the legal structure, membership, purpose, operations, and voting mechanisms that facilitate the organization's creation and dissolution.
The individual aspect, or exit, includes those who value self-government, the common good, and personal rights. This can also apply to registered or unregistered entities operating under their jurisdiction and treated as individuals.
Loyalty relates to decentralization, combining technological and political aspects to create a belief system that shapes the characteristics of DAO participants. The level of decentralization and the people and motives behind a DAO are crucial factors influencing its trustworthiness. The degree of decentralization in each DAO varies, depending on its capabilities, purpose, and participation costs.
Legal Challenges
DAOs may face several legal issues due to their decentralized nature and the evolving regulatory landscape. Some of these challenges include:
Legal recognition and status: As decentralized entities, DAOs might not be recognized as legal entities in many jurisdictions. This lack of legal status can create difficulties enforcing contracts, resolving disputes, and determining liability.
Regulatory compliance: DAOs often operate across multiple jurisdictions, which can lead to complex compliance requirements. Ensuring adherence to anti-money laundering (AML) and know-your-customer (KYC) regulations and compliance with securities laws can be challenging for DAOs.
Intellectual property rights: DAOs that deal with digital assets and non-fungible tokens (NFTs) might face legal challenges related to intellectual property rights, such as copyright and trademark infringement claims.
Taxation: Tax regulations surrounding DAOs and their tokens often need to be clarified, making it difficult for members to accurately determine and report their tax obligations. This can lead to potential tax liabilities and penalties.
Liability and dispute resolution: The decentralized nature of DAOs can make it difficult to determine individual liability for actions taken by the organization. Dispute resolution can also be challenging due to the need for centralized authority and the global nature of DAOs.
Employment and labor laws: DAOs that rely on contributors and collaborators might face legal challenges regarding employment status, worker classification, and compliance with labor laws and regulations.
Data protection and privacy: DAOs that collect, process, or store user data must navigate data protection and privacy regulations across multiple jurisdictions, which can be complex and burdensome.
Governance and decision-making: As DAOs are governed by their members through token-based voting mechanisms, they may face legal challenges surrounding the legitimacy and enforceability of decisions made through these processes.
Securities laws: DAO tokens can sometimes be considered securities by regulators, subjecting them to strict regulatory requirements and potential enforcement actions. Ensuring compliance with securities laws is a significant challenge for many DAOs.
Consumer protection: DAOs offering products or services to consumers must navigate consumer protection laws and regulations, which can vary significantly between jurisdictions.
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Prokopiev Law Group is dedicated to helping DAOs navigate the complex legal landscape and overcome challenges. With our deep understanding of the evolving regulatory environment and expertise in various legal areas, we provide tailored legal solutions that ensure compliance, mitigate risks, and enable DAOs to grow and thrive. By partnering with us, DAOs can focus on their core mission, confident that they have a trusted legal partner supporting their journey toward success and innovation.
DISCLAIMER: The information provided is not legal, tax, or accounting advice and should not be used as such. It is for discussion purposes only. Seek guidance from your legal counsel and advisors on any matters. The views presented are those of the author and not any other individual or organization. The information provided is for general educational purposes only and is not investment advice. The author of this material makes no guarantees or warranties about the accuracy or completeness of the information. A professional should review any action based on the information discussed. The author is not liable for any loss from acting on the information discussed.
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