What is a DAO? A DAO is an organization operating on a blockchain platform. Unlike a traditional LLC, which is governed by its operating agreement, a DAO is usually governed by:
(i) Smart contracts: A DAO's operating rules are written in computer code stored on a blockchain ledger, known as the "smart contract." This series of executable code determines the operation of the DAO, and runs automatically when certain predefined triggering events occur; and
(ii) Governance tokens: Similar to certain membership interests in an LLC, each member of a DAO receives tokens as a representation of their interest in the DAO. As could be the case in other LLCs, it is possible to structure a DAO so that different tokens have different rights. The smart contract defines those rights; in a typical DAO, those with governance tokens (which would be similar to a membership interest with voting rights in a traditional LLC) can propose new initiatives and then vote on them.
When a legal entity is a DAO, each step of corporate governance and decision-making is automated through smart contracts and the participation of token holders. As a result, DAOs are self-sustaining and autonomous entities with a self-administering organizational structure and a correspondingly reduced need for manual administration when compared to traditional LLCs or corporations.
Why establish a DAO? A DAO allows people all over the world to participate in, mergers and acquisitions, to advance non-profit goals, or for other specific initiatives. In February 2022, a DAO raised $4 billion to acquire the Denver Broncos. In 2021, another DAO was formed for the purpose of bidding on an original copy of the U.S. constitution being auctioned by Sotheby's. Because they are truly decentralized organizations, most DAOs can issue tokens that do not meet the current definition of a “security” and are therefore able to avoid securities law compliance.
Why do we need DAO Legislation? Prior to passage of the DAO Act in Wyoming and now Tennessee, a DAO was not formally recognized as a unique governance structure, and therefore there was no easy way to establish a DAO structure that provided liability for the equity owners. Without that protection, a token holder in a DAO that is not organized as another type of entity could theoretically be held liable for the debts of the DAO, even though the DAO actions were carried out automatically by a computer-run smart contract on autopilot without any human intervention.
While Wyoming and Tennessee are the only states t have enacted DAO legislation so far, the hope is that the utility of such legislation will not be lost on legislators in other states, thus conferring the benefits of DAO to people and businesses throughout the country.