How DAOs Increase Your Project’s Legal Resiliency
As the regulatory landscape for crypto in many parts of the world may be shifting for the better, it’s easy to overestimate how much things may have already changed for builders today. For all the progress made, launching a crypto project - especially one with a token - still comes with a lot more legal risk and exposure than most would expect from a typical startup.
DAOs offer a framework that, when implemented correctly, can provide a vital legal safeguard for protecting your entire community of members while making the most of decentralized governance.
The Legal Risks of Launching A Token
In many jurisdictions around the world, and certainly in the US, launching a token has historically been a potential legal minefield and a source of additional scrutiny for project teams. There are multiple legal risks projects must navigate, each involving particular nuances that need to be considered.
Securities Regulations
Though the SEC has recently adopted a less antagonistic approach to crypto regulation, tokens still risk being classified as unregistered securities under the Howey Test if investors expect profits based on the founding team's efforts. Generally, the more provably decentralized a project is, the stronger its argument against its token being classified as a security.
Financial Crime Regulations
For DeFi protocols in particular, navigating regulations around financial services is crucial. Violating these can result in criminal charges much more severe than civil securities violations.
Anti-Money Laundering (AML) Requirements
Projects facilitating certain transactions may also be required to implement KYC procedures, suspicious activity reporting, and other AML controls.
Fraud Liability
Perhaps most concerning is the broad reach of anti-fraud laws. Even unintentional misrepresentations in white papers, marketing materials, or community communications can be construed as fraud.
Tax Considerations
Token distributions can immediately create taxable events for both the project and token recipients, with complex reporting requirements that vary by jurisdiction.
In any case, a properly structured DAO can mitigate concerns around a token's status through community governance, utility value, and a separation between token distribution and founder control.
DAOs vs. Traditional Structures
Traditional organizations centralize both power and liability in a few key individuals, concentrating decision-making authority in boards and executive teams while giving stakeholders minimal governance input.
DAOs represent a paradigm shift, distributing both governance rights and operational transparency across many participants. While traditional structures shield individuals from personal liability, they fall short in distributing ownership and governance in a truly decentralized manner.
The ideal approach combines the decentralized governance and transparency of DAOs with the established legal protections of traditional entities, allowing DAOs to interact with existing legal and financial systems while preserving their decentralized operations.
One of the most compelling advantages of properly structured DAOs is the creation of a legal barrier between individual members and potential claims against the organization. This protection works through a couple of mechanisms.
DAO-Hybrid Legal Models
Traditional Foundation/Association Models
Traditional foundation models in jurisdictions like the Cayman Islands and Switzerland continue to provide viable options for DAOs seeking established legal frameworks.
Cayman Foundations offer specific regulations for "Virtual Asset Service Providers," creating a predictable regulatory environment, lower setup costs compared to Switzerland, and no mandatory minimum capital requirements.
Despite lacking DAO-specific regulations, Switzerland has also developed established practices for applying existing regulations to decentralized organizations. Association charters can prescribe detailed governance rules that align perfectly with DAO operations. However, this option comes with higher setup costs, local representation requirements mandating a Swiss resident director, and substantial audit obligations depending on organization size.
Wyoming’s DUNA and DAO LLC
Enacted in 2024, Wyoming's DUNA (Decentralized Unincorporated Nonprofit Association Act) created a new type of legal entity giving DAOs all the benefits of recognized legal entities, like liability protections for members and access to financial services, while allowing profit-making activities under nonprofit status.
Prior to the DUNA, Wyoming also enacted a law for DAO LLCs. In practice, both models have seen low levels of adoption since coming into law, with many more DAOs opting to incorporate using the DAO-foundation models.
Transparency: The Key to Legal Freedom
DAOs set a high bar for decentralized ownership, access to information, and operational transparency, making them a powerful way to enhance an organization's legal resiliency.
Unlike traditional entities that operate behind closed doors, DAOs conduct governance in the open. This transparency creates an immutable record of decision-making and community participation, giving organizations a strong defense against claims targeting individual contributors.
Best Practices for DAO Structuring and Governance Implementation
These steps provide an overall approach to maximizing legal protection through your DAO:
- Work with specialized partners with expertise in DAO formation: this can include legal counsel familiar with crypto regulation, and DAO builders like Decent
- Thoroughly document your governance processes, maintaining records of governance participation and organizational decision-making.
- Choose your formational jurisdiction wisely, according to the markets you want to explore and your legal structure of choice.
- Implement progressive decentralization with clearly marked milestones
Decentralize Your Organization The Right Way
DAOs aren't perfect legal shields, but they offer great protection in today's constantly shifting regulatory landscape, with certain advantages that are harder to access in traditional organizational structures. DAOs can even unlock markets that would otherwise be inaccessible to you, as long as they’re set up the right way.
Decent makes it easy for you to form legally compliant, incorporated DAOs that both empower and protect your members. We’ve gone through the process of progressive decentralization ourselves, and we bring our years of expertise along with a suite of tools that makes forming a functional DAO as easy as it’s ever been. Ready to see what Decent can do for your DAO?
