How to create a DAO legally: The different options to launch DAOs without breaking the law
This question has come up regularly since the beginning of my Web3 adventure and especially since the launch of Mobula, which is based on 2 DAOs… How to incorporate and manage a decentralized company legally and optimally. I did a lot of research and talked to many experts, which allowed me to identify several solutions I wanted to share with you today.
My name is Julian, Co-founder of Web3Island & The Secret Company.
We build ambitious decentralized companies, bringing next-generation Web3 products to life (Mobula, StaySAFU, Safetin). In this article, you will discover everything you need to know to incorporate and manage a decentralized company.
Launching or planning to launch your Web3 startup?
Receive the weekly Web3 entrepreneurship newsletter: Inside Web3 💎
If you want to get daily resources, strategies, and learnings on how to build your Web3 business, feel free to connect on Twitter (@JulianIvaldy)
This guide is the result of months of research and discussion on the subject of DAO legislation. However, some of the details may be outdated, so please feel free to DM me on Twitter if you see anything that needs to be corrected, improved, or even added.
WHAT IS A DAO?
A DAO (Decentralized Autonomous Organization) is a decentralized organization governed by a series of smart contracts that allow the organization to operate autonomously through blockchain technology without the need for an intermediary or central authority.
They are Internet-based enterprises collectively owned and managed by their members. Their governance results from consensus algorithms based on community voting mechanisms that protect the democratic nature of the DAO.
WHY IS EVERYONE TALKING ABOUT DAO?
We live in a world of organizations. The most common organizations of today are defined by their form of legal entity and internal structure, mainly pyramidal hierarchical. DAOs offer a new form of enterprise with more horizontal and community-based governance. This type of corporate governance is not new, as many more liberal governance concepts have emerged (C-Form, Community Platform, Holocracy). However, blockchain technology allows the structuring and scalability of this new type of shared governance.
This type of organization appeals to employees who want more power and consideration and consumers who want more visibility and transparency. They are more competitive because they eliminate middlemen and address many of the problems of modern society.
HOW CAN WE INCORPORATE AND MANAGE A DAO?
The DAO (decentralized autonomous organization) economy has recently attracted considerable interest from state and regional governments. However, reactions vary.
On the one hand, major economies seem somewhat reluctant to legalize DAOs. They are not really necessary in their view and threaten the financial system and society in general, especially because of their decentralized aspect. On the other hand, a growing number of smaller countries are beginning to recognize DAOs, legalize them, and structure their development. They recognize the benefits of decentralized structures for their countries and their people and want to be a precursor to what they see as the organizations of the future. For example, the Republic of the Marshall Islands has passed legislation allowing DAOs to incorporate legally. In the Bahamas, Singapore, and Liechtenstein, DAOs are recognized and can be incorporated and managed.
There are two ways to manage a DAO. The first way is to incorporate and manage it in a country that recognizes it. This is the most optimal and recommended way. However, if you have a business in a country that doesn’t recognize DAOs, or even worse, in a continent that doesn’t recognize them, don’t panic. There are solutions. We’ll look at how you can use a DAO alongside a more traditional legal entity, even in the strongest jurisdictions.
COUNTRIES THAT RECOGNIZE DAOS:
Regarding the countries that recognize DAOs, I have decided to present to you the 6 most suitable countries to incorporate and manage a DAO. This list is not exhaustive, and details are provided to give you information to help you incorporate and create the structures.
1 — Switzerland
Switzerland may be the best-positioned country to become the center of the cryptocurrency industry. It is home to some of the best financial institutions in the world. The Ethereum Foundation is based in Switzerland (Zug). There are also Bitcoin Switzerland, Xapo, ShapeShift, ConsenSys and Tezos.
The Swiss are playing a balancing act here. On the one hand, they are trying to attract cryptocurrency companies. On the other, they are doing their due diligence, taking up to a year to issue crypto licenses.
🔗 Links: DAOBox, A guide to setting up a crypto business in Switzerland
2— Malta
Malta was the first country to legalize DAOs. The legislation introduced some form of corporate governance in DAOs. Today, any DAO wishing to do business in Malta must be licensed, incorporate a limited liability company and employ at least three people.
🔗 Links: Malta cryptocurrency company solution in 2022, Set up a Cryptocurrency Company in Malta
3 — Estonia
Estonia introduced a crypto licensing plan in 2019 to attract crypto companies and give its economy a much-needed boost. No other country in the EU appears to be as crypto-friendly as Estonia today.
🔗 Links: Open a Cryptocurrency Company in Estonia, Consulting24: #1 Start a crypto/blockchain company in Estonia,
4 — Gibraltar
Gibraltar, a British overseas territory, has been looking for ways to make government services more effective and efficient for some time. It recently decided to integrate blockchain into its existing systems. RSK, the smart contract platform that underpins bitcoin, has become the platform of choice. The Gibraltar government hopes this move will allow its citizens to store their personal documents on a decentralized ledger. This will make accessing documents such as IDs, driver’s licenses, or car registration easier.
🔗 Links: Set Up a Cryptocurrency Company in Gibraltar, A Lesson From Gibraltar: How to Build a Blockchain Bastion
5 — Cayman Islands
For several reasons, the Cayman Islands are one of the popular jurisdictions to create a Legal Wrapper for DAO. The country adopted special regulations for VASP (Virtual Assets Service Providers): this means that there are specific rules for working with virtual assets, and companies know what they need to prepare for. Caymanian corporate legislation is largely based on American and English law, making it quite universal in its application and operation worldwide.
🔗 Links: Cayman Islands Foundation as a DAO Legal Wrapper, Cayman Islands Foundation Companies for DAOs, Defi, and NFTs
6— Wyoming, United States
Wyoming officials recently took a major step forward by introducing a regulatory framework for DAOs. The legislation they passed allows DAOs to incorporate in the state and be founded as limited liability companies (LLCs). This bill removed some of the doubts about the legal liability of DAOs by turning them into legal entities.
The legislation has provided structure to a growing business segment. However, it did not give the DAO a free hand. The Wyoming Secretary of State retains the right to remove liability protection from a DAO if it is involved in any illegal activity.
🔗 Links: How to form a Wyoming DAO LLC, Forming & Operating a Wyoming DAO LLC
*There are more and more countries that recognize DAOs. To find an overview of the complete list, I recommend this Wikipedia page about the legality of cryptocurrency by country or territory, updated regularly.
In most countries that recognize DAOs, you will implement a DAO Mirroring system. The general idea is to change the shareholder composition to reflect DAO tokens' ownership percentage. One challenge is the cumbersome and costly procedures for transferring and registering shares, which are not nearly as liquid as tokens registered on a blockchain. That’s why in most countries that recognize DAOs, you will be bound to a traditional legal entity such as a Limited Liability Company in the United States or The Swiss Foundation in Switzerland.
However, more and more countries are creating dedicated entities for DAOs, such as The Decentralized Autonomous Association (DAA), a variation of the DAO developed by Switzerland to regulate its use. Recognizing the overall flexibility and user-friendliness of an association compared to a Swiss foundation, DAAs seek the best of both worlds — a DAO with limited liability.
The main objective of a DAA is to establish a decentralized and democratic legal entity structure with flat hierarchies. Therefore, the points of centralization should be reduced as much as possible (legally).
COUNTRIES THAT DO NOT RECOGNIZE DAOS:
If you have a business in a country that doesn’t recognize DAOs, or even worse, in a continent that doesn’t recognize them, this can cause stress. Don’t panic. There are temporary solutions to operate your DAO.
DAO Delegation:
With DAO Delegation, the DAO will be associated/linked to a parent entity. Decisions on the governance and development of the parent entity will be voted on and carried out from the DAO and executed on the parent entity.
The DAO will allow the emergence of a substitute third party, a new decision-making body. It should be remembered that decisions are made “via” the DAO rather than “by” the DAO, which has no legal personality.
With the delegation method, we can therefore use the DAO as a decision-making tool, and the decisions will be behind and translated into a traditional legal entity.
If your country does not recognize DAOs and you do not wish to create a structure in other jurisdictions, the simplest solution seems to be to set up a delegation system. However, it should be noted that this setup does not solve the problems of centralization and the limits of the parent legal entities. The limits of the entity can be the number of members, the flexibility of evolution of the configuration, and the different flows (financial, decisional)…
CHOOSE THE OPTIMAL LEGAL FRAMEWORK:
More and more countries recognize DAOs. The hardest part now is to choose the optimal configuration. Now you have to choose the most appropriate solution for your needs. In a recent article on the legal framework for DAOs, a16z listed the main objectives of an entity structure as follows:
- Minimizing the risk of imputed ownership by governance token holders of the DAO Treasury tokens.
- Limiting the liability of developers, users, and members of DAOs.
- Creating a taxpayer capable of paying taxes within the applicable jurisdiction for any taxable transactions, especially those involving the DAO Treasury.
- Maintaining decentralization by limiting the scope of operations of any individual entity.
- Staying consistent with any assertions utilized in other regulatory compliance responsibilities.
- Avoiding any reporting obligations under applicable Corporate Transparency laws concerning underlying governance token holders.
- Promoting the availability of trustless and disintermediated transactions wherever possible.
There are several things to clarify before incorporating your DAO:
First, you should have a detailed token cap table in mind. In particular, it should explain the size of the issue and the resulting pools (pools of tokens for founders, team, validators, investors, treasury, etc.) You should also have finalized the white paper. It should describe how the DAO works, the principles of forming and funding the treasury, and the procedures for accepting new members, voting, and decision-making (governance). You will also need a detailed description of the status of the token. You need to know the token type and how you interact with it.
It is also essential to decide in which country the central DAO team will be located, who will be appointed as guardian/supervisor of the DAO, and the expected jurisdiction of potential investors (if fundraising is planned). This information helps determine which operating companies are needed in the legal structure. It will also help decide whether a separate company is needed to issue the tokens and subsequently transfer them to the Treasury for distribution. To decide which jurisdiction the DAO will be incorporated, the team should compare its white paper and token cap table with the criteria for foundations in different countries. The option with the most matches is the optimal choice.
Launching or planning to launch your Web3 startup?
Receive the weekly Web3 entrepreneurship newsletter: Inside Web3 💎
If you want to get daily resources, strategies, and learnings on how to build your Web3 business, feel free to connect on Twitter (@JulianIvaldy)
Resources
- https://daobox.org/
- https://www.coindesk.com/markets/2018/07/04/among-blockchain-friendly-jurisdictions-malta-stands-out/
- https://www.mondaq.com/fin-tech/729456/malta-technology-arrangements-the-return-of-the-dao
- https://mirror.xyz/0x43d06b9eBFB0c76A448fBd5B6faa2cfba81901d6/CYm-hNaniW0C1Mn9KR677jn4o9okGugkKC3C8iD9k28
- https://lrz.legal/en/the-lrz/how-can-a-decentralized-autonomous-organization-dao-be-legally-structured#h2-setting-up-a-dao-with-a-liability-wrapper-or-as-a-dao-llc
- https://legalnodes.com/article/caymanian-foundation-for-dao
