In part 1 we provided a primer on DAOs. This article will explore some of the evolving structures and infrastructure that DAOs can utilise.
To better understand where we are going, some brief historical context is helpful, although an extensive analysis of the history of DAOs is outside the scope of this article (for one, see this comprehensive prehistory).
A Brief History of DAOs:
DAOs can be traced back to the 90s when it was conceptualised that multi-agent systems would achieve decentralised action in social movements. However, in a cryptographic context, reference to DAOs began appearing in early Bitcoin forums under the guise of Decentralised Autonomous Corporations (DACs) — the reference to corporate models was eventually abandoned. Later on, in an article by the Ethereum co-founder, DAOs were described as:
“[…] 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.”
- Vitalik Buterin
Bitcoin as the first DAO: Although the protocol does not own any shared resources besides the ledger, it operates in total autonomy and has many distributed actors. It optimises a simple function: keeping a consistent order of valid transactions. This has united thousands of people across the globe to compete for network rewards which can be measured by hash power, i.e., the energy consumed to secure the network.
‘The DAO’ as the first venture DAO: Since then, there have been countless iterations of DAOs, beginning most famously with the DAO in 2016. This was one of the first ICOs on Ethereum and collected 12.5m ETH (at the time, approximately 15% of the circulating supply). However, the smart contract wasn’t correctly audited, resulting in a money-draining bug. For a complete legal analysis of the DAO incident, see this paper.
Aragon Initial Coin Offering: Now that DAOs were a reality, the space needed better ways for people to create these entities. DAO “off the shelf” platforms were the first attempts at facilitating easily launchable DAOs. Aragon had its ICO in the spring of 2017, aiming to create a plug-and-play modular DAO builder. This was followed by DAOstack and then Colony.
Inaugural MakerDAO vote: In 2018, MakerDAO, a stablecoin and loan issuance protocol, held its first public vote with its MKR token, starting a new phase of on-chain decentralised governance. Since then, many DeFi protocols have followed in its footsteps, including AAVE and Compound (borrowing and lending protocols), Uniswap and Curve (decentralised exchange), and dYdX (decentralised trading platform).
The summoning of Moloch: It wasn’t until 2019, with the launch of Moloch, that DAOs safe from exploitation started to proliferate. Having seen the problems that emerged around the Ethereum fork after the DAO hack, its founders created a framework to launch a “minimally viable DAO” initially focused on the issuance of grants. However, it acted as a foundation upon which many more complex DAOs could be launched.
The LAO — the first legally wrapped DAO: Members of DAOs were still liable; however, up until early 2020, DAOs existed within the cloud and often without jurisdiction, and when they did, they were leveraging pre-existing corporate structures (see above). This meant there was an unknown liability for its members, which presented a challenge for countries to regulate and tax them appropriately. This year the Moloch framework was utilised by the OpenLaw team (now Tribute Labs) to legally wrap the first DAO, the LAO, as discussed in the next section.
A DAO Explosion: With all of the above infrastructure in place, 2021 saw the rise of the legally wrapped DAO, with many popping up to target investments in diverse crypto verticals (NFTs, GameFi, Music, Fashion, etc.). In the last 12 months, the number of DAOs has exploded, as evidenced by this tweet, rising from 700 to over 6000, including some to try and govern real-world assets such as LinksDAO, CityDAO, and the failed ConstitutionDAO.
Infrastructure and tooling:
Essentially DAOs require just three simple things to work:
(1) A multi-signature treasury, for example, Gnosis Safe, meaning no single person has control over the DAOs funds.
(2) A governance module, for example, Snapshot or Compound Governor, allowing soft (off-chain) and hard (on-chain) consensus, respectively, to be reached.
(3) Coordination platforms such as Discord and Discourse so that DAO members can discuss and debate how funds may be spent and what votes should be conducted.
However, as addressed in the previous article, for all their advantages, DAOs face many problems. And just as the positive developments above have addressed the issues on the legal side, we have seen the emergence of many solutions on the infrastructure side that will be influential in helping DAOs realise their full potential:
The landscape is extensive, with many projects and founders trying to tackle some complex problems:
Issue 1 — Security, Usability and extensibility: DAOs must be customisable in function and membership and require advanced features and complexity beyond a multisig treasury and governance module.
Solution 1a — Modular frameworks: Based on Moloch’s minimum viable DAO design (with the mantra; less code = less bugs), Tribute Labs improves the process of building and managing DAOS through customisable adapters and extensions. Tribute DAOs have optimised treasury management and new proposal types, and they can hold a variety of tokens, including support for NFTs. They are low cost for the DAO using optimistic rollups for smart contract executions and the members through close integrations with snapshot for gasless voting. Syndicate transforms any wallet into a web3 investment club that can invest in tokens and NFTs as well as off-chain startups whilst providing DAO legal docs and legal entities in just a few clicks (a useful comparison is shown here).
Solution 1b — Token Gating: Depending on their token holdings, individuals will be allowed to join specific communities, so DAOs can tightly control access to information. With Collab.Land this is managed by bots that have been added to telegram and discord channels. Noble takes this a step further by adding boolean logic, so access can be granted to users who have performed specific, on-chain actions, creating definable roles and privileges.
Issue 2 — Incentivisation and Compensation: Despite their name, DAOs are not entirely autonomous and require the action of agents working for them. There is a delicate balance to getting the right inputs and outputs from people for optimum efficiency without noise.
Solutions 2a — Payroll: Tally and Parcel are two solutions allowing DAO members to easily propose and approve payouts for contributors, services and sub-DAOs — these are input-orientated solutions. Coordinape flips the model by asking members who is doing the best work, with the collective answer giving a better sense of where value is being generated — this is output orientated and provides better insights into the types of work that should be prioritised. Superfluid and Sablier are both able to create streaming payments, which unlocks liquidity for workers, so they are paid in a continuous stream.
Solutions 2b — Benefit Packages: Opolis was formed to provide access to competitive pricing by accessing corporate rates for DAO participants on behalf of the DAOs. This includes health and dental care, disability and retirement packages, and savings plans.
Issue 3 — Coordination and Operations: Currently using web2 platforms such as Discord, their amorphous nature makes it hard to track all the activities occurring within a DAO. Soft consensus within these forums is susceptible to governance attacks.
Solution 3a — Web3 native platforms: Clarity is an advanced DAO coordination suite in which task boards and docs can be shared, and cross-group activities can be managed. Access and privileges can be issued and controlled by access tokens. This also allows soft off-chain consensus to be more reflective of DAO ownership. Signing in to access information must be done by web3 wallets, and incentive rewards can be paid out directly.
Solution 3b — Service providers: If members of the DAO agree, engaging a service provider such as Tribute Labs or Thing3 to help coordinate activities across the DAO ensures efficiency and execution.
Solution 3c — DAO aggregators: Rather than an individual having a career, we believe DAOists will work for many DAOs simultaneously (similar to the gig economy). Boardroom is a governance aggregator helping members keep up to speed and make faster, more informed decisions across their various DAOS.
Issue 4 — Contribution and participation: It is complicated to measure who is doing what for the DAO, especially when there are no central manager logging activities. Furthermore, DAO reputation is non-transferable should a member choose to move on.
Solution 4a — Activity primitives: By breaking down the base units of participation into their fundamental units, Govrn is attempting to create a foundational layer upon which DAO participation can be measured. Through proof of engagement, commitment and completion, it has developed “governance legos” where members own their contributions. This means that other external DAOs can leverage these contributions — especially important in the instances of a contributor rage quitting a DAO — nothing is lost.
Solution 4b — Reputation primitives: Although aiming to be a decentralised social graph, Lens protocol is creating NFT-based reputation primitives, which means people’s status in the DAOs due to their contributions can be instantly recognised over time.
Issue 5 — Spinning up DAOs is technically challenging: If DAOs are going to take over the world, then anyone should be able to spin up a DAO without needing technical knowledge.
Solution 5 — DAO creation platforms: Aragon enables people to create DAOs built on open-source infrastructure without prior coding knowledge. Their plugins are designed to address broader governance issues, and, at the time of writing, there have been 3800 DAOs built with Aragon with a TVL of $300m and 300,000 members. In addition, Colony instantiates bespoke DAOs for the non-crypto natives and aims to streamline governance by embracing “permissionless by default”, eliminating the need for voting in daily operations.
Legalising DAOs: To Wrap or Not to Wrap?
Strides on the legal side have been made that tackle some of the aforementioned problems with DAOs. This article presents a comprehensive overview of the various structures available to projects looking to wrap their DAOs.
In February 2020, the world’s first legally wrapped DAO was pioneered by the team at OpenLaw (now Tribute labs), known as The LAO, which quickly raised $5m. It aimed to build an internet-native silicon valley and succeed where the original DAO had failed. The members purchased an interest in the LAO, and these proceeds were pooled and then allocated to blockchain start-up projects with the intent of profit. To date, it has invested in over 150 projects. Furthermore, unlike the DAO, it has a Delaware LLC wrapper, with a 99 professional investors capacity that adheres to the US tax code and provides limited liability for its members.
Benefits
Legal wrapping solves some crucial issues: it can limit legal risks to its members and help shield them from liabilities, damages and tax obligations that the DAO or its members may cause.
Other benefits, dependent on the nature of the wrapper itself, include reduced fiduciary obligations amongst members, reduced potential conflict of interest amongst members, denominated rights and obligations, accounts for dispute resolution and clarity on what laws will and when. It also legally sets out that the DAO will be run by code. Importantly, these structures also mean that DAOs can interact with more traditional organisations as they operate in a widely trusted manner.
Limitations
Integrating real-world legal infrastructure, and ensuring full compliance, may limit the design space within which DAOs can operate. However, as evidenced in other immature industries, it is usually those that comply with existing legal structures that often win in the long run. For example, parallels can be found in the copyright industry and why Napster is extinct and Spotify is flourishing.
There remains the apparent conflict between compliant legal structures and a revolution, but decentralisation doesn’t have to be done non-legally — and for many, this was never the aim. However, in a space that values anonymity, a DAO with a legal footing requires that it knows all of its constituents by name, which excludes participation by those who wish to remain unknown, whether for privacy reasons or something a little more nefarious.
There are several avenues that DAOs can explore to obtain legal recognition, as outlined below. The most progress has been made in the States; however, these DAOs are susceptible to federal reach through, i.e. the US government could decide to shut the DAO down. In most cases, where DAOs are acting legally, this shouldn’t be a problem — but it does represent a risk to future operations.
Therefore we are starting to see the emergence of competitive products outside the US. On the one hand, these other ways of legally wrapping DAOs may involve less taxation, but on the other, they will not benefit from the robust oversight of the US judicial system.
We are now seeing nations compete for DAOs business, in the same way, they may be competing for that of sovereign individuals. Any DAOs operating within grey markets can use these opportunities to perform regulatory arbitrage. Some examples include registering as a foundational company in the Cayman Islands, Singapore, or Panama, but these are not without risks.
Choosing a Jurisdiction
The United States
In the US, DAOs can be incorporated as LLCs, making them fully compliant with US law and subsequent taxes. Unlike other parts of the world, in the US, an LLC can be member-managed and does not require a board, manager or leader. Delaware has a strong history in this regard with safe, predictable, and widely recognised corporations — it also hosts many SNP500 traded companies. Alternatively, under specific legislation passed in Vermont, a DAO can register as a Blockchain Based LLC or BBLLC. Subsequently, a bill passed in 2021 in Wyoming allows DAOs to register as LLCs. These DAOs are all limited to 99 accredited investors. Recently Slow Ventures have launched sDAOs, which expand membership to 499 members, but unlike the LLCs, members must be US natural persons. The proposed but unpassed Lummis-Gillibrand Responsible Financial Innovation Act posits there be no requirement for DAOs to incorporate as entities, but that incorporation will be a requirement to qualify for tax benefits.
Australia
The Digital Law Association, an association of technology lawyers, and global law firm Herbert Smith Freehills have been lobbying the Australian Senate committee to propose the creation of the new entity. Their recommendations got accepted and ratified by the committee, and there is now a roadmap to create such a structure. The problem is that governments are notoriously slow at getting things done.
The Marshall Islands
In March 2022, the Marshall Islands revised its Non-Profit Entities Act 2021, making it possible for any DAO to register and commence operations in the country. Registering as a non-profit LLC establishes corporate personhood without paying taxes to the Marshall Islands. The DAO can register without a single person taking liability for the entire DAO. This is an off-shore version of the US structure without Federal reach through.
Cayman Islands
Numerous DAOs are choosing the Cayman Islands as their jurisdiction to utilise the Foundation companies. These structures allow DAOs to operate as companies without the need for shareholders legally. This presents a reasonably clear pathway to a decentralised DAO, whereby an entity is spun up, issues tokens, and is then shut down in an orderly manner, allowing the DAO to take over.
Malta
Malta became the first country to legalise DAOs through legislation introducing a form of corporate governance into DAOs. However, regretfully, it ended up placing too much responsibility on the executives of these organisations. This is incompatible with the spirit of DAOs; however, it has been proposed that possible amendments could address these issues in the future.
Closing Thoughts:
DAO structure and infrastructure have progressed significantly. Iterations and failures have paved the way for the design space to create truly revolutionary organisations.
We see some breakout use cases, particularly around Investment DAOs, some of which are quietly delivering exceptional performance. However, many factors are required to make a successful DAO beyond its structure. In the following article, we highlight, from experience, these other elements essential for Investment DAOs to thrive and speak to why ID Theory has made such a significant commitment in this area.
The following article discusses why we believe the best investable opportunities in this space are legally wrapped DAOs.
Special thanks to Aaron Wright, Priyanka Desai and Harry Ephremsen for reviewing and providing critical feedback.
ID Theory may hold positions in some of the assets discussed in this post. This post is strictly for informational and educational purposes only. It does not in any way constitute an offer or solicitation of an offer to buy or sell any investment or cryptoassets discussed herein. Always perform your own research and conduct independent due diligence prior to making any investment decisions.
Interested in partnering with ID Theory or building something special? Get in touch through our website or at info@idtheory.io.
