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Misadventures in DAO incorporation
Misadventures in DAO incorporation

Tech around the world

Misadventures in DAO incorporation

Wyoming’s Bill 38 lets DAOs incorporate as LLCs. But not everyone thinks the legislation is right for them.

Written by Shreeda Segan

Illustrations by Ryan Nguyen

On Thursday, July 1, 2021, Thiel fellow and AirGarage CTO Scott Fitsimones accidentally tweeted a decentralized autonomous organization (DAO) into existence: “Buying 40 acres of land in Wyoming as a DAO.”

The tweet amassed over 1,000 likes. That interest turned into a Discord community. And a few weeks later, the group registered CityDAO as an LLC in Wyoming. It took ten days for CityDAO, an experiment in collective land ownership, to receive formal approval; it is one of the very first DAOs in the country to register as an LLC.

“It was not this nice Web3 experience where you press a button and you get an organization,” Fitsimones recalls. “But Wyoming still tries to make it easy.”

CityDAO could buy land collectively thanks to Wyoming’s newly-passed Bill 38, which allows DAOs to incorporate as LLCs, the first law of its kind in the U.S. DAOs are member-owned communities without centralized leadership, where members collectively drive decisions via smart contracts. They have grown in popularity since DAOs first got their start in 2016. But they haven’t received much encouragement from the U.S. government.

“The new legislation is Wyoming raising a flag and saying: we want you to come here to innovate, experiment, and build,” says Fitsimones. With incorporation, DAOs are granted benefits like limited liability protection (meaning the personal assets of all the members are separate from the company’s), access to banking, and tax ID numbers.

According to Wyoming state senator Chris Rothfuss (D), who drove the bill, at least 350 DAOs have incorporated in Wyoming since the passing of Bill 38. “Our core philosophy is to regulate-to-enable rather than regulate-to-restrict,” he says. “We want this innovative technology space to realize its potential — and hopefully realize it in the state of Wyoming.”

But not everyone believes that the new incorporation rules are the best fit for DAOs. A range of critics have arisen in response to the legislation.

“You need the right tool for the right job,” says David Kerr, the principal at Cowrie LLC and the head of research at the DAO Research Collective. According to Kerr, a key reason the legislation isn’t the right fit — not right now, but possibly in the future with some iteration — is because DAOs and the reasons people start them are diverse.

While LLCs work for investment DAOs, a collective of people who invest funds like ConstitutionDAO, which attempted to acquire a copy of the U.S. constitution, they don’t work as well for network or social DAOs, which are communities formed around shared values and projects. An example of a network DAO is Friends With Benefits, a DAO in which web3 creatives convene.

Kerr likens network DAOs to informal gatherings and makes clear that they aren’t businesses. “They’re developing oversight of a protocol and an idea, not opening a Starbucks.” These DAOs often have anonymous members, and this anonymity can be incompatible with incorporation. “Tons of LLCs don't know who the members are, but they have a manager who does know,” Kerr explains. “How does anonymity fit in there?”

Lawyer Eric Hess, who advocates on the behalf of equity exchanges, broker-dealers, fintech, digital asset, and cybersecurity companies — as well as DAOs like Cabin — goes on to ask who should actually be considered members in a DAO LLC and how one manages a fluid community.

In his view, a DAO is not an entity in itself, but it can have entities as members, perhaps some that are recognized as LLCs. But registering as an LLC requires all members to be involved in a way that might not be productive — or easy to discern.

Let's say someone simply buys and sell tokens. Are they really involved in the day-to-day operations and governance of the DAO? And how well are they covered by LLC protections?

~

After incorporation, CityDAO’s contributors started to research land options and add them to spreadsheets, replete with details like size, distance from airports, and water access. The top parcel choices went to a vote. The DAO decided to buy a piece of land they call Parcel 0 in Clark County, Wyoming, about an hour outside of Yellowstone.

CityDAO fundraised to buy land, including selling “citizen” NFTs for about .25ETH; these gave purchasers access to the Discord, voting rights, and a claim to the land. And two months later, CityDAO’s offer on a 42-acre parcel of undeveloped land near Cody, Wyoming was accepted.

The land was a vast expanse of sprawling fields surrounded by rolling hills. As of mid-August 2022, CityDAO was in the works of acquiring two more parcels of land — one in Colorado and another in an undisclosed, to-be-determined location. The former will be smaller and treated as an experiment in NFT land leases; the latter “hundreds of acres in size, in America, which can be used for various city-building purposes.”

Fitsimones has faced some real-world challenges. Local neighbors of CityDAO’s parcel 0 (there aren’t many) were initially confused when they learned what was happening next door. But Fitsimones was able to assuage their concerns that a city was sprouting up by explaining that “a city doesn’t necessarily mean skyscrapers.”

Eventually, some inquiring Wyomingites went on to join the CityDAO community.

Fitsimones also found it challenging to buy land. “It inspired us to rethink how land works,” he says. He wants CityDAO to make this process easier for web3 natives by “putting land on-chain and representing it as an NFT” and “creating NFTs that represent the title of that land.”

~

The other major criticism of the legislation involves smart contracts, which are hosted on the blockchain and automatically execute actions based on the results of a DAO’s collective vote. An LLC requires smart contracts to be amendable, which several critics — like web3 lawyer Jordan Teague — have said contradicts their goal, which is that they are permanently recorded on the blockchain.

Plus, Kerr adds, smart contracts make decisions that guide DAOs and can often be more binding than articles of organization. So which should take precedent? “When do smart contracts matter more than the state law?” he asks.

“The operating agreement could be encoded as a smart contract, enforceable by code not courts,” agrees Fitsimones.

Others take it further. Web3 lawyer Jordan Teague writes that Wyoming should defer to smart contracts over articles of organization. Carla Reyes, assistant professor of law at Southern Methodist University, speculates about finding a new form for incorporation and endowing smart contracts with legal “personhood.” Hess explains that granting corporate personhood might help account for taxes and liability in those cases that DAOs don’t incorporate: “if you don’t create an entity, if something goes wrong, everyone who is a part of [the DAO] is vulnerable to liability.”

"There's no need for incorporation because smart contracts deterministically execute agreements," agrees Jonathan Hillis, the founder of Cabin, a DAO that helps creators make a living online.

Many DAOs like Cabin have started to look to unincorporated nonprofits (UNA), which consist of two or more people agreeing to work together on a charitable cause. They can get a tax ID number, potentially qualify for tax-exempt status, and raise profit; but they cannot redistribute profits among members. In order to avoid legal confusion around member interests and anonymity, they’re treated as an entity separate from their members.

“Tons of LLCs don't know who the members are, but they have a manager who does,” says Kerr. “How does anonymity fit in there?”

"The unincorporated nonprofit association is not the only legal structure for DAOs, but it is an interesting one," Hillis says. "Decentralized communities like Cabin are nonprofits because all of the gains are reinvested in the community. There are no dividends being distributed to shareholders. It's more like a cooperative, more like a city. And it’s an association because the members of the community are not acting within corporate structures; there's no CEO dictating ‘here's what we're going to do.’"

Hillis inherited the land for Cabin's first node from his family. Despite their benefits, unincorporated nonprofits can not buy land collectively — Cabin will have to find another way to acquire more land.

~

Today, the land bought by CityDAO may only feature a bench and flagpole, but the DAO is free to do with it what it likes. The plot has been “fractionalized” into over 6,000 plots that can be bought and controlled by NFT holders. In mid-September, lots were going for $0.03 ETH — around $42.

“People have rightly pointed out the law isn’t perfect,” Fitsimones says, listing potential changes like understanding which tokens determine voting power, handling off-chain voting better, and offering guidance on how to interface with the real world. “I also think states should frame these laws for crypto-native organizations in general, not just DAOs.”

And yet, Fitsimones is happy with CityDAO's choice to incorporate.

“The LLC is an incredible human invention,” he says. “It fosters innovation by limiting liability and offering protections that a DAO without incorporation might not have. Many DAOs currently operate with no legal entity. They exist in the crypto cloud. This arrangement is technically called a general partnership, where you have unlimited liability. So for that reason, I do strongly recommend anyone starting a DAO to consider using a real legal entity.”

Rothfuss, who joined the senate in 2011 and became the minority leader in 2013, says that the working group formed to create Bill38, which includes government officials, lawyers, business members, and crypto leaders like bitcoin evangelist Caitlin Long, is “already working on revisions.” (According to Rothfuss, Long once tried sending the University of Wyoming a gift in bitcoin, but they were unable to accept it at the time. This sparked her first conversations with the Wyoming government.)

Rothfuss adds that Wyoming's DAO-friendliness is in line with their history as the first state in the U.S. to allow for LLC incorporation in 1977.

He describes their progress in 2022 as mostly “bug fixes” and says the group is continuing to consider other “feature requests,” sharing that the legislature is getting very close to passing an amendment to Bill 38 that will specifically allow DAOs to also explore becoming unincorporated nonprofits.

“[Bill 38 is] not a perfect law; there are problems with it,” says Fitsimones. “But at the end of the day, this law created a very clear pathway. It basically planted a flag in the ground that said, ‘You are welcome in Wyoming to come try your crazy DAO experiments.’" And it's something that is helping CityDAO achieve its mission.



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