The State of Wyoming is solidifying its position as the friendliest state in the US for digital asset innovation.
Although comprehensive digital asset regulation at the federal level remains elusive, US states are angling to establish themselves as blockchain and crypto-friendly jurisdictions. At the forefront stands Wyoming, with a track record of fostering digital asset-friendly policies. Most recently, on April 21, 2021, Wyoming’s governor signed into law a bill sponsored by the state’s Select Committee on Blockchain, Financial Technology and Digital Innovation Technology, the first in the nation to allow decentralized autonomous organizations (DAOs) to obtain legal company status. The legislation becomes effective on July 1, 2021.
In general, DAOs are organizations without a centralized entity like traditional corporations. Governance of DAOs is driven by the coded terms of smart contracts maintained on the blockchain ledger, rather than top-down by a management team. And rather than having a hierarchy of control, all DAO stakeholders with tokenized voting rights are considered equals, proportional to tokens held.
The proposed legislation would allow DAO protocol creators to pursue development and growth post-token launch by registering in Wyoming as a limited liability company (LLC) (a popular business structure first established by Wyoming in 1977). DAOs would benefit immensely from the ability to incorporate, register, transact, hire employees, and scale like any other LLC can. The legislation would therefore provide legal structure, regulatory clarity, and operational legitimacy for many fledgling digital asset projects.
What’s in the Legislation?
Under the terms of the legislation, a DAO “is a limited liability company whose articles of organization contain a statement that the company is a” DAO. An LLC may also convert to a DAO by amending its articles of organization to conspicuously include the same statement. The DAO’s registered name would also be required to include the appropriate designation, such as “DAO,” “LAO” (limited liability autonomous organization), or “DAO LLC.”
The articles of organization filed with the secretary of state for registration would also be required to describe the DAO’s structure as either a “member managed decentralized autonomous organization,” or an “algorithmically managed decentralized autonomous organization” managed by smart contract. If not specified, the organization will be presumed to be a member-managed DAO.
Importantly, an algorithmically managed DAO may only be formed “if the underlying smart contracts are able to be updated, modified or otherwise upgraded.” Such a provision would ensure ongoing member involvement in the DAO.
The DAO’s articles of organization would also govern various elements, including:
- Relations among the DAO members, and between the DAO members and the DAO
- Rights and duties of DAO members
- Activities of the DAO and the conduct of those activities
- Means and conditions for amending the operating agreement
- Rights and voting rights of DAO members
- Transferability of membership interests and withdrawal of membership
- Distributions to members prior to dissolution
- Amendment of the articles of organization
- Procedures for amending, updating, editing, or changing applicable smart contracts
The DAO’s articles of organization would need to be amended if:
- An error needs to be fixed.
- The DAO name changes.
- The DAO’s smart contracts have been updated or changed.
The legislation states that unless otherwise provided for in the articles of organization or supplemental operating agreement, no member of a DAO shall have any fiduciary duty to the DAO or any DAO member “except that the members shall be subject to the implied contractual covenant of good faith and fair dealing.” The legislation also includes a discussion of calculation of member interests, a quorum requirement for voting, miscellaneous rights and restrictions on DAO members, and terms of dissolution. Finally, the legislation concludes with a hierarchy of authority for the various governing documents: the articles of organization preempt any operating agreement, but the smart contract will preempt the articles of organization (with a few limited exceptions).
Weighing the Benefits and Concerns
Supporters of the DAO legislation maintain that it is a significant step for blockchain and digital asset innovators. In particular, they hold that it potentially opens the field to fully programmable autonomous legal entities. Many proponents also argue that the legislation advances the once fanciful notion of “code is law,” whereby digital code and algorithms embedded in smart contracts are the final arbiter of governance, contract performance, and dispute resolution.
Concerns can be raised, however, on the issue of whether registration as a Wyoming LLC tempers the fundamental “decentralized” aspect of DAOs. That is, does the US Securities and Exchange Commission (SEC) now have an identifiable entity or individuals that encapsulate network development and governance structure? The determination that such an entity or individuals are “active participants” (APs) is crucial to the third prong of the Howey Test as it relates to digital assets, whereby expectation of profits derived from the efforts of others (e.g., a manager, promoter, sponsor, or other third party (or affiliated group of third parties)) plays a key role in determining whether a digital asset is a security. (See this previous post for more information.) Without organizing as an LLC, one could argue that all the participants are independent and do not constitute a structured group of APs.
Registration under the law, however, could enable a more sustainable decentralized ecosystem. For instance, user interface (UI) hosting and maintenance can be shifted to the DAO rather than being maintained by the initial developer. This change would ultimately allow the decentralized governance protocol to control, or direct the control of, the UI. Ideally, a small group of people could be elected by the DAO’s decentralized governance protocol to oversee non-critical and off-chain decisions. For instance, the governance protocol could empower the elected individuals to make decisions regarding certain aspects of treasury management and asset allocation.
Achieving the proper balance between centralization and decentralization will not be easy in a climate of regulatory uncertainty. Clear guidance from the SEC would be welcome regarding what centralized activities would be viewed as permissible for a DAO to engage in (e.g., administration, upkeep, etc.) without the risk that any individuals affiliated with the DAO be labelled APs that are somehow responsible for network development and digital asset appreciation.
Another Block in the Chain
The DAO legislation further bolsters Wyoming’s reputation in the industry as “Blockchain Valley.” Notably, it follows Wyoming’s decision in 2019 to charter special purpose depository institutions (SPDIs), enabling digital asset companies to operate as depository banks and custodians in the state and beyond, with access to the federal payments infrastructure. These developments should help promote blockchain business development across the United States.