Idle DAO Legal Structure - Summary

Authors

Cowrie LLC and Treasury League

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Introduction

As posted by the Idle Treasury League on September 25, 2021, Idle DAO is exploring how best to implement an entity structure. This process involves weighing several complex legal and regulatory considerations across a variety of jurisdictions and is made more difficult by many of the applicable laws having been written in a period where the technological possibilities of Web 3 were not feasible and thus, not contemplated at the time the laws went into effect.

This post outlines potential DAO entity structures and the implications (both positive and negative) of the available options. As Idle DAO is a decentralized decision-making authority, the community is actively involved in the governance process and accordingly, it is essential that the community be knowledgeable of the regulatory and compliance environment to make an informed decision [1].

Section 1 outlines the league election process and the involvement of the elected members in developing the community approach, Section 2 outlines the possible entity structures to be brought before the community and Section 3 proposes next steps of a grant from the DAO to move forward in establishing a legal entity. Over the course of this project, it is expected that a fourth section will be developed, which will contain suggestions to existing activity or new activity that would be complimentary to the chosen entity structure.

Section 1 – Working with the Idle Leagues

Identifying which legal structure is best for Idle DAO is complex and time-consuming. We believe that this responsibility and burden should initially be led by the Idle Leagues who have been elected by the Idle DAO to guide such decisions on behalf of the community [2]. Once Idle League members have come to a consensus on a path forward, they will present a plan to the community that lays out its benefits and weaknesses and allow the broader community to make a final determination.

Section 2 – Possible Entity Structures of Idle DAO

The difficulties in entity structure related to DAOs and the availability of domestic structures are discussed in detail in A Legal Framework for Decentralized Autonomous Organizations [3]. The two options we most thoroughly considered were an Unincorporated Nonprofit Association (β€œUNA”) and an offshore Cayman Foundation (discussed in more detail here: Legal structure for the Idle DAO - :card_index_dividers: Proposals / :bookmark_tabs: Formal Proposals - Idle).

The threshold question was to determine whether the Idle community is better served by having a US entity or a non-US, or more specifically, whether the Idle community is better served by establishing an UNA or a Cayman Islands Foundation.

Where an entity, organization or DAO has substantial ties to the US, we think the necessity of a US entity structure is relatively clear. However, Idle’s connections to the US are fairly minor and are primarily a result of the developers participating in an accelerator program operated by ConSensys. The ConSensys’ accelerator was located in New York and the team traveled to New York to perform much of the work that would become the Idle Protocol. However, as a result of the Covid outbreak – the developers returned to their countries of origin and continued to develop the protocol outside of the US. Additionally, in November 2019, the developers formed a US C Corp for Idle Labs.

Although this timeline contains ties to the US that should be considered in determining an entity structure, there is nothing in these facts that necessarily requires Idle DAO to utilize a US entity structure. The development of the protocol is minimally tied to the US and the existence of a US development Corp is not an unusual occurrence for any number of businesses, protocols and organizations with international entity structures. Additionally, Idle DAOs contributors and league membership is demonstrably international, its user data contains no characteristics that suggest an overwhelming rate of US membership and at this time, there has been no activity that would comprise significant activity or in-person events within the US [4].

The disadvantages to a US entity structure are often presented as additional exposure to US regulators and increased taxation (it is evident from reviewing the Idle DAO message boards that some members of the community hold these opinions). The reality is a bit more nuanced. US securities laws and US taxes can be applied to activity regardless of whether or not a US entity exists. For example, if tokens are being traded by US persons or if sufficient economic activity is occurring in the US, US securities and tax laws can be triggered, respectively.

While choosing an UNA as the legal structure would establish a more distinct US presence that could carry some legal and tax obligations, a US entity does provide clear benefits. In the face of regulatory uncertainty, opting into US taxation of the DAO’s activity demonstrates a commitment by Idle DAO to avoid using uncertainty to its benefit, reduces the risk around tax reporting issues inherent to all DAOs and provides a structure which affords the membership of the DAO limited liability protections around DAO activities.

Accordingly, the presentation of the three options discussed on the Idle Treasury League’s post ( e.g. , remain regimeless, Cayman Islands Foundation and UNA) should be presented as containing significantly different levels of risk.

Remaining regimeless is an option that the DAO can choose and is the default if no entity structure is chosen by the membership – but the risk of being classified as a general partnership (especially the joint and several liability associated with that entity form), having a tax levy applied from any number of taxing authorities and the inability for the DAO to exist as a legal entity ( i.e., being unable to attain bank accounts, sign contracts or attain insurance) demonstrate that although theoretically possible, remaining regimeless would be an especially risky decision for the Idle DAO long term.

Establishing as a Cayman Islands Foundation is a popular decision amongst DAOs, however – popularity is not in and of itself an indicator of merit or risk mitigation. The benefits of any Cayman structure would include establishing within a tax advantaged jurisdiction and that, to date, many DAOs have formed as Cayman Islands Foundations with minimal resistance from regulators. The risks of any Cayman structure would be the additional regulatory uncertainty, the need to ultimately defend whether the DAO activities were properly established in a tax advantaged jurisdiction and involvement with a jurisdiction synonymous with regulatory and tax avoidance. Additionally, as more DAOs select the Cayman Islands Foundation structure, the Cayman Islands taxing authority has begun inquiries into whether DAOs meet the requirements to use such a structure for tax beneficial status, resulting in even more risk to this approach.

As discussed above, a DAO structured as an UNA would present a good faith effort to pay taxes around DAO operations (in particular, those associated with the treasury), resolve a number of complications around tax reporting, provide limited liability to the DAO members for DAO activities and allow for the filing and payment of taxes. Additionally, the limitations on activities resulting from its nonprofit structure would be complimentary to any analysis that the governance token was not a security, as the nonprofit limitations would be restrictive of membership distributions and provide additional evidence of the DAOs compliance with US securities law.

Section 3 - Next steps: Governance Proposal for Idle DAO to implement an UNA entity structure

After consideration of all the available options and discussions with subject matter experts, the Idle Treasury League proposes that the Idle DAO adopts an UNA entity structure.

In order to give ample time to any alternative proposals pertaining to entity structure – this post, an FAQ providing additional information and the intended governance proposal will be shared with the community on 01.17.2022 with an intended date of 01.22.2022 to officially make the governance proposal. In the time between, we will make ourselves and the advisors to Idle DAO available to answer any community questions to provide the context necessary for the community to make an informed decision around DAO entity structuring.

The governance proposal will include a request for distributions from the Idle Treasury for purposes of paying the attorneys, advisors and costs associated with the filing.

[1] On November 26, 2020, the governance of Idle protocol was activated, turning management of the governance system to IIPs (Idle Improvement Proposals).

[2] We are cognizant that such community members tasked with making such a decision should be compensated for their time and resources accomplishing said task.

[3] https://a16z.com/wp-content/uploads/2021/10/DAO-Legal-Framework-Jennings-Kerr10.19.21-Final.pdf

[4] Although plans for increased partnerships in the US and in-person events have been introduced within the community, a domestic entity structure would not be required for Idle DAO if an international structure was capable of identifying and paying any taxes related to this activity in the future. However, a US entity structure would eliminate the need to identify US sourced income in this situation because all income would be taxed at the entity level as the UNA would elect for taxation as a C Corp.

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