DAO (Decentralized Autonomous Organizations) and Regulation

Originally published on Cryptos on the Rise.

A DAO (Decentralized Autonomous Organization) is a revolutionary change in the manner that people and businesses can organize.  Leveraging blockchain technology, it is a decentralized model of control and governance.  The essence of a DAO is transparency, clarity of rule, and process driven decisions – primarily utilizing smart contracts on distributed ledgers.  Once a DAO has been established, via a blockchain, participants take ownership of its token, which allow them to participate in the system.  Token holders can propose changes, and can vote on those changes, with the subsequent actions being taken, “leaderlessly”.  There are no CEOs, CFOs, CTOs, only code and community.

Close to 5,000 DAOs have been formed to date, expecting to grow exponentially.  Many involve pooling digital money together to purchase assets, both physical and digital.  ConstitutionDAO was established seven days prior to the auctioning of one of the eleven remaining copies of the US Constitution. The intent, to purchase and house it at a protected public location.  Participants in the DAO contributed money in ETH (Ethereum token) to the cause, raising $45 million.  Separately, the AssangeDAO raise $53 million for the criminal defense of Julian Assange.  These are quick and powerful ways form decentralized autonomous organizations.

Central to a DAO is transparency.  Anyone can see which individual (wallet address) owns tokens.  Tokens allow for people to vote on proposals.  Anyone can create a proposal.  Simply stated, and in an ideal setting, it is egalitarian.  Challenges to the model are its extremely democratic nature, i.e. voting on everything.  As a result, it can be overly deliberate and result in a slower process compared to a more centralized formed organization like a corporation.

With this nascent, but extremely powerful organizational structure, the regulatory landscape at the state level is nearly non-existent.  Wyoming, which has led the US on regulation for blockchain and cryptocurrency, recently codified rules for DAOs residing in the state. Therefore, a DAO could be created under the laws of the State of Wyoming. No other state enables this yet.  Further, there is a movement afoot for corporations in the cryptocurrency space to dissolve and become DAOs.  With potentially hawkish regulation on the horizon for cryptocurrency, DAOs, by their very nature, are code based, self-running, leaderless entities running via a decentralized network, which permits actions based on how users interact under brassbound, predefined rules. Theoretically, under the current regulatory landscape there is nothing the law can do about such an entity. The converted corporation to a DAO would no longer be in control of the platform, which reverts to a completely new decentralized model, unlike anything regulated currently.

According to the SEC guidance issued in 2017, they determined that “The DAO”, an entity raising money in an ICO, Initial Coin Offering, that it was indeed a security.  The difference here is that many of the DAOs created now are under the auspices of “investment clubs” or are simply voting mechanisms, whereby the SEC generally does not regulate, unless met by the “Securities Act of 1933” regulating the offer and sale of those membership interests, or under the Investment Company Act of 1940 (1940 Act), or if a person who is paid for providing advice regarding the investments of the club or its members may be an investment adviser under the Investment Advisers Act of 1940 (Advisers Act) or state law. (SEC, https://www.sec.gov/reportspubs/investor-publications/investorpubsinvclubhtm.html)

The SEC is reportedly looking into true DAOs like Uniswap in the decentralized finance (DeFi) space, as a decentralized exchange (DEX), which is a code-based organization that matches buyers and sellers of cryptocurrency.  One area of focus is lending pools, where users will provide their assets for other users to trade, which provide healthy yields, just as banks provide interest on your assets.  This may fall into the Howey Test investment contract realm. 

DAOs are in their embryonic stage with legislatures and regulators.  There is little question that this space if bursting with potential and therefore creating a framework with regulation is certainly on the horizon. 

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