The legislation allows decentralized autonomous organizations to gain legal entity status and operate within the bounds of applicable law.
By Jenny Cieplak, Stephen P. Wink, Daphne Lambadariou, and Deric Behar
On March 7, 2024, Wyoming Governor Mark Gordon signed into law a new legal framework for decentralized autonomous organizations (DAOs), allowing them to be recognized as “decentralized unincorporated nonprofit associations” (DUNAs). The Wyoming Decentralized Unincorporated Nonprofit Association Act (the Act) was adopted with bipartisan support, reflecting Wyoming’s progressive stance on blockchain technology and its applications. The Act is set to take effect on July 1, 2024.
DAOs typically have a diffuse group of members that make decisions on behalf of a blockchain ecosystem “on-chain” through code and smart contracts. They have struggled to fit into traditional legal frameworks due to their decentralized nature and their often anonymous member base. The Act addresses this by allowing DAOs to engage in legal contracts, acquire and transfer property, open bank accounts, appear in court, and pay taxes, all while aiming to preserve their decentralized natures and provide certain legal protections to their members.
Key Features of the Act
- Legal Entity Status: DUNAs will be recognized as separate legal entities, distinct from their members, for the purposes of determining and enforcing rights, duties, and liabilities in contract and tort.
- Governance: a DUNA may use distributed ledger technology (including smart contracts and consensus formation algorithms) for its governance and operations.
- Liability Protection: individual members of a DUNA will not be held personally liable for the actions of the association or of other members, nor will a judgment against the DUNA alone be applicable to individual members. This legal shield is vital for fostering participation in DAOs, as it mitigates the risks associated with being part of a decentralized organization.
- Indemnity: the Act permits a DUNA to indemnify its members and administrators for liabilities incurred in the course of activities on behalf of the DUNA.
- Legal Standing: a DUNA may institute, defend, intervene, or participate in a judicial, administrative, or other governmental proceeding or in an arbitration, mediation, or any other form of alternative dispute resolution.
- Service of Process: a DUNA may appoint an agent for service of process in Wyoming, and can be validly served with legal process at the specified address.
- Perpetuity: DUNAs are granted perpetual existence unless their governing principles state otherwise.
- Membership: membership in a DUNA is based on the DUNA’s governing principles. In the absence of such principles, a person shall be considered a member of the DUNA upon purchasing or assuming ownership of a membership interest or other property or instrument that confers a voting right with the DAO. A DAO must have and maintain at least 100 members to qualify for DUNA status.
- Member Duties: a member shall not have any fiduciary duty to a DUNA or to any other member of the association solely by reason of being a member, but the implied contractual covenant of good faith and fair dealing will apply to all members.
- Profit-Making Activities: DUNAs are permitted to engage in profit-making activities as long as the proceeds are directed toward, or set aside for, their nonprofit purpose.
- Property: a DUNA may acquire, hold, encumber, or transfer an estate or interest in real or personal property, in its name, while maintaining its nonprofit status.
- Mergers: a DUNA may merge with any organization (DUNA or non-DUNA) that is not expressly prohibited by the law, subject to various conditions.
- Conversion: a DUNA may convert into a corporation, partnership, or LLC, subject to applicable Wyoming laws and its own governing principles.
- Dividends and Compensation: a DUNA may not pay dividends or distribute any part of its income or profits to its members, administrators, and persons outside the association, except to pay reasonable compensation for services rendered, reimburse reasonable expenses, or confer benefits on its members and administrators in conformity with its common nonprofit purpose.
- Governing Law: Wyoming law will govern any DUNA formed in the state, and the DUNA’s governing principles shall identify the jurisdiction in which it is formed.
Industry Reactions and Ramifications
This legislation significantly improves upon Wyoming’s previous efforts, including the Wyoming Decentralized Autonomous Organization Supplement Act in 2021, which allowed DAOs to incorporate under the state’s LLC laws (for more information, see this Latham blog post). Subsequent amendments in 2022 clarified the management and smart-contract capabilities of DAOs. Market participants, investors, and observers have praised the Act for its improvements over past legislation, its potential to become the industry standard for DAOs seeking to form and operate in the US, and its potential to set a legislative precedent for other jurisdictions.
At least one prominent investment firm active in the digital asset space has indicated that it “intends to facilitate the widespread use of the DUNA across web3 so that it becomes an industry standard.”
Regulatory Treatment of DAOs
The SEC has established — as far back as the 2017 DAO Report — that DAOs themselves are not exempt from the registration requirements of the federal securities laws simply by claiming they are decentralized. The securities laws, the SEC asserted, “apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.”
The Commodity Futures Trading Commission (CFTC), another major US market regulator, has maintained a similar position. When the CFTC obtained a default judgment against a DAO in 2023, the court agreed with the CFTC that the DAO was a “person” and unincorporated association under the applicable federal and state laws (a type of entity which typically cannot provide limited liability to its members). The director of the CFTC Division of Enforcement heralded the default judgment as “a precedent-setting decision” that “should serve as a wake-up call to anyone who believes they can circumvent the law by adopting a DAO structure” (for more information, see this Latham blog post).
Implications for Securities Laws
While DUNAs are innovative as a legal structure, we believe they should be utilized carefully so as to not vitiate the central argument that a related token is sufficiently decentralized. That is, under SEC v. W.J. Howey Co. and its progeny, if there exists an enterprise responsible for creating value in a token, that token may be deemed an investment contract. Specifically, through the ownership of a token, purchasers of that token may be led to reasonably expect to profit from the enterprise’s managerial and entrepreneurial efforts.
In the Framework for “Investment Contract” Analysis of Digital Assets, the SEC recognized that to the extent a protocol is sufficiently decentralized such that there is no single identifiable enterprise, an investment contract is unlikely to result. This reasoning is in line with how the SEC at one point viewed Ether (or ETH) and the Ethereum protocol (see, e.g., former SEC Director William Hinman’s speech, Digital Asset Transactions: When Howey Met Gary (Plastic)). More recently though, in a 2023 congressional hearing, Representative Patrick McHenry (chair of the House Financial Services Committee) pointedly asked SEC Chair Gary Gensler “Is Ether a commodity, or a security?” — to which Chair Gensler was not willing to provide an unambiguous answer.
Accordingly, the role of the DUNA should be circumscribed so that it is not a “legal wrapper” around the DAO, which could be viewed by the SEC as the relevant enterprise with “a lead or central role in the direction of the ongoing development of the network or the digital asset.”[1]
The structure of the DUNA — as a nonprofit that in itself does not have its own management — does not ostensibly lend itself to being found to be an entity whose management “provides essential managerial efforts that affect the success of the enterprise.”[2]
In this way, we do not see DUNAs taking the place of the foundation structures that are currently being used in connection with token issuances, but rather, they would supplement such role. Foundations still have a role to play to promote and support the growth of networks, although their role should not be vital to the operation of the network.
The DUNA therefore could potentially offer the limited liability protections of the law for a set of delimited actions while maintaining the viability of the decentralization argument. However, whether this argument would be sufficient for token projects to rely on at this point remains uncertain.
We also note that establishing a DUNA (or a foundation) does not act to shield other actors in a token ecosystem from liability. In bringing actions related to token issuances, the SEC has not distinguished which entity was the issuer; instead naming any companies involved in the token — including development companies — as defendants.
Conclusion
Wyoming’s DUNA act represents a landmark moment for legal recognition of DAOs, providing a model for legal compliance and addressing key challenges faced by decentralized organizations. It underscores Wyoming’s commitment to fostering innovation in the blockchain space and sets a potential standard for other jurisdictions to follow. The response of federal regulators and the broader Web3 community to the DUNA structure in the months ahead will be critical in determining the law’s effectiveness. In any event, for certain activities the benefits of adopting the DUNA structure as a liability shield for DAO participants may significantly outweigh the risks of introducing this new structure into the DAO ecosystem.
Latham & Watkins will continue to monitor state digital asset developments.
Endnotes
[1] See Framework for “Investment Contract” Analysis of Digital Assets, at 4 (available at https://www.sec.gov/files/dlt-framework.pdf).
[2] Id. at 3.