WYOMING’S LEGAL DAO-SASTER

Note: This piece is co-authored by me and Brooklyn Law School student Sydney Abualy.

INTRO

Let’s talk about the ‘Wyoming DAO Law’ that has been receiving much attention. Designed as a supplement to Wyoming’s Limited Liability Company Act, “Bill 38” is pending passage in the Wyoming state legislature and seeks to enable “the formation and management of decentralized autonomous organizations” by allowing DAOs to become franchise-tax-paying LLCs chartered by the State of Wyoming. Although the authors support the use of smart contracts by traditional business entities (one of the authors helped found a prominent ‘venture DAO’ that is organized under a Delaware LLC), we believe Bill 38 rests on fundamental misunderstandings of how corporate and contract law relate to one another and of the functions and benefits of blockchain-based smart contracts. Furthermore, by equating DAOs to state-chartered entities, Bill 38 implicitly colonializes the anarchist concept of “DAOs” to facilitate re-intermediation and rent extraction by TradFi intermediaries such as lawyers, registered agents, and secretaries of state. The approach is unsound legally, technically and culturally, and should be rejected by Wyoming’s legislature and the people of Wyoming whom the legislature represents.

OVERVIEW OF BILL 38

We suggest readers review the full text of Bill 38 here, but have also provided a brief overview as an appendix at the end of this article.

PROBLEMS WITH BILL 38

            The problems with Bill 38, from both a legal and technical perspective, are almost too numerous and in some cases too subtle or lawyerly to fully list and explain. We will have to make do with identifying the ‘low-hanging fruit’—i.e., the problems that are most conceptual and easiest to understand. Note though, that from a drafting perspective the Bill is a complete nightmare of circular definitions, ambiguous syntax and similar issues. In the interests of time and the reader’s attention span, we will not be dissecting all of these numerous issues, but will focus on a few key substantive failures.

PROBLEM #1: BILL 38 DOES NOT SOLVE A PROBLEM

The first issue with Bill 38 is that it is completely unnecessary and provides no benefits. A number of LLC-based DAOs have already been formed and are successful ongoing ‘DAOs’: the LAO, Metacartel Ventures DAO, and more. These were formed as Delaware LLCs that utilize Delaware’s flexible LLC governance rules and respect for freedom of contract to define how members of the LLC should use the accompanying smart contract as a funds escrow and voting tool.

            This is not to say that the pairing of LLCs with DAOs could not be improved through changes of law. However, Bill 38 does not fix the actual pain points. For example, a major pain point for Moloch-based DAOs is that members of the LLC who receive distributions that impair the capital of the LLC to the detriment of the LLC’s creditors may face personal liability to the creditors, breaking the limited liability veil for which the entity has been established in the first place. Since a Moloch DAO’s primary minority protection mechanism is “ragequit”, upon which a member receives a ratable distribution of assets, this is a major issue: Ragequit becomes punitive to members if the DAO has sufficient debts, because the members will not want to incur personal liability. By the same token, there is a moral hazard for ‘early leavers’ who pull out their funds first (pushing the DAO toward insolvency) while leaving the late-exiters holding the bag for creditors. Bill 38 does nothing to mitigate Wyoming’s version of this LLC rule (§17-29-406 of the Limited Liability Company Act,), which will apply to ‘DAOs’ just like it does to other Wyoming LLCs.

PROBLEM #2: BILL 38 CREATES PROBLEMS AND CONSTRAINS CREATIVITY

            Because Bill 38 imposes various extra requirements on DAO LLCs that normal LLCs do not face, it actually makes forming an ‘LLC DAO’ less attractive than forming a normal LLC. Why?

Because of the special DAO LLC rules in Bill 38, a DAO choosing to be a ‘DAO LLC’ would face the following additional burdens, among others—burdens that could be avoided by just pairing the DAO with an ordinary LLC:

• Under Bill 38, the entire public must know the DAO’s smart contract address, because Bill 38 requires the smart contract address to be stated in the articles of organization filed with the Wyoming Secretary of State. This is a security and privacy nightmare that is entirely created by Bill 38 for no good reason.

• Bill 38 provides that the DAO will automatically be deemed dissolved if the DAO is inactive for one year. This is a huge trap for the unwary and there is just no reason for it.

• Bill 38 requires DAO users and their lawyers to vex themselves with figuring out the meanings of phrases like “algorithmic management” and other unclear and ambiguous language in order to determine which requirements apply.

• Bill 38 unnecessarily limits structuring options for DAOs by prohibiting a ‘DAO LLC’ from being ‘manager-managed,’ even though normal LLCs can be ‘manager-managed.’ But this prejudges what a DAO must be. Maybe the members get sick of active governance and want to appoint professional management instead? Why should that be prohibited or require them to dissolve their DAO LLC in favor of a non-DAO LLC. It’s just stupid, inefficient and unnecessarily prescriptive.

The penalty of failing to comply with these various requirements or misinterpreting one of these strange new phrases is not clear, but one must assume that it could include losing the limited liability shield for which the LLC is being used in the first place. It’s just not worth it—using an ordinary LLC would be preferable to dealing with this mess.  

Although in theory one could still use the normal LLC Act like was done with The LAO and Venture DAO, we worry that, after Bill 38, such an approach will be invalidated. Given that a specific DAO LLC statute exists and imposes a laundry list of requirements approved by the state legislature, a judge or the Secretary of State might be inclined to invalidate any “DAO” that is not formed as a DAO LLC. The practical effect of this Bill is more similar to creating new burdensome regulation of DAOs than it is to a so-called ‘enabling statute’ like the normal LLC Act.

PROBLEM #3: BILL 38 FETISHIZES A MYSTICAL AND UNSOUND VIEW OF SMART CONTRACTS AND HOW THEY RELATE TO LAW

            The bill defines a “smart contract” as “an automated transaction … that executes the terms of an agreement” and thus perpetuates the widely-debunked view that “smart contracts” should be viewed as legal agreements that happen to be written in code rather than natural language. In reality, smart contracts are simply bytecode that is tied to a specific blockchain address and executed by miners when adding a relevant transaction into a block on the relevant blockchain. Just as contracts can be implied by “course of performance,” various casual oral statements, or scribbles on the back of a napkin, a contract can of course be implied by a smart contract, but this does not mean smart contracts generally are or should be viewed as good substitutes for legal agreements or natural language texts expressing such agreements. One should never define a “smart contract” as being tied to a legal agreement unless one wishes to exclude every smart contract for which this is not true. But there is no reason to do that—there is no reason why an LLC cannot use its DAO-like smart contract as a technology tool rather than as “executing an agreement”. 

            Similarly, the Bill defines a bizarre subgenre of DAOs called “algorithmically managed DAOs.” “Algorithmic management” is not defined, but is contrasted in the Bill with “member management.” This, however, is absurd, because all DAOs are 100% managed by people, not algorithms. Blockchain-based smart contracts are not AIs—they are passive scripts that humans must call by broadcasting transaction messages to the network, and which are then executed by miners because the miners get paid for it. The fact that members call a smart contract to vote, for example, does not mean that an algorithm is voting on anything or deciding anything. Rather, the members are deciding—they merely use algorithms to count the votes and implement the results of the vote. Algorithms cannot govern anything because, until autonomous AIs like Neuromancer and Wintermute evolve, software lacks full-fledged autonomy.

            Whatever “algorithmic management” means, if your DAO is “algorithmically managed” it becomes subject to extra requirements—e.g., that the smart contracts be upgradeable. These requirements are silly—there is no need for a smart contract to be upgradeable . The LLC operating agreement can simply define a “Designated Smart Contract” with an address and allow members to amend the operating agreement to change the address to point at a different smart contract, if so desired. Of course, there is also nothing wrong with using an upgradeable smart contract—i.e., by specifying a proxy contract’s address as the “Designated Smart Contract”. The point is that Wyoming laws should not be prescribing such granular rules for a technological tool used by an LLC to help with normal governance functions; rather, the members of the LLC should be free to use any kind of smart contract deployment pattern they want. A rule that smart contracts must be upgradeable is similar to a rule requiring that all board of directors meetings take place over Zoom instead of in person, by phone or through Jitsi.

PROBLEM #4: LLCs ARE NOT DAOS

            “DAO” is an inherently anarchist concept. The “autonomous” in the term DAO is not meant to mean “automated” but exactly what it says—“autonomous”. Autonomous is an anarchist term and concept, as seen by the “autonomous zones” set up by anarchists in the Pacific Northwest in the summer of 2020, Hakim Bey’s “temporary autonomous zones,” and similar uses of the concept. True DAOs are not meant to be existentially dependent on a state charter or limited to compliance with a particular parochial set of laws. True DAOs should not be dissolvable because the Secretary of State of Wyoming deems that they should be dissolved. Under Bill 38, an LLC can claim to be a “DAO” even if it does not use any smart contracts or blockchain, or even if it uses a read/write-permissioned enterprise blockchain. Equating an LLC to a “DAO” is a fundamental misappropriation of blockchain’s anarchist roots and misunderstands the entire purpose and culture of the movement. 

A BETTER PATH FORWARD

            There are better paths forward for increasing the use of smart contracts by traditional entities. They involve experimentation by private parties and, if desired, their lawyers, in jurisdictions that have highly flexible corporate entity-enabling statutes and a judiciary with a strong respect for freedom of contract. A normal LLC’s operating agreement can easily require that members use a smart contract to perform various functions such as escrowing funds, issuing membership interests and counting votes. It can even provide that the results of the smart contract will be final and binding under most conditions. An example of such a “qualified code deference” approach, which relies purely on normal LLC law and contract law, can be found here.

Yes, in the long run, some legislative patches are probably needed, but we should first get a better sense of what the real problems and pain points are and aim to solve those problems using technically and legally sound definitions—drafting that is developed with care through a collaboration of a broad group of experts (devs, lawyers, everyone. (A peer review process is sorely lacking in Wyoming’s rushed blockchain-related legislative sprees.)

Examples of legal DAO problems worth solving might include tax problems, the problem of when and how to preserve the anonymity of DAO members while still affording them limited liability and how to square default rules like limits on distributions with MolochDAO-style minority protection mechanisms like ragequit. These are the proper objects of exploration and legislation—not the strange mix of technofetishism and prescriptivism that is the Wyoming “DAO” law.

APPENDIX - OVERVIEW OF BILL 38

The main effect of Bill 38 is to authorize the creation of a new sub-genre of Wyoming LLCs referred to in the Bill as “decentralized autonomous organizations” (DAOs). Under the Bill, an LLC that is a DAO has some permissions that normal Wyoming LLCs do not explicitly have (but probably implicitly have) and must comply with some conditions and rules that normal Wyoming LLCs do not have to comply with.

            The Bill defines DAOs as “a limited liability company organized under this chapter.” (§17-31-102(a)(ii)) It also defines DAOs a second time as “a limited liability company whose articles of organization contain a statement that the company is a decentralized autonomous organization.” (§17-31-104(a)). There is no requirement that “DAOs” as defined by Bill 38 be decentralized, use blockchain, use smart contracts, be open, be autonomous or have any of the other traits one normally associates with the term “DAO”. The only DAO-like trait unique to DAO LLCs is that there is no option for them to be manager-managed; rather, they must either be “member-managed” or “algorithmically managed”. But normal LLCs can also be “member-managed” and, as will be discussed later, “algorithmic management” is an undefined and likely nonsensical term. In short, Bill 38 defines a DAO simply as any LLC which contains in its articles of organization a statement that the LLC is a DAO, regardless of whether that statement is true according to the normal community uses of “DAO”.

            The primary effect of choosing to call your LLC a DAO is to make it subject to various confusing default rules and requirements that exist for Wyoming LLCs that are DAOs but not for normal Wyoming LLCs. For example, each LLC DAO:

• ·        cannot be manager-managed, but must be either member-managed or “algorithmically managed”;

• ·        must provide its smart contract addresses in its publicly filed articles of organization (if it happens to use smart contracts—which, again, is not a requirement);

• ·        must display “conspicuously” in its articles of organization or operating agreement, verbatim, a wordy warning from Wyoming that “the rights of members in a [DAO] may differ materially from the rights of members in other limited liability companies...” etc.—a silly disclaimer, because the rights of members in any LLC “may differ materially from the rights of members in other [LLCs]”;

• ·        must include “DAO” or “LAO” in its name;

• ·        must maintain (and therefore pay) a registered agent in Wyoming for service of process and other matters;

• ·        if it is an “algorithmically managed” DAO, must only use smart contracts that “are able to be updated, modified or otherwise upgraded”;

• ·        must be dissolved if it has failed to approve any proposals or take any actions for one year or if the secretary of state orders it dissolved; and

• ·        if it has a smart contract, must allow the smart contract to preempt any conflicting provision of its articles of organization.

Aside from this, the Bill mostly just re-states fairly ordinary LLC formation rules with very minor variations supposedly tailored to DAOs. In many cases, the variations appear fairly arbitrary and are likely drafted to suit the taste of whoever was most involved in advocating for the Bill—for example, there is a rule that fiduciary duties are waived by default, as well as a rule that members cannot make a books and records request to obtain information that also happens to be ‘available on an open blockchain.’ These are fickle variations on normal default LLC rules, and are therefore likely to cause surprises and result in unintended side effects. For example, there is good reason for making fiduciary duties opt-out rather than opt-in—so that the members of the LLC will have to end up seeing an express provision in the operating agreement that makes them understand (without digging around in an obscure statute) that fellow members of the LLC will owe them almost no duties at all.