Cryptocurrency Trend Observation | Behind the Trend of Compliance, DAOs are Moving Towards the Real World

Author: Richard Lee, Chain Catcher

"2022 is the inaugural year of DAO explosion." This was one of the trends collectively favored by various predictions during the year-end review of 2021.

Recently, several well-known projects such as Gitcoin and SuishiSwap have announced that they have established or plan to establish legal entities for community DAOs. DAOs, which have long been in a legal gray area, are showing a trend of self-compliance, bringing more possibilities for the interaction between DAOs and the real world.

On March 21, the GitCoin community proposed that the newly registered Gitcoin Foundation in the Cayman Islands will become the legal entity representing Gitcoin DAO. At the same time, the SushiSwap community also initiated a proposal to establish an association or foundation for Sushi DAO to clarify the rights and obligations of token holders and contributors, limit their liabilities, and reduce risks.

More recently launched DAO organizations have "silently" set up similar compliance entities at their inception. On March 17, Yuga Labs launched the governance token ApeCoin, and the announcement page indicated that the legal entity ApeCoin Foundation was also established to oversee its governance community, ApeCoin DAO. Earlier, the ENS community's governance charter revealed that a non-profit organization in the Cayman Islands—the ENS Foundation—acts on behalf of ENS DAO in the real world.

Why are well-known project communities seeking to establish legal entities? What legal dilemmas does DAO face today? What problems can the community's compliance attempts solve?

1. Why is "Compliance" Necessary?

DAOs (Decentralized Autonomous Organizations) connect multiple parties through a code-based and distributed ledger system, and with characteristics such as trustlessness and automatic execution, they are expected to reduce the costs of contracting, execution, and supervision for modern organizations, being long viewed as a "new organizational structure paradigm."

According to analysis platform DeepDAO.io data, as of March this year, the number of DAOs has increased to 4,832, with 216 leading DAOs managing assets totaling $9.5 billion. Compared to the same period last year, the asset management scale of DAOs has grown nearly tenfold over the past year.

The large amount of funds is simultaneously facing the helplessness brought by an awkward legal status. To date, except for a few regions such as the Marshall Islands and Wyoming in the United States, DAOs are in a legal gray area between legality and illegality in most major regions worldwide. In the United States, unless a DAO is suspected of violating securities laws, federal regulatory agencies currently have almost no clear legal authority to regulate DAOs.

This gap means that DAOs are isolated from the current legal framework, having no obligations but also no rights. As Yuga Labs stated in their announcement that, most DAOs in reality "cannot sign leases, hire personnel, manufacture goods, or do anything else that the community decides to do on its own."

In terms of risks, according to analysis from informed sources, under the U.S. legal system, in the event of litigation, a DAO may be defaulted to be treated as a general partnership, with all DAO members bearing unlimited liability; correspondingly, the tax burden of DAO organizations may also fall on individual members.

Having a legal entity representing a DAO in the "real world" can enhance the DAO's ability to interact with the real world and mitigate risks. On one hand, it allows DAO participants to bear only limited liability; on the other hand, it enables DAOs to contract with other "real-world" service providers, legally hold assets, intellectual property, domain names, and raise funds.

2. The "Centralization" Controversy of Council Structure

According to H.Forest Ventures research, besides establishing representative legal entities for DAOs, there are other options for DAO compliance, such as "operating as a limited partnership (under the legal system of Wyoming, USA)." However, in practice, referring to the choices of projects like ApeCoin, GitCoin, and ENS, the "council structure" solution is the most popular.

The "council structure" refers to a core group designated by the DAO to represent and execute actions approved by the DAO (such as signing contracts or agreements with other companies) and appropriately manage the daily operations of the DAO. In the context of the ApeCoin Foundation and ENS Foundation, this "core group" refers to the "board of directors" established within these institutions.

However, some in the crypto community have questioned whether the council structure is sufficiently "decentralized," making the decision-making process of DAOs no different from that of traditional companies. Addressing the age-old "decentralization-efficiency" proposition in the blockchain industry, former Sushi leader OxMaki stated in an interview with the New York Times that he believes the advantages of DAOs—diversity and decentralization—have also proven to be their weaknesses.

"DAOs are composed of a variety of people from all over the world, with no relationships between the parties. Each group's vision and direction are different. DAOs have never reached complete decisions internally. This is a mistake," said OxMaki.

H.Forest Ventures believes that in the short term, in terms of interaction between DAOs and traditional companies, council DAOs are the most effective and seamless choice.

In practical design, the board not only acts as a centralized decision-maker but also has space to exist as a "supervisor." For example, in Yuga Labs' design, the ApeCoin Foundation "does not control ApeCoin or ApeCoin DAO." The board of the foundation acts as a "third-party project management team," responsible only for overseeing the decisions of ApeCoin DAO and ensuring that those decisions are implemented.

In the ENS and GitCoin communities, the foundation grants the DAO the power to appoint and dismiss board members, thus balancing the aforementioned centralization concerns.

3. Impact and Reflection

Establishing external legal entities has enhanced the ability of DAOs to interact with the real world, bringing DAOs one step closer to becoming a mainstream form of financial and cooperative organizations.

However, this is merely an effort towards external compliance in the DAO field.

Currently, the anonymity praised within the crypto community can, to some extent, foster power abuse, while DAOs lack clear obligations and accountability constraints in internal management.

At the end of last year, the SushiSwap team was embroiled in a departure dispute, and an investigation revealed that former CTO Joseph Delong allegedly forced out the Sushi leader through an internal power group, while he himself, as an employee of Sushi, was not fulfilling his duties in code development. This incident ultimately ended with Joseph Delong's voluntary resignation.

CoinGecko author Benjamin Hor summarized these phenomena, stating, "The reality is that all DAO members almost entirely rely on trust in selected individuals, and these individuals can choose to abandon accountability for their actions." In similar incidents, the crypto community often has to rely on public opinion to force resolution, lacking any formal internal accountability channels.

In the absence of external laws and internal self-restraint, existing DAO governance mechanisms often lead to phenomena such as "oligarchic" centralization or "tyranny of the majority" (the former case being the dominant position of "UNI whale" a16z in the Uniswap grant incident decision-making, and the latter being the Juno Network community's Proposal 16 to confiscate part of the assets of "airdrop whales").

Therefore, the future standardized operation of DAOs also needs to extend to the internal level.

As Juno Network core member Jake Hartnell reflected after the "Proposal 16" incident, with mechanisms such as minting/burning tokens, mandatory re-delegation, rollbacks, and freezing smart contracts, "community governance has more 'dictatorial' power than centralized institutions in the Web2 era," thus every proposal in the future should be discussed more cautiously and thoroughly, and a series of non-violable principles should be established in advance.