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Want to create a DAO? 5 Things That You Need To Consider About

Updated: Nov 26, 2023

What is a DAO?

A decentralized autonomous organization (DAO) is an internet-native ecosystem with no central leadership.It is collectively owned and managed with a set of rules written in computer code in a smart contract. Members collectively own and manage a functional DAO. A committee organized around a particular set of foundational rules takes part in the group's decision-making process.


How is a DAO different from a traditional company?

DAO is an autonomous, Internet-based community. This is something that traditional companies do not have at all. The community unites contributors through a shared bank account and the same goal: to create value by implementing a set of rules on the blockchain.


This set of rules is created by DAO members, governed by an open source blockchain protocol, and can act automatically without intermediaries. This is what we call the "social contract", and it is an important feature that distinguishes DAOs from traditional companies.


Decentralized rights

A DAO is not owned by a small group of founders and investors, but by the people who create value for it. Ownership, power and control are spread throughout the community, and everyone has influence, regardless of their "experience". It reverses the idea that one person or entity "owns" an organization.


This concept of "decentralization" works because everyone is a stakeholder, and no one is the sole holder or decision maker. Everyone who is committed to the development and achievement of the DAO's common mission is on an equal footing.


Transparency

Because on the blockchain, anyone can see all the operations and funding of the DAO, this makes the DAO more transparent than a traditional company. This transparency greatly reduces the risk of corruption within the company.

This structure takes away the control of information from the company, and the open source of information means that many people can contribute to a project without the permission of external resources.

This transparent operational framework is the most important part of a DAO and is a key reason why DAOs are the center of Web3.


Self-governance

Because a DAO is decentralized, it does not belong to a person or entity, and therefore it cannot be governed in a traditional way.

The governance and rules of each DAO are encoded in a smart contract and cannot be changed unless voted on by DAO members.

DAOs make the ecosystem fairer by giving all members equal decision-making power. every decision in a DAO is publicly proposed, discussed, voted on and recorded, which further increases its transparency.


Efficiency

When people who share a common goal and passion work together, they ensure the best and efficient results.

Hierarchical structures can be a barrier. When you have too many layers to manage, speed, efficiency and engagement can suffer. Most importantly, it isolates everyone, except the managers. Because of the social contract that exists in a DAO, all decisions and changes to the network are executed automatically, which is not possible in an LLC because of the hierarchical relationships.


Anonymity

DAOs do not require or force you to disclose your identity.

DAO allows investors to send money from anywhere in the world. Since members remain anonymous on the network, they can be more flexible and experimental in their funding decisions and investments.

DAOs are a complex subject with many parts that can be flexibly adapted. However, at the end of the day, they are simply businesses run by teams of diverse individuals, not by a single leader. The rules and functions of the management team may change over time, but the spirit in which the organization operates will always be the same.

DAO offers its members a unique opportunity that is simply not available anywhere else in the marketplace: complete freedom. What better way to inspire people than a digital, decentralized space?


Creating a DAO is relatively simple

First, creat the smart contract and develop the governance structure of the DAO. These rules are embedded in the smart contract. Next, the DAO project needs to raise funds to get started. DAOs are typically funded by issuing DAO tokens. These tokens give members the right to vote in the DAO. Finally, the DAO's operations are executed and everything is transferred to the blockchain. If the DAO needs to make a decision, community members must vote on such changes.


That said, there are several key factors to keep in mind when considering the formation of a DAO.


I. DAO is a fully decentralized autonomous organization that does not operate based on a hierarchical management structure

DAOs do not follow the corporate hierarchy with the board of directors and company executives at the top and the employees at the bottom.DAOs have no hierarchy. For traditional entities such as corporations, there must be founders, promoters, articles of incorporation, bylaws, board of directors, etc. In addition, most companies are private entities. a DAO is different. a DAO is organized as a series of codes or smart contracts on a blockchain that automate the entity's decisions. No one person or group of people will own or control a DAO. because DAOs use blockchain technology, they are transparent to the public. It is a completely decentralized management system.


Even though DAOs do not have a hierarchy, they can still be successful and have their members execute important decision making authority. If members have management or operational ideas, it's a much easier process to hear them than with a traditional corporate entity. With a DAO, members simply tell the DAO members about the idea, and then everyone can consider and vote on it in a democratic manner.


2. Most DAOs do not protect their members from unlimited liability

DAO members usually do not enjoy the usual protection from liability as shareholders of a corporation. This is because DAOs are not usually incorporated as corporations or LLCs. As a result, the potential liability of each member of a DAO is unlimited.


A corporation is formed to conduct business and does not impose unlimited personal liability on each individual. The shareholders of the company or members of the LLC only bear the risk of their capital contribution. In other words, they are only liable for the percentage of the ownership interest they contribute or are entitled to receive.


DAOs do not follow this model. As unincorporated entities, they are not required to follow legal procedures such as incorporation, bylaws and contracts. Therefore, DAOs are considered unincorporated partnerships. In a partnership, each person has unlimited liability. Therefore, if a DAO is hacked or declares bankruptcy, each member will be liable for the entire amount of funds. If litigation ensues and the plaintiff is unable to fully recover from the DAO Partnership, the plaintiff will turn to the personal assets of each DAO member until their claims are satisfied. To address this weakness, the DAO must be registered and recognized as a limited liability legal entity.


3. Decision-making in a DAO is carried out by DAO members

Decision-making in the DAO is bottom-up. each member of the DAO has the right and ability to express opinions or submit proposals regarding the governance or management of the DAO. Each member with a stake in the DAO then considers and votes on the proposal. The vote depends on the DAO's governance token - which is the cryptocurrency of the particular DAO project. In other words, each member of the DAO can influence the future of the DAO by voting on other members' proposals or by initiating new governance or management proposals themselves. This is in stark contrast to traditional companies, where decision making is based on power or position and voting to make major changes.


In addition, DAOs' financial resources are more protected and better utilized than those of traditional companies. Their treasury can usually only be used with the approval of DAO members. This makes DAOs less susceptible to financial abuse because no single or small group of individuals has sole access to financial resources.


4. Most U.S. states do not recognize DAOs as legal entities

DAOs face significant barriers to public awareness and recognition, primarily because most states do not recognize DAOs as a legal entity. Without legal recognition, DAOs do not have to comply with state incorporation requirements and therefore do not receive any of the corporate privileges available to traditional legal entities, such as limited liability. In addition to the possibility of unlimited liability, a DAO's lack of legal status may prevent it from entering into certain business contracts with other entities or governments. This limits the types of business a DAO can perform and may prevent a DAO from realizing its full earning potential.


There are only a few notable exceptions to the DAO's legal recognition. Under Vermont's Limited Liability Company Act, a DAO may register as a blockchain-based limited liability company ("BBLLC") and therefore provide limited liability to its members. In addition, Wyoming passed legislation in April 2021 that allows DAOs to be legally recognized as LLCs.


5. DAO regulation is inconsistent, exposing its creation and operational aspects to various legal challenges

DAOs do not have a consistent regulatory framework. Because they are unincorporated, many DAOs are by default partnerships - which imposes unlimited liability on their members and raises a variety of legal issues. For example, many traditional business entities must comply with anti-money laundering and know-your-customer (AML/KYC) policies. These safeguards ensure that corporate entities deal only with customers, token holders, and members who pass various identity verification checks and pose a low risk of money laundering.


With DAOs, individuals are typically anonymous. As a result, compliance with AML/KYC policies is complex, if not impossible. Sometimes, these burdens can prevent the DAO from being established in the first place. In addition, because DAOs can include individuals from all over the world, the laws of multiple jurisdictions are at play together. Deciding which country/region's laws apply can be difficult and can lead to protracted legal battles if disputes arise.


This regulatory uncertainty can also lead to internal federal investigations. The most famous example is the SEC's 2017 investigative report on "The DAO". In this report, the SEC concluded that The DAO sold DAO tokens as "securities" without proper registration, thereby violating multiple federal securities laws.


Conclusion

The DAO wave is sweeping the world as the next generation of financial and business innovation. DAOs offer many advantages over traditional firms, such as decentralization, member-empowered voting and decision-making, automated code execution through smart contracts, and pooling of resources and funds. At the same time, however, DAOs face many legal challenges because they are not recognized as legal entities. Their lack of legal status makes DAOs general partnerships, which can expose each member to unlimited liability. In addition, the multiple jurisdictions that may be involved and the anonymity of DAO members make any attempt at compliance by DAOs very challenging. Only a consistent regulatory framework can provide the legal certainty that DAOs need to thrive without being hampered by regulatory inconsistencies and gaps.



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