DAO founders should establish concrete rules for the six fundamental rights to organizational ownership, namely: (1) voting power; (2) ownership structure; (3) distributions; (4) ownership transfer; (5) record inspection; and, (6) the right to sue the DAO for violation of its rules.
DAOs often allocate one vote to each token, with a majority required to pass a resolution. However, there are a variety of other ways to distribute voting power. For example, members could be required to hold a certain number of tokens in order to participate in a vote. Each individual tokenholder could be given one vote, regardless of how many tokens they hold. Special token classes could be segmented to give voting priorities only to a subset of members of the DAO. While a simple majority vote is a common default, founders would be wise to require a two thirds super majority in order to modify the DAO rules, spend large amounts of money, or perform any other act that should require a broader consensus. Conversely, if the decision is less consequential and organizational efficiency is prioritized, a lesser voting threshold could be established.
The ownership structure of a DAO can be divided evenly among tokenholders, or classes of tokens can be created to afford special benefits to a subset of tokenholders. Investors could be segmented from governance tokenholders by separately allocating voting tokens and distribution tokens. In addition, some group of tokenholders could be given a liquidation preference, meaning in the event of a DAO dissolution or broad token selloff, a certain class of tokenholders could be given priority to sell over others. This is common in traditional companies where debtholders are given first rights to the organizations cash and other liquidable assets upon dissolution. In a similar vein, a rule could be constructed in a DAO to afford added protection to large tokenholders, very active contributors, founders or other parties that merit special protection.
Distributions of additional tokens or other payouts may, akin to ownership, be distributed evenly among token members or to certain classes or participants according to a rule condition. DAOs occasionally distribute additional compensation to those who stake the network (LP tokens). However, in a DAO of journalists, for example, tokens may be distributed to members based on the quantity or significance of their contributions (word count, clicks, shares, etc.). The central principle here is to reward the valuable contributors. In addition, distributions can be set to disburse at set dates, occur upon a vote, or another rule condition such as every 100 publications (to again use the example of a journalism DAO).
Ownership transfer in DAOs typically occurs through buying and selling tokens on an exchange. DAOs may restrict the sale of tokens to create participation-based membership groups, such as artist collectives or programmer guilds. Restrictions on the sale of tokens may also be conditioned on a vote, be set at a predefined value, or give the option to other members to buy the exiting member’s tokens prior to them being listed on an exchange. To protect minority tokenholders, restrictions may also be placed on majority tokenholder sales, such as requiring that the minority tokenholders have the opportunity to participate in the token sell-off at the same value of majority shareholders. In crypto colloquial terms, this is of particular benefit to prevent a “whale” from passing control of a DAO to another “whale” in a side deal. Instead, all tokenholders would have the opportunity to participate in the sale.
The right to inspect DAO records is critical for DAO transparency. The blockchain allows for clear records of token exchanges, distributions, and votes; however, it does not necessarily capture and store large format content such as images, music, or even long-form text. As a result, DAOs may rely on traditional servers to host files, and members should have at least read-only access to these documents. In the event that some of this information is sensitive data such as personally identifiable information, then there may be reason to restrict members from accessing the raw data, and instead only allow the DAO to autonomously access the data upon a rule condition (outputting a graph or perform a computation, for example). Nevertheless, transparent recordkeeping is paramount to DAOs succeeding as a successor organization to modern companies and partnerships. DAO founders must design systems to distribute and restrict record access as individuals acquire and sell their tokens.
Finally, and perhaps most controversially, the right of DAO members to commence a formal action, or otherwise sue the DAO, is necessary in order to provide a means to correct errors, discourage malfeasance, and enforce DAO rules which may not be written explicitly into smart contracts. While the hope is for DAOs to resolve problems through amicable cooperation on Discord and voting, if a majority of members were to engage in prohibited self-dealing, the DAO may not have a mechanism to remedy this wrongful act. As a result, DAOs should write into their articles of organization (or smart contracts-based governance documents) the explicit right for tokenholders to seek relief through law, equity, arbitration or otherwise. In addition, the forum procedure and choice of law should also be defined in a neutral and non-biased way. That is difficult to accomplish, particularly when DAOs are national or even global organizations. There are nonetheless ways to mitigate this by mandating teleconference procedures that, at minimum, allow all parties to participate virtually.
The procedure and details necessary to establish a robust DAO may seem daunting, but the effort will avoid countless headaches, confusion, and infighting which in the long run are much greater drain of the organizations resources than the time and effort one may spend initially establishing the ground rules. Please reach out if you have any further questions.
Disclaimer: This blog is not intended to provide legal advice or my legal opinion. Any legal references or citations mentioned in these articles may be out-of-date.
It is your responsibility to speak with an attorney before relying on any information included in these articles. Should you need a legal opinion on any topic discussed in this blog, please do not hesitate to contact me.