Original title: The DUNA: An Oasis For DAOs Original author: Miles Jennings, David Kerr, a16z
Everyone active in Web3 has heard of the term "DAO," which stands for Decentralized Autonomous Organization. DAO is a key tool for keeping blockchain networks open and has been working hard to become a benchmark for Web3, but there is a topic that cannot be avoided, and that is law and regulation.
This week, Wyoming passed a new bill that brings DAOs under the purview of legal entities. This will allow blockchain networks to operate within the boundaries of applicable laws without compromising their decentralized nature. This is a major breakthrough as it will provide much-needed protection to DAOs and give them the ability to keep their blockchain networks open.
Wyoming has a long history of supporting innovative legal entity structures. The state was the first to adopt the Limited Liability Company (LLC), the first to adopt the Unincorporated Nonprofit Organization (UNA), and the first to introduce a subset of its LLC statutes for use by DAOs. The new Wyoming law incorporates many of the provisions proposed in the model legislation we published.
This new entity structure will likely become the industry standard for blockchain networks created in the U.S. So, here’s everything you need to know about the Wyoming Decentralized Unincorporated Nonprofit Organization (DUNA).
1. What is DUNA?
On March 7, 2024, SF50, the Wyoming Decentralized Unincorporated Nonprofit Association Act, was signed into law, with an effective date of July 1, 2024. The bill is closely related to Wyoming’s existing Unincorporated Nonprofit Association Act, but it is specifically designed for decentralized organizations.
Just as Wyoming’s prior DAO law (W.S. 17-31 Decentralized Autonomous Organization Supplement) could be considered a “Digital LLC,” the SF50 could be considered a “Digital UNA.”
Additionally, one can think of it as the Web3 version of a Town Council. The purpose of a Town Council is to protect the standards and operations of the town by enforcing the community’s rules and regulations, ultimately serving the interests of its citizens, their homes, and their businesses.
Likewise, DUNA’s purpose is to protect and support the underlying blockchain network, but like the town council, it is not a company itself.
2. Why is DUNA necessary?
Entrepreneurs around the world are using blockchain technology to build a better internet, which is fundamental to returning the internet to its original open form. However, if we let corporations own these networks, we will end up back in the same situation we are in today: our entire digital world is controlled by a few giant companies.
Blockchain technology offers a promising solution to this problem. It makes it possible to create open blockchain networks that are more like public infrastructure than proprietary technology, meaning that anyone can build on top of them, just as anyone can currently build businesses using open internet networks (e.g., email and websites).
DAOs are made up of community members who manage the affairs of an open blockchain network. They are a critical tool to ensure that the network remains open, does not discriminate, and does not extract value unfairly. DUNA helps them achieve this by addressing three key challenges facing DAOs. It gives DAOs legal status, enables them to contract with third parties and have legal person attributes, and it enables DAOs to be taxpayers and provides them with limited liability for the actions of other members. All of this is commensurate with other legal entity forms and protected by U.S. jurisdictions.
DUNA solves these challenges without adding additional risk to consumers. DUNA can be used for decentralized governance of open blockchain networks, but anyone building consumer-facing applications on top of these open networks (such as social media apps, car services, or music streaming apps) will continue to use traditional legal entity forms such as corporations or LLCs. Although this paradigm includes the use of corporations, the fundamental difference is that corporations no longer control the underlying network, they only control the user-facing applications. This difference greatly reduces their ability to extract value like web2 companies do.
3. Why should DAOs use DUNA?
Membership and participation in DAOs currently face several legal risks. DAOs that fail to use a legal entity for their organization are unable to have legal rights, such as being unable to pay taxes, and face potential liability risks. At the same time, the lack of a legal entity also threatens the privacy of DAO members. Due to these risks, the failure to use a legal entity hinders the decentralization of blockchain networks, limits their growth, and hinders the development of economic models for such systems.
If DAOs fail to adopt legal entities, these risks could lead to worse outcomes until a better solution emerges. For example, regulatory actions and class-action lawsuits in the United States claim that a DAO without a legal entity is just a general partnership. While there are several strong arguments to challenge these allegations, such a classification would be disastrous for DAO members, exposing them to unacceptable tax risks and legal liabilities. As it stands, the odds are on the side of regulators and plaintiffs. If their theories spread and succeed, it could even be the death knell for decentralized governance.
DUNA prevents this from happening, solves key challenges facing DAOs, and significantly reduces the risk to DAO members. It provides DAOs with legal standing, enables them to contract with third parties, open bank accounts, and provides simple tools for the servicing process. It enables DAOs to pay taxes and meet their information reporting requirements. It protects DAO members’ privacy from intrusion by the federal government. And, it provides liability protection for DAO members.
It achieves all of these requirements without disrupting the way DAOs are currently launched and operated, it protects the fundamental principle of decentralization, and it enables DAOs to effectively grow the ecosystem of their underlying blockchain network.
4. If DUNA is a nonprofit organization, can they engage in for-profit activities?
The answer is yes. Under Wyoming law, both UNA and DUNA can engage in for-profit activities. This would include operating a decentralized exchange protocol, a decentralized social media protocol, you name it.
Wyoming’s DUNA statute also explicitly allows for fair compensation for any services provided to the DUNA ecosystem. This feature is expected to enable DUNA to compensate members who help promote its growth without extracting value from users. This is critical because it ensures that blockchain networks can operate in a decentralized manner and compete with centralized corporate networks.
For example, using this feature, a DAO could pay its members in exchange for governance participation. In this case, the rationale for DUNA rewarding people for voting or delegating could be that, according to regulations, DUNA has no centralized management and therefore needs to rely on its members to manage all of its affairs. Therefore, in order to ensure proper management of DUNA, significant participation is necessary, and DUNA could provide compensation to members to achieve this goal.
While Wyoming courts will ultimately rule on what compensation is reasonable, there are plenty of real-world examples of nonprofits from which to draw inferences. In addition, the unique characteristics of blockchain networks also provide a solid foundation for arguments about the reasonableness of member compensation. For example, because blockchain networks are typically open source and can be "forked" (copied) by anyone, the continued adoption and development of a particular blockchain network that collects fees and distributes compensation to members actually represents a tacit acceptance by users that the network is reasonable to pay compensation, otherwise they would launch an alternative network (e.g., through a fork).
Nonetheless, the “reasonable” qualifier does place an upper limit on the value that a blockchain network can extract from its users and use to compensate members. While those who wish to design vertically integrated and centralized blockchain products and services may struggle with barriers to value extraction, the concept is consistent with the ethos of blockchain networks, not in opposition to it. If web3 blockchain networks ultimately extract value from their users in the same way that web2 enterprise networks do (e.g., Apple takes a 30% cut of AppStore products), then Web3 will have failed. Wyoming’s approach supports the ethos of web3 while still providing cash flow to digital asset holders. This is a significant breakthrough.
5. What are the securities law implications of using DUNA?
Under the Howey test, which is the test for determining whether U.S. securities laws should apply to digital asset transactions, three elements must be met. There must be (1) an investment of money, (2) participation in a common enterprise, and (3) a reasonable expectation of profits based primarily on the managerial efforts of others.
Proponents of blockchain technology have long argued that none of these are met for the vast majority of digital asset transactions. Most of these arguments would hold, and they could even be enhanced by a DAO taking the DUNA legal entity form.
For example, using DUNA can largely resolve the arguments raised by Howey Article III. First, DUNA is essentially a decentralized entity form, and its underlying structure does not include management functions and has no officers and directors. Second, DUNA members have no legal obligations or rights to maximize the organization's profits. Together, these characteristics greatly negate any claim that members may have "reasonable expectations of profits based primarily on the management efforts of others" when purchasing digital assets. Finally, as mentioned above, the nonprofit nature limits DUNA's ability to distribute organizational profits to its members, but does allow it to compensate members for their contributions to the organization. Therefore, any member who is compensated is necessarily not profiting from the management efforts of others, but from their own efforts.
Nonetheless, the SEC may attempt to argue that DUNA satisfies Howey’s “common enterprise” requirement because membership in DUNA is denominated in the DAO’s digital assets. However, a number of counterarguments can be made based on DUNA’s decentralized structure. Moreover, regulators have sought to designate DAOs as general partnerships or unincorporated associations under common law, which at the very least suggests that designating DUNA as a “common enterprise” is self-contradictory. Finally, the rights of DUNA members are largely a product of the DUNA’s governing principles, which are typically rights set forth in the underlying governance and protocol smart contracts that constitute the DAO, and which exist regardless of whether the DAO formally adopts a DUNA structure. Therefore, if the underlying governance smart contracts are insufficient to qualify as a “common enterprise,” there is no reason to argue that the existence of DUNA changes that conclusion.
While the SEC’s theories regarding the applicability of U.S. securities laws to digital asset transactions are murky and evolving, the fact is that they remain subject to the Howey Act and subsequent cases, under which a DAO could adopt a DUNA to support its community’s arguments against the application of securities laws to the DAO’s digital assets.
6. What are the tax implications of using DUNA?
For anyone who has consulted with a tax advisor about DAO taxation, the specific circumstances and circumstances of a project are the most important factors in forming the answer to a specific question, and generalizations are not a substitute for project-specific advice.
Like LLC and UNA, DUNA can eliminate the complexity of DAOs operating under the US tax law framework because they can be taxed as corporations. Corporate tax treatment allows UNA and DUNA to fulfill their tax obligations in a way that does not require disclosure of individual members and avoids the complexity of pass-through taxation, which solves a common problem for blockchain network DAOs. In addition, the United States has signed a large number of tax treaties with many countries and regions and provides an environment where tax obligations can be clarified by utilizing domestic entities, which is an excellent advantage for DAOs composed of members from multiple countries.
To be clear, all of the above means that the DAO will have tax liabilities arising from its activities, which may be different than those that exist today, but ultimately these tax liabilities will greatly reduce the risk associated with membership and provide clarity in an uncertain tax environment. By paying taxes somewhere, and having it be within the US tax purview, the DAO is able to resolve the huge unknowns surrounding its operations and member risks.
7. Why don’t more DAOs adopt UNA entities?
Because the DUNA structure was introduced only recently, there has not yet been any in-depth criticism of the structure. However, some arguments have been made against the use of the UNA, the statutory predecessor to DUNA. The following is a summary of those arguments and corresponding counter-arguments in light of Wyoming's passage of DUNA.
In short, the arguments against using UNAs are either addressed with DUNAs or they are unconvincing. While DAOs will indeed continue to face uncertainty despite the DUNA structure, it is undeniable that the uncertainty factor surrounding DAOs will be greatly reduced. While some may wish for a perfect legal entity structure to emerge that provides legal special treatment for DAOs and blockchain technology, this is an unrealistic approach that will hinder their advancement from the beginning.
Nonprofit status limits flexibility. Some have argued that the UNA is not an appropriate structure for a DAO due to its nonprofit character. This is a fundamental misunderstanding of the “nonprofit” designation. Both the UNA and DUNA are permitted by statute to engage in for-profit activities. Additionally, they are permitted to pay compensation to members. Wyoming’s DUNA statute explicitly states that reasonable compensation is permitted (including in exchange for participation in DUNA governance).
· Undermines decentralization. Some argue that UNA introduces centralization risks. While UNA typically relies on “administrators” to manage the day-to-day affairs of the UNA, a DAO can easily limit these powers. Regardless, any concerns about centralization are addressed by DUNA, which is specifically designed for large decentralized organizations. It applies regardless of whether the number of members is 1,000 or 10 million. In addition, DUNA contemplates a baseline structure that does not include management functions, which allows administrators with limited authority to be selected to perform specific tasks authorized by members. For most DAOs, this type of activity is already exercised by the protocol foundation and does not pose a greater risk of centralization. Therefore, this classification makes DUNA meet the applicable standards for decentralization under U.S. securities laws.
Jurisdiction selection. Some have argued that DAOs are not jurisdictional and therefore should not choose to establish entities in any jurisdiction (including UNA). There are many problems with this argument, simply put, it is a fantasy that does not consider the consequences it brings. Not taking advantage of the laws of any one jurisdiction means that one may be subject to the laws of all jurisdictions. As a result, this approach favors potential attackers (both individual plaintiffs and governments) by enabling them to sue in the jurisdiction that is most favorable to them. This is not a theoretical discussion, it has already begun to play out in regulatory litigation against Ooki DAO, as well as class actions against Compound DAO, Lido DAO, and others. These actions are currently being primarily brought in California, based on the theory that such DAOs are general partnerships. In the case of Ooki DAO, the court has already determined that Ooki DAO is a general partnership, and if this decision is widely replicated, it will be the death knell of decentralized governance on web3. DAOs that ignore this risk are doing so at their own risk.
Undermining permissionlessness. Some argue that using a legal entity undermines the permissionlessness of a DAO because it requires DAO members to join a legal entity. This is incorrect based on the definition of a DUNA. Holders of a DAO’s digital assets are not required to join its DUNA and are free to choose not to. Rather, the DAO determines the terms of membership in the DUNA based on the DAO’s governing principles.
Unclear Use Case/Untested by the Courts. Some have argued that because existing UNA legislation does not contemplate the use of blockchain networks, state legislatures may not have intended blockchain networks to use this structure, and blockchain networks’ use of UNAs has not been tested in the courts. These arguments are no longer relevant because DUNAs were designed specifically for decentralized organizations and with blockchain networks in mind. Furthermore, the use of a disembodied structure by DAOs has already led courts to apply it to general partnership statutes, which should be a significant risk to DAOs remaining disembodied.
8. How does A16Z CRYPTO plan to support the adoption of DUNA?
a16z crypto will work to promote widespread adoption of DUNA in web3 and make it an industry standard. These efforts will include:
1) Develop decentralized governance proposals for DAOs we are currently involved in to help them adopt DUNA.
2) Assist our existing portfolio companies to adopt DUNA structures relevant to their decentralization objectives.
3) Where appropriate, as a condition of investment, require its potential portfolio companies in the United States to agree to adopt the DUNA structure when decentralizing and adopting decentralized governance. In addition, a16z crypto also intends to devote a lot of energy to providing resources to entrepreneurs, law firms, accounting firms and other advisors to promote the adoption of the DUNA structure.
Adopting a DUNA entity structure can solve most of the uncertainty that DAO members currently face when participating in DAO activities. Therefore, we hope that through our efforts, DAO members can make more contributions and enhance the fundamental principle of decentralization in Crypto. For a16z crypto, this means unleashing the full potential of its engineering and research teams to promote the interests of DAOs.
9. Where can I get more information?
For background and more information on DAO, UNA, and DUNA, see:
Legal Framework for DAOs (October 2021). Provides background on DAOs, explores the challenges they face, introduces UNAs as an excellent choice for a DAO structure, and reviews the history of the structure.
Legal Framework for DAOs – Part II: Entity Selection Framework (June 2022). Provides a comprehensive argument for why the UNA is the only appropriate entity structure for a blockchain network DAO.
Legal Framework for DAOs – Part III: Model Decentralized Unincorporated Nonprofit Association Law (March 2024). Introduces DUNA, proposes model legislation for adopting DUNA, and provides a detailed analysis of the provisions of the model legislation.