Wyoming’s DAO Law Provides a Regulatory Safe Haven for U.S. DeFi Projects

WYOMING’S DAO LAW PROVIDES A REGULATORY SAFE HAVEN FOR U.S. DEFI PROJECTS

Decentralized finance (“DeFi”) projects exploded in popularity in recent months, and some of that attention is coming from federal and state regulators. The SEC has been particularly active in the space lately, with Chairman Gary Gensler arguing that few projects are actually decentralized, settling its first enforcement action against a DeFi project, and investigating Uniswap Labs’ claims of decentralized governance. This heightened scrutiny by regulators has led to many projects leaving the U.S. market altogether.

There is an alternative to leaving the U.S. and that is the Wyoming decentralized autonomous organization (“DAO”) LLC. DAOs are a revolutionary corporate form that decentralizes corporate governance.  Wyoming, however, is the first jurisdiction in the world that recognizes DAOs as a formal legal entity and provides limited liability protection to DAO managers. In this way, Wyoming’s DAO law, provides an attractive alternative to DeFi projects considering leaving the U.S.

WHAT IS A DAO?

A DAO operates according to a series of software protocols called smart contracts[1], permitting distributed groups of individuals or entities to make decisions on the DAO’s behalf rather than a conventional governance model based on documents such as a shareholder’s agreement. In contrast to traditional corporations, DAOs can operate without a centralized entity such as a management team and instead allow token holders to vote on corporate governance according to the number of governance tokens that they possess.

Typically, the DAO’s creator will develop the initial smart contracts that govern the organization and maintain a significant number of the governance tokens, but, over time, as the number of token holders increase, the underlying structure allows the community to assume primary leadership. For example, many DAOs allow token holders to propose ideas for improving and governing the organization without having to rely on managers who may be out of touch with the majority will of the organization’s stakeholders. DAOs also provide greater transparency to corporate decision-making because governance decisions and financial transactions are maintained on the organization’s distributed digital ledger.

Despite initial failures, DAOs have become incredibly popular among DeFi projects and govern many of the leading DeFi organizations such as Uniswap and Sushiswap. DAOs have become especially widespread as regulators have cracked down on DeFi projects that are not sufficiently decentralized.

WYOMING’S DAO LAW

Wyoming’s law applies to DAOs organized under the Wyoming Limited Liability Company Act and helps to guarantee the rights of a DAO as a legal person, giving structure and clarity to DAO projects.

Limited liability companies (“LLC”) offer several key advantages: protecting their owners from personal liability for the LLC’s obligations, offering pass-through taxation, and providing significant flexibility in management structure with fewer formalities than corporations. Without the protections afforded by an LLC, members of a DAO could be exposed to personal liability for the DAO’s actions and obligations. Through its DAO law, Wyoming has conferred these key advantages upon investors in decentralized organizations.

The law allows two different types of DAOs: those managed by members and those managed by algorithms. A member-managed DAO operates similarly to a member-managed limited liability company because certain designated persons or entities are responsible for the organization’s management. In contrast, an algorithmically-managed DAO will be governed primarily by the organization’s smart contracts.

Notably, the DAO LLC’s articles of organization must contain a publicly available identifier of the smart contracts used to “manage, facilitate or operate” the organization. Moreover, in the case of an algorithmically managed DAO, the organization’s smart contracts must be capable of being updated or modified.

These requirements provide disclosure to the public and resolve potential conflicts between the DAO’s articles of organization and its smart contracts, but also arguably undermine the goal of a completely decentralized organization that many DAOs seek.

However, as Wyoming Senator Chris Rothfuss, the co-chair of the Select Committee on Blockchain and Financial Technology that sponsored the legislation, explained, “[t]he bill’s passage doesn’t mean the Wyoming legislature is finished with providing regulatory guidance around DAOs.” Rothfuss has said that the Committee is seeking feedback from industry participants to identify areas where the existing DAO legislation can be improved emphasizing, “Maybe we need a DAO C Corp next to address other challenges. We're certainly not done yet.”

Therefore, even though there are unresolved questions, Wyoming’s legislators and regulators have committed themselves to a proactive approach toward crypto regulation, valuing and incorporating input and counsel from industry leaders.

WYOMING REAPS THE BENEFITS OF THE DAO LAW

With its DAO law, Wyoming has continued the “pioneer spirit” that led it to create the LLC in 1977. In the face of growing hostility toward DeFi on the federal and state level, the Cowboy State is harnessing the incredible innovative power of DAOs while providing regulatory certainty and protections to its managers.

When Wyoming first adopted the LLC in 1977, the rest of the United States eventually followed because other jurisdictions recognized the tremendous benefit that limited liability could confer in a member-managed organization. Wyoming has already reaped tremendous benefits from this proactive stance on blockchain and, if history repeats itself, we expect that the rest of the U.S. will follow suit.

For future updates on developments shaping the new Crypto Frontier, be sure to follow the Tacen Regulatory Corner.

[1] Smart contracts are simply programs stored on a blockchain that run when predetermined conditions are met. They typically are used to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without any intermediary’s involvement or time loss. They can also automate a workflow, triggering the next action when conditions are met.

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