Imagine that you’re a regular working Joe, and you want to support research companies working on a cure for cancer or Alzheimer’s disease by creating a venture capital organization. You happen to be part of a large online community that wants the same thing.
However, you don’t really know each other. How can you get members of that community to trust you enough to put their money into the venture? For starters, you could create and run a decentralized autonomous organization, or a DAO.
How Does Decentralized Autonomous Organization (DAO) Work?
As the term suggests, a decentralized autonomous organization (DAO) is a group of people that bands together for a common purpose. It is essentially the formation of new digital communities. Members follow the rules created when the DAO first launched, but each stakeholder has a say in anything the group does, including how to spend the community treasury.
Instead of a central authority, e.g., CEO, board of directors, or hierarchy, a DAO has smart contracts that contain the group’s rules embedded in code using blockchain technology. In essence, though it’s not a tech company, it is a democracy in the digital space.
The operative phrase here is “smart contracts,” which are a series of “if-when” programs stored in a DAO’s blockchain network that automatically execute when the terms of an agreed action are met. These are publicly available, verifiable, and visible. There is no delay or need for an intermediary.
The smart contracts dictate all operational aspects of the DAO, although the stakeholders are the ones that make up the rules. Once encoded in the blockchain, no one person can change the rules, including the developer who created the programs. A majority of stakeholders must agree to any modifications in the smart contracts. That, too, is embedded in a smart contract.
So how does a DAO do business? Typically, any stakeholder or member of the DAO can submit a proposal to a fast vote to take the desired action, e.g., invest in a research firm, and the stakeholders vote on it. No proposal passes without the approval of the group.
The vote can be token-based (each token has a pre-agreed voting value) or quorum-based (each member has one vote), depending on the membership type. Voting is entirely voluntary. A stakeholder may choose not to exercise that right.
For token-based voting, stakeholders must typically commit a certain number of their tokens to a proposal to signify their approval. If the proposal passes, they have “skin” in the game equivalent to the number of tokens they committed. For quorum-based voting, all stakeholders commit their shares to the successful proposal whether they voted for the proposal or otherwise.
You should note that a DAO is not the same as “The DAO” as you might encounter in a search. The DAO is a failed attempt by a team of developers to form a venture capital fund in 2016 through the Ethereum blockchain network. A vulnerability in the code base enabled hackers to steal $50 million worth of ether, Ethereum’s native token, from the fund earmarked for The DAO and led to a hard fork within Ethereum. Despite its failure, The DAO was the precursor of many successful DAOs today.
Why Do We Need a DAO?
Most businesses and organizations still subscribe to the traditional hierarchical structure with a central (or C-suite) decision-maker. However, a DAO offers an attractive alternative to people that do most things online, including business and financial transactions. According to Aragon, a DAO is “[a]n online community with a shared crypto wallet.“
Because a DAO is a verifiable and visible automated system, it removes the need for people to trust other people to do business with them. DAO members only need to trust the blockchain technology and the code in the smart contract, typically tested extensively before launch and governed by the community. Stakeholders do not have to be afraid that their agent, usually the CEO, will act in ways that do not align with the organization’s goals or best interests.
DAO is also borderless, representing a unique opportunity for people worldwide to coordinate and collaborate on blockchain technology projects. Such projects may involve cryptocurrency, such as Bitcoin, but with Ethereum, a DAO can be anything. Below is a quick comparison of a DAO and a traditional organization:
How to Create a DAO
Now that we know the benefits of a DAO, the next question is how to create one. Creating a DAO involves three main steps. These are the creation and extensive testing of smart contracts, determination of a funding setup and governance framework, and deployment on the blockchain.
Typically, the first step requires the services of a team of developers. However, given the rising popularity of DAOs, it is now possible for non-coders to create Ethereum dApps and smart contracts using a Web3 development platform, such as Moralis. That said, it would be advisable to get someone with technical knowledge to set up a DAO right up to deployment. After that, the DAO creators will no longer have unilateral control over the project.
While creating a DAO is straightforward, the legal ramifications of doing so are still under debate. Because DAOs are new legal entities in the US (more on this in the next paragraph), issues, such as tax reporting and partner liability, constitute a significant concern.
One solution is to register a DAO as a limited liability company (LLC) in Wyoming, which is the only state in the US that allows it. As an LLC, DAO members receive the same protections from personal liability as traditional stakeholders in regular LLCs.
Below are the steps to register your own DAO startup as an LLC in Wyoming.
Understanding DAO and Ethereum
Now that you understand the practical and legal aspects of creating a DAO, you must now choose a platform for running a DAO and making financial transactions. Ethereum is probably the best-known and most popular ecosystem for this purpose.
Ethereum is an open-source community-supported platform based on blockchain technology. It is most widely known for its cryptocurrency (ETH), but unlike Bitcoin, it can support other cryptocurrencies and applications, including dApps and smart contracts associated with DAOs. You can access an Ethereum dApp using a cryptocurrency wallet like MetaMask.
Among the DAOs you can create on the Ethereum platform include:
- Charities – Because DAOs are digitally-native, it has no borders. Charities can greatly benefit through a DAO as it facilitates trust with donors and members anywhere in the world. An Ethereum DAO also makes it easy for stakeholders to decide where the funds should go. One example is the Big Green DAO.
- Freelancer networks – Freelancers today are essentially anonymous, so getting a supportive community together can be challenging. A DAO of freelancers provides them with an opportunity to connect with other freelancers and financially support each other, whether it is to get software subscriptions or to put up a referral service, such as Freela.
- Venture capital – Venture capital funding is an excellent use of DAO because members have a say in distributing the funds. Provided the DAO is diverse, it can level the playing field for all businesses looking for investors. A good example of this is VitaDAO, which finances longevity research.
Despite The DAO debacle, which was attributed to human error rather than a problem with the infrastructure, Ethereum is sufficiently established and distributed to be a reliable network for DAOs. Its community is collaborative and supportive, making it ideal for creating and implementing best practices for decentralized finance (DeFi). Additionally, the smart contracts it supports can securely execute on-chain transactions, and the code cannot be modified once they go live.
Running a DAO
Creating a DAO LLC protects you from legal liabilities, but you then need to worry about other things. Running a DAO is relatively simple once you have smart contracts created, tested, and deployed. However, the success of a DAO relies heavily on its governance framework, which is the DAO process of managing collective decision-making for optimizing funds and its operations.
Common DAO governance areas include:
- Ownership and management of collective assets – Addressing asset and liability, income, liquidity, and financial allocation considerations for the DAO balance sheets and community treasury
- Asset risk management – Addressing the mitigation of risks by monitoring price, volatility, and other market conditions
- Curation of assets – Addressing goals and the process of curating all assets as pertinent to the nature of a DAO, e.g., artwork, non-fungible tokens (NFTs)
It might seem ironic that an organization based on autonomy should need a governance framework. Still, it stands to reason that such an open-finance-based system would require decision frameworks to incentivize people to invest in DAO so it can grow. These decision frameworks address two things: security and financial incentives.
Security is the first hurdle. People will not invest in an entity that might result in their money disappearing. As evidenced in the case of The DAO, a single mistake can lead to the downfall of even the best-conceived DAO. Experiments with and implementing better security standards on Ethereum and other platforms assured stakeholders that their investments are safe in a DAO.
The next hurdle is getting stakeholders to participate more actively in voting and investing in DAOs. The rise of DeFi led to the formation of incentive models. One of them is the token distribution model of Compound, which is an on-chain lending protocol that incentivized members to take out loans and increase the protocol’s interest-earning assets.
Similarly, yield farming rewards users for increasing a DAO’s asset liquidity by borrowing, lending, and staking in the form of DAO tokens representing a slice of ownership of the protocol. Retroactive airdrops are also another incentive model that contributed to the growth of DeFi protocols, distributing tokens to reward early investors and supporters of a project. Various use cases provide evidence of the effectiveness of these models, but they are by no means the only ones in use.
A DAO with good governance has a fair chance of success in the DeFi and blockchain space. Creating and running a lucrative DAO will encourage mainstream consumers to adopt blockchain technology to take advantage of its opportunities.
Want to Learn More About the DAO Process?
As you can see, creating and running a DAO is not as complicated as you might have thought. Provided you do your due diligence in creating smart contracts using a reliable platform, such as Ethereum, you should have your DAO up and running at the push of a button.
If you want to know more about the DAO process, check out our article on the website. If you are already in the process of creating a venture capital DAO to support cancer or Alzheimer’s disease research, we can help guide you on how to incorporate it as an LLC in Wyoming.
We at doola offers everything you need in compliance with Wyoming statutes, including registered agent services and a business address for non-Wyoming residents. We can also provide annual compliance reminders, tax filing services, and anything else you need to maintain and operate your DAO LLC in Wyoming.
If you have plans to create and operate a DAO LLC instead of a C Corporation, it is critical to know the basics. Find out more about DAO LLC and LLC formation by visiting doola and checking out the blog. We have the answers you need when it comes to LLC formation, maintenance, and compliance anywhere in the US. You can also chat with us about your needs and requirements 24/7. We are always willing and ready to help.
FAQs on How to Create and Run a DAO
What does member-managed DAO LLC mean?
Because of the nature of DAOs, a DAO LLC is always member-managed. A majority of members must vote for any decision to move forward concerning the management and operations of a DAO.
Can I file a DAO in other states?
Currently, only Wyoming has passed legislation that would allow a DAO to register as an LLC.
Is DAO legal?
That depends. The legal status of DAOs varies by jurisdiction, although generally, they may operate as a general partnership anywhere in the US. However, they may be vulnerable to legal or regulatory actions. The only exception is Wyoming, which recognized DAOs as a legal entity on July 1, 2021.