DAOs Demystified

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You might have heard of a hot new term in the Crypto world called DAO. DAO stands for Decentralized Autonomous Organization. I know, like Non Fungible Tokens, another terrible name by the Crypto crew. You can think of a DAO as the Crypto equivalent of a corporation. Just like a regular corporation, DAOs can be for profit or not. DAOs are created on the blockchain and governed by a token. They elect leadership just like a corporation, based on voting of their token holders. DAOs are growing rapidly with easily over $10Bn in assets accumulated into DAOs worldwide already.

In a future post, I’ll go through the details on some of the really cool early applications of DAO technology, but as a quick preview DAOs are being used for social clubs, purchasing assets, decentralizing marketplaces, gaming communities, and much more. If you are banker or investor, you are going to need to understand DAOs. I am certain that in the coming years, DAOs will be looking to open bank accounts or brokerage accounts or loans, and DAOs are already working with VC investors.

The big difference between a DAO and a corporation is that the DAO’s rules are written on the blockchain instead of an operating agreement. In this way, DAOs are open books. Anyone can read the code on the blockchain and see exactly how the DAO will work. Who runs a DAO, what the leaders can do, what type of issues require votes, and more will all be set out on the blockchain. Financial entities that work with DAOs are going to need to be able to read and audit the code on chain to protect their interests.

Just like a traditional corporation, DAOs are governed by their shareholders. The difference is that in a DAO this is accomplished via a cryptocurrency, not equity shares. The tokens often confer more than just voting power, they often bring utility within the organization. Tokens can be used to facilitate transactions by the DAO. They can be used to encourage business objectives or increase participation. Tokens can provide access to in person or virtual events. There is no end to the creativity we are seeing as it comes to DAO token utility. However, at their core, the tokens typically allow the holders to vote on key governance issues in the same way equity works for a traditional company. There is a big unanswered question on when a DAO token is considered a security under U.S. law. None have been registered as securities offerings yet, but this issue will come to the forefront with the SEC before too long.

DAOs typically communicate with their members via Discord, a VoIP, instant messaging and digital distribution platform. Discord grew up in the video game community and has quickly become the dominant communication tool for Crypto and web3. DAOs can create a server on Discord, and they can bifurcate parts of the conversation between public and private. Users connect their Crypto wallets to prove that they are holders of the DAO token, and this gives them access to the private conversations. I’ll spend time talking about Discord and it’s value to creating communities in a future post.

There is a lot still to be figured out about the legal status of a DAO in the United States. So far, most of the entities are being treated as non-profits and are not technically registered to operate within the U.S. or likely any other jurisdiction. Some DAOs are setting up parallel U.S. registered corporations, either for profit or not, to allow them to operate cleaner here. Right now, a DAO can open a Crypto wallet and can make payments in Crypto to employees, contractors, and vendors, but it cannot open a bank account and make fiat payments. A DAO cannot get a US Tax ID number or report income via a W2 or 1099 when paid to a U.S. person. I suspect many DAOs are violating all kinds of U.S. rules as it relates to payments like this.

I expect this will change. Regulations are going to need to catch up fast to this emerging corporate structure. Wyoming is the first state in the U.S. to act. They passed a law allowing for a DAO to register in Wyoming back in summer 2021. Some DAOs are registering in Delaware with a wrapper LLC to get properly set up to operate within the U.S. The legal issues are complex, and only a few law firms are experts in the topic. This will change as new DAOs are popping up every week.

Companies in the crypto or web3 space are making important decisions at inception now on whether to organize as a Delaware C Corp or a DAO. Several VC firms have invested into DAO tokens, giving credibility to the structure as a new way to manage a startup. A16Z has been an early leader in DAO investing, with significant bets on PleasrDAO and Friends With Benefits. The former is buying NFTs and other digital collectibles, and the latter is basically a social club. Braintrust is a decentralized talent marketplace DAO, and it has raised over $130MM on two VC token sales. DAOs are quickly becoming big businesses. OpenSea is the largest marketplace for trading of NFTs, and its users are starting to show their unhappiness with OpenSea’s traditional corporate structure. A new competitor popped up recently as a DAO called LooksRare, and they are beginning to steal market share from OpenSea.

As DAOs continue to build in scale and scope, it will be important for them to access the traditional finance system in the U.S. This will mean opening bank accounts, holding fiat currency, making payments in fiat, and reporting activity to the IRS. I have seen pitch decks from a few companies already looking to build the operating systems for DAOs, and the most progressive banks will look to offer services to DAOs as soon as they can figure out the legal issues. Keep an eye on this new innovation, there is a lot of change coming with DAOs.