What is a DAO?

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Summary

A DAO or Decentralized Autonomous Organization is a type of limited liability company (LLC) in which there is no single commanding body behind decisions. All decisions are made by majority vote by either those who have invested in the organization or through a computer algorithm, depending on the type of DAO. A DAO effectively runs itself based on a set of rules that are implemented upon its creation and then updated by either stakeholders of the organization or by an algorithm over time.

A DAO completes actions through a series of “smart contracts”, which are different from traditional legal contracts in that they exist and operate autonomously through the internet without need for manual human action. Despite this autonomy, there are still some actions a DAO cannot complete autonomously, for example some interactions with the legal system.

This autonomous action allows for a DAO system to operate outside of the administrative structure of a traditional organization. Instead of top-down management, every member has an equal part in deciding the action of the organization, or all management can be conducted by a computer program outside the control of the establishing party. In either case, no single person or party makes decisions within the DAO.

This has both advantages and disadvantages in the efficiency of decision making. Being more responsive to the needs of stakeholders is a common advantage when a DAO is managed by a group, but is often met with potential for less-informed and slower changes. When managed by an algorithm, it is possible for mistakes to be made that a human would not, but this often comes with the benefit of increased objectiveness and success-oriented action. It is important to note that although a DAO LLC is technically still an LLC, the operations of the two vary drastically in practice.

Creation of a DAO

A DAO LLC is formed very similarly to a traditional LLC, with the primary difference being the two new steps of establishing the rules behind the DAO and funding the DAO prior to it becoming operational. Establishing the rules involves deciding how the DAO will operate at the time of the formation, and although this can be changed later on, doing so often involves significant action from stakeholders. Funding the DAO involves creating a token which represents and tracks the investments of stakeholders in the DAO, and is a way for stakeholders to participate in and influence the actions of the DAO.

DAO’s are not controlled by any single entity; although there must be an entity to create the DAO, this founder does not control the DAO after it’s creation. Although it is common for the founder of a DAO to participate in said DAO by contributing to the initial funding, this is not necessary. It is possible for a founder to create a DAO, but have no part in the management of said DAO following its creation.

Because DAO’s rely heavily on the initial ruleset implemented during formation, it is extremely important that the code behind this rule set is carefully written and that all potential bugs and security flaws are fixed before the system is deployed. Having a strong initial base for the DAO is essential to the success of the DAO moving forwards.

Concerns

DAO’s are still a relatively new concept, built on the relatively new technology of the blockchain. With the advantages of this innovation also come some growing pains, namely those of security flaws and a higher potential for future changes in government regulation.

Security:

Within a stakeholder-voting structure, security flaws are far more difficult to address in DAO systems than in traditional LLC’s, a result of the sluggishness when implementing changes compared to traditional management structures . Even for obvious flaws, a DAO still requires all issues to be voted on by its stakeholders. This can lead to delays when fixing flaws in the structure behind a DAO’s operations, which in the context of security breaches can be detrimental to stakeholders and their holdings within the DAO.

Algorithmic management structures are also subject to security flaws, but in a slightly different way. Flaws in algorithmic decision making may be harder to catch than flaws in the decision making of humans, and as such have a higher potential to be exploited by malicious parties.

Potential for Legal Changes:

Decentralized autonomous organizations are completely legal, however as with all new technologies, DAO’s are subject to significant changes in regulation. Current Wyoming legislation under Bill-SF0038 (effective 07/01/2021) dictates that the management of DAO LLC’s has many of the same requirements of traditional LLC’s, with some additional criteria for the more complex management structure and backend required for its operation.

Conclusion

By treating DAOs as a distinct legal entity with the same limited liability protections as traditional LLCs, Wyoming has become the only rational place to form a DAO. A DAO can provide all the advantages of an LLC with additional capabilities to fulfill a wide variety of possible needs that a traditional LLC is not capable of.



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