Legal Framework for running a Decentralized Autonomous Organization

Decentralized systems have been making their way through various fields and sectors. Every time the decentralized approach was added to the ecosystem, it posed a big challenge to the traditional methods of doing things in the ecosystem. This is because it has the potential to either compete with them or completely replace them. Decentralized Autonomous Organizations (DAOs) are one such system that has resulted in challenges since it entered the corporate structure.

Due to its level of traffic, issues regarding its legal status and the problems that come with it have been reoccurring, and several suggestions have been made. This article discusses two existing legal options for DAO structuring and gives an overview of DAOs, their formation, and operation. 

Overview of Decentralized Autonomous Organizations (DAOs)

Decentralized Autonomous Organizations (DAOs) are groups created by rules encoded like a computer program which are often transparent, controlled by the organization’s members, and unaffected by a centralized government. A blockchain stores the program rules and financial transaction history of a DAO.  

Researchers are looking into the possibility of using the structure in many common organizational frameworks, such as business and government, due to the DAO’s potential applications in these settings. Consequently, DAOs are regarded as a possible solution to the issues of bureaucracy and corruption because of their effectiveness and transparency. 

Formation and Operation of a DAO 

DAOs operate through smart contracts and a system of decentralized governance. Smart contracts are computer protocols that make the negotiation of predetermined terms easier, more reliable, or more enforceable. Many governance procedures, including voting and asset management, can be automated.

Smart contracts are created using code and then encoded into the blockchain, which makes them transparent, irreversible, and unchangeable. Intelligent contracts’ capacity to execute contracts automatically without intermediaries makes DAOs effective.

The smart contract is carried out as long as its requirements are satisfied. Additionally, by automating workflows with smart contracts, DAOs can complete tasks independently of a central authority or overseer.

How are Laws Created in a DAO?

The DAO’s intelligent contracts contain rules that the community has approved. DAOs are very adaptable because the rules can be changed through subsequent voting.

Members can buy DAO tokens to participate in voting or other governance processes. Also, DAO tokens can be acquired or given out. DAO tokens can be used to reward particular actions as well. For instance, a DAO might give tickets to members who finish tasks advantageous to the DAO. These tokens can then be used to access exclusive benefits or cast votes on proposals.

A DAO has rules that cannot be changed without the community’s approval because they are open and transparent. This prevents one person or organization from changing the rules to suit their needs.

Legal Framework for running a Decentralized Autonomous Organization

Most states do not recognize the DAO as a legal entity, one of the most significant barriers to DAO adoption. A DAO is not required to abide by the state’s registration requirements if it is not recognized legally. As a result, DAOs are not eligible for the corporate privileges granted to traditional corporate entities.

This restricts the businesses they can run and makes it impossible for them to enter into business agreements. DAOs do not enjoy limited liability protection since the law does not recognize them. As a result, contributors of a DAO may be held personally accountable for their debts and liabilities.

This is a significant limitation because it would probably discourage many potential investors from participating in a DAO. The lack of limited liability also makes it challenging for DAOs to raise funds since most investors would hesitate to invest their assets.

As mentioned earlier, researchers are considering using the structure in many common organizational frameworks. However, before this can happen, the issue of the legal clarity of DAOs has to be addressed, and several legal frameworks have been proposed. 

The first is that a legally sound structure that removes the frequently unforeseen liability risk of DAOs should be developed because many consumers participate in these DAOs. As an illustration, legislation allowing DAOs to be incorporated as limited liability companies with the recognition of legal personality, or as so-called DAO LLCs, was passed in the U.S. state of Wyoming in July 2021.

This legislation also had noticeable repercussions on the business environment in Germany and Europe due to the Treaty of Friendship, Commerce, and Navigation between the Federal Republic of Germany and the United States of America on October 29, 1954. As a result, DAO LLCs from Wyoming are permitted to conduct business in Europe and are recognized as limited liability corporations in Germany. 

Another Option to Legalize DAOs is using an unincorporated nonprofit association (UNA) as a “wrapper.” This would give such organizations sufficient legal coherence, including the ability to pay taxes, make filings, and the like. 

Unincorporated nonprofit organizations have a wide range of meanings. In many places, they can be just a small group of people who have decided to work together on a charity project verbally or in writing. Unincorporated nonprofit organizations have a wide range of meanings. In many places, they can be just a small group of people who have decided to work together on a charity project, verbally or in writing. Many DAOs may not be able to apply for tax-exempt status because of how they work or are set up, but they can do so under Section 501(c)(3) of the tax law, which is available in several states.

Conclusion

Decentralized Autonomous Organizations (DAO) are groups made up of rules that are coded like computer programs. They are usually open to the public, run by members, and don’t have a central authority. The fact that most places don’t see the DAO as legal is one of the biggest reasons why it hasn’t caught on yet. Because of this, DAOs can’t get the corporate benefits that regular corporations can.  Also, they can’t make business deals, which limits what kinds of businesses they can run.

However, several legal frameworks have been recommended for DAOs, two of which have been discussed in this article. One of these frameworks has been adopted by the US. This would give decentralized autonomous organizations sufficient legal clarity and recognition.