Regulatory Landscape of DAOs (SEC Oversight)

The past

As of now, the regulatory landscape surrounding DAOs is extremely limited.

When DAOs made their first debut to the DeFi environment, their absence of regulation and oversight was to be expected. Often times, being on the cutting-edge means moving faster than legislation.

Today, DAO tokens are considered securities — a tradable financial asset. Since the SEC has defined DAO tokens as securities, increasing regulation is inevitable.

There is still little to no legislation that exists specifically within the DAO environment, but the recent rise in DAO popularity and participation has set fire to regulatory questions.

Here are a few notable milestones:

More than $200M is currently locked in DeFi protocols, which indicates massive market potential given DeFi’s relatively recent rise.
BlockFi’s recent $100M settlement with the U.S. Securities and Exchange Commission and agreement to register its crypto lending product is a sign of what’s to come for DeFi platforms.
On April 21, 2021, Wyoming Governor Mark Gordon signed Bill 38 into law allowing Wyoming to recognize decentralized autonomous organizations (DAOs) as limited liability companies.

We can expect DAOs to continue to climb the ladder — and we can expect legislation to follow closely behind. But, as of now, we are still waiting for it to catch up.

Until then, the conversation is limited. The most we can discuss is:

  • The present regulatory landscape
  • The potential regulatory landscape

The present

The current lack of legal representation does make DAOs incredibly easy to join and create — but it does not mean that no laws apply.

When a DAO exists without a specific legal structure, default laws will apply instead.

Default Regulation

The beauty of DAOs is their decentralized structure.

They are driven by the coded terms of smart contracts, rather than top-down by a management team. And rather than having a hierarchy of control, DAO token holders are considered “equals” in regard to the membership and management of the DAO.

This decentralization is what makes DAOs different from any framework that came before. It also means that there is no legislation already designed to handle it. And in the absence of legislation designed specifically for DAOs, courts are forced to default to the principles of a general partnership:

A general partnership requires no registration and is de facto formed when “two or more persons engage in a business for the purpose of joint profit.” - Sarcuni et al. v. bZx DAO

According to the courts, DAOs fit this description almost perfectly. That means, if a DAO were to become the target of a lawsuit, each of the DAO’s co-founders and governance participants is jointly and severally liable.

It might seem like the obvious course of action would be to demand that DAOs have more legal representation. This train of thought is what led to Bill 38 in Wyoming.

The state tried to combat the concerns of a DAO member’s personal liability under the “general partnership” by enacting a law that:

…permits DAOs to incorporate as limited liability companies – a corporate structure whereby the members of the company are not held personally liable for the debts and liabilities of the company. The new law is in essence an add-on to the current Wyoming Limited Liability Company Act.

This is great news for DAOs in terms of recognition.

States are recognizing the strength and potential of DAOs, and the decision to incorporate them into law is a sign of their growth and popularity.

But this is not likely to be the final solution.

DAOs have a distinct purpose — decentralization.

The heart and soul of a DAO is that they favor and function on pure, unadulterated democracy. While Wyomings LLC regulation approach might combat liability, it might also combat this founding principle.

Wyoming Senate Bill 38 would defeat the purpose of, and the idea behind decentralization, by requiring managers to be present and exercise discretion over the governance functions of the DAO, such as member voting.

The presence of a manager and their exclusive ability to exercise discretion is opposite of a DAOs decentralized objectives. So, while Bill 38 is good news for DAOs in general, it is not an ideal stopping point. We must continue to explore potential solutions.

The future

The answer to “what is the best way to handle regulation” is simple: there isn’t one.

There’s a lot.

DAOs are dynamic. They are an outlet for anyone, anywhere, to create a mission and establish a community. This means that there is no limit to the type of DAO being created, or what it does.

Laws are also dynamic. Regulation varies by county, state, and country. And one small detail in the DAO can alter the nature of its regulatory domain.

That being said, the most likely option for helping DAOs stay compliant with U.S. regulations is not a broad, blanketed protocol — its a world of individual, DAO-specific structures.

A protocol called Syndicate is already exploring this option.

Syndicate’s goal is to embed a legal entity into each DAO’s smart contract. They go on-record as having worked with a number of law firms to help create legal templates for DAOs to use based on their specific purpose.

https://twitter.com/SyndicateDAO/status/1493248919211438082?ref_src=twsrc^tfw|twcamp^tweetembed|twterm^1493248919211438082|twgr^|twcon^s1_&ref_url=https%3A%2F%2Fcointelegraph.com%2Fnews%2Fsyndicate-protocol-helps-create-450-new-daos-in-just-three-weeks

DAO creators will need to evaluate their mission, and Syndicate will suggest a structure that works best for their DAO while still remaining compliant.

For example:

  • If a DAO is used to trade cryptocurrencies, it will likely become federally regulated because of its similarity to equity investment vehicles or exchanges.
  • If a DAO is used for fundraising or philanthropic services, it will likely only need the loose regulation of a cooperative association.

Conclusion

For now, the regulatory landscape of DAOs will remain limited. But DAOs are gaining momentum, and it won’t be long before legislatures start looking for some more full-body solutions to this lack of legality.

While it is impossible to know what those solutions will look like, we do know that DAOs and regulation have two things in common:

  • They vary.
  • Anyone can create a DAO for any reason — they are an opportunity for ideas to flow freely.
  • Regulation is dependent on jurisdiction — it changes between countries, counties, and states.

These characteristics create a rich environment for diversity and variation.

  • They evolve.
  • DAOs members converse constantly — discussing new ideas, ventures, and proposals.
  • Regulation is always being re-imagined — a byproduct of social and technological advancement.

These characteristics create a rich environment for evolution and improvements.

What we can expect is for DAOs and regulation to vary and evolve together — to create a landscape for DAOs that prioritizes community and compliance equally.

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