a16z: What is DUNA and why will it advance the future of Web3?

Original title: The DUNA: An Oasis For DAOs

Original author: Miles Jennings, David Kerr, a16z

Everyone active in Web3 has heard the word "DAO", which is the abbreviation of Decentralized Autonomous Organization. DAO is a key tool to keep blockchain networks open and has been working hard to become a benchmark for Web3, but there is a topic that cannot be avoided here, that is, law and regulation.

This week, Wyoming passed a new bill that brings DAOs into the scope of legal entities. This will enable blockchain networks to operate within the scope of applicable laws without affecting their decentralized properties. This is a major breakthrough because it will provide much-needed protection for DAOs and give them the ability to keep blockchain networks open.

Wyoming has a long history of supporting innovative legal entity structures. The state was the first to adopt the Limited Liability Company (LLC), the first to adopt the Unincorporated Nonprofit Organization (UNA), and the first to introduce a subset of its LLC statutes for use by DAOs. The new Wyoming law incorporates many of the provisions proposed in the model legislation we published.

This new entity structure will likely become the industry standard for blockchain networks created in the United States. So, here’s everything you need to know about Wyoming’s Decentralized Unincorporated Nonprofit Organization (DUNA).

1. What is a DUNA?

On March 7, 2024, SF50, the “Wyoming Decentralized Unincorporated Nonprofit Association Act,” was signed into law with an effective date of July 1, 2024. The bill is closely related to Wyoming’s existing Unincorporated Nonprofit Association Act, but it was specifically written for decentralized organizations.

Just as Wyoming’s previous DAO law (W.S. 17-31 Decentralized Autonomous Organization Supplement) can be thought of as a “Digital LLC,” SF 50 can be thought of as a “Digital UNA.”

In addition, one can think of it as the Web3 version of a Town Council. The purpose of a Town Council is to protect the standards and operations of the town by enforcing the community’s rules and conventions, ultimately serving the interests of its citizens, their homes, and their businesses.

Similarly, DUNA’s purpose is to protect and support the underlying blockchain networks, but like a town council, it is not a company itself.

2. Why is DUNA necessary?

Entrepreneurs around the world are using blockchain technology to build a better internet, which is fundamental to returning the internet to its open network roots. However, if we let corporations own these networks, we’ll end up back in the same situation we’re in today: our entire digital world is controlled by a few giant companies.

Blockchain technology offers a solid solution to this problem. It makes it possible to create open blockchain networks that are more like public infrastructure than proprietary technology, meaning that anyone can build on top of them, just as anyone can currently build a business using open internet networks (e.g. email and websites).

DAOs are made up of community members who manage the affairs of open blockchain networks. They are a critical tool to ensure that networks remain open, non-discriminatory, and value is not extracted unfairly. DUNA helps DAOs achieve this by addressing three key challenges they face. It gives DAOs legal status, enabling them to contract with third parties and have legal personhood, while it enables DAOs to be taxpayers and provides them with limited liability for the actions of other members. All of this is commensurate with other legal entity forms and protected by U.S. jurisdictions.

DUNA addresses these challenges without adding additional risks to consumers. DUNA can be used for decentralized governance of open blockchain networks, but anyone building consumer-facing applications on top of these open networks (such as social media apps, car services, or music streaming apps) will continue to use traditional legal entity forms such as corporations or LLCs. While this paradigm includes the use of corporations, the fundamental difference is that corporations no longer control the underlying network, they only control the user-facing applications. This difference greatly reduces their ability to extract value like web2 corporations.

The future of web3: Proprietary clients that operate using normal internet entity architecture, but built on a public infrastructure consisting of smart contract protocols and blockchain networks run by DAOs.

3. Why should DAOs use DUNA?

Membership and participation in DAOs currently face several legal risks. DAOs that fail to use a legal entity for their organization are unable to have legal rights, such as being unable to pay taxes, and face potential liability risks. At the same time, the lack of a legal entity also threatens the privacy of DAO members. Due to these risks, the failure to use a legal entity hinders the decentralization of blockchain networks, limits their growth, and hinders the development of economic models for such systems.

These risks could lead to worse outcomes if DAOs fail to adopt a legal entity until a better solution emerges. For example, regulatory actions and class action lawsuits in the United States claim that a DAO without a legal entity is just a general partnership. While there are several strong arguments to challenge these allegations, such a classification would be disastrous for DAO members, exposing them to unbearable tax risks and legal liabilities. As it stands, the odds are on the side of regulators and plaintiffs. If their theories spread and succeed, it could even be the death knell of decentralized governance.

DUNA prevents the possibility of this deteriorating, solves key challenges facing DAOs, and significantly reduces the risks faced by DAO members. It provides DAOs with legal status, enables them to contract with third parties, open bank accounts, and provides simple tools for the service process. It enables DAOs to pay taxes and meet their information reporting requirements. It protects the privacy of DAO members from intrusion by the federal government. And, it provides liability protection for DAO members.

It achieves all of these requirements without interfering with the way DAOs are currently launched and operated, it protects the fundamental principle of decentralization, and enables DAOs to effectively grow the ecosystem of their underlying blockchain network.

4. If DUNA is a nonprofit, can they engage in for-profit activities?

The answer is yes. Under Wyoming law, both UNA and DUNA can engage in for-profit activities. This would include operating a decentralized exchange protocol, a decentralized social media protocol, you name it.

Wyoming’s DUNA statute also explicitly allows for reasonable compensation for any services provided to the DUNA ecosystem. This feature will hopefully allow DUNA to compensate members who help facilitate its growth without extracting value from users. This is critical because it ensures that blockchain networks can operate in a decentralized manner and compete with centralized corporate networks.

For example, using this feature, a DAO could pay its members in exchange for governance participation. In this case, the rationale for DUNA rewarding people for voting or delegating could be that, by regulation, DUNA has no centralized management and therefore needs to rely on its members to manage all of its affairs. Therefore, in order to ensure proper management of DUNA, significant participation is necessary, and DUNA could provide compensation to members to achieve this goal.

While Wyoming courts will ultimately rule on what compensation is reasonable, there are plenty of real-world examples of nonprofits from which to draw inferences. In addition, the unique characteristics of blockchain networks also provide a solid foundation for arguments about the reasonableness of member compensation. For example, because blockchain networks are often open source and can be “forked” (copied) by anyone, the continued adoption and growth of a particular blockchain network that collects fees and distributes compensation to members is, in effect, a tacit endorsement by users that the network is reasonable to pay compensation to, or they would launch an alternative network (e.g., by forking).

Nevertheless, the “reasonable” qualifier does place an upper limit on the value that a blockchain network can extract from its users and use to compensate members. While those who wish to design vertically integrated and centralized blockchain products and services may be confused by the barriers to value extraction, this concept is consistent with the spirit of blockchain networks, not in opposition to it. If web3 blockchain networks ultimately extract value from users in the same way that web2 enterprise networks do (e.g., Apple takes a 30% cut of AppStore products), then Web3 will have failed. Wyoming’s approach supports the spirit of web3 while still providing cash flow to digital asset holders. This is a major breakthrough.

5. What are the securities law implications of using DUNAs?

Under the Howey test, which is the test for determining whether U.S. securities laws should apply to digital asset transactions, three elements must be met. There must be (1) an investment of money, (2) participation in a common enterprise, and (3) a reasonable expectation of profits based primarily on the management efforts of others.

Blockchain technology supporters have long argued that for the vast majority of digital asset transactions, none of these are met. Most of these arguments will hold, and they can even be enhanced by a DAO that adopts the DUNA legal entity form.

For example, using a DUNA would largely resolve the arguments raised by the third Howey Principle. First, a DUNA is essentially a decentralized entity whose underlying structure does not include management functions and has no officers or directors. Second, DUNA members have no legal obligation or right to maximize the organization’s profits. Together, these features significantly negate any claim that members may have “reasonable expectations of profits based primarily on the managerial efforts of others” when purchasing digital assets. Finally, as noted above, the nonprofit nature limits DUNA’s ability to distribute organizational profits to its members, but does allow it to compensate members for their contributions to the organization. Therefore, any member who is compensated is necessarily profiting not from the managerial efforts of others, but from their own efforts.

Nevertheless, the SEC may attempt to argue that DUNA satisfies Howey’s “common enterprise” requirement because membership in DUNA is denominated in the DAO’s digital assets. However, a number of counterarguments can be made based on DUNA’s decentralized structure. Moreover, regulators have sought to designate DAOs as general partnerships or unincorporated associations under common law, which at the very least suggests that designating DUNA as a “common enterprise” is self-contradictory. Finally, the rights of DUNA members are largely a product of the DUNA’s governing principles, which are generally rights set forth in the underlying governance and protocol smart contracts that constitute the DAO, and which exist regardless of whether the DAO formally adopts a DUNA structure. Therefore, if the underlying governance smart contracts are insufficient to qualify as a “common enterprise,” there is no reason to argue that the existence of DUNA changes that conclusion.

While the SEC’s theories regarding the applicability of U.S. securities laws to digital asset transactions are murky and evolving, the fact is that they remain subject to the Howey Act and subsequent cases. Under the Act, a DAO can use a DUNA to support its community’s arguments against the application of securities laws to the DAO’s digital assets.

6. What are the tax implications of using a DUNA?

For anyone who has consulted a tax advisor about DAO taxation, the specific circumstances of a project are the most important factors in forming the answer to a specific question, and generalizations are not a substitute for project-specific advice.

Like LLCs and UNAs, DUNAs can eliminate the complexity of DAOs operating under the U.S. tax framework because they can be taxed as corporations. Corporate tax treatment allows UNA and DUNA to meet their tax obligations in a manner that does not require disclosure of individual members and avoids the complexity of pass-through taxation, a problem common to blockchain network DAOs. Additionally, the United States has a large number of tax treaties with many countries and regions, and provides an environment where tax obligations can be clarified by utilizing domestic entities, which is an excellent advantage for DAOs that are composed of members from multiple countries.

To be clear, all of the above means that the DAO will have tax obligations arising from its activities, which may be different than those that currently exist, but ultimately these tax expenditures will greatly reduce the risks associated with membership and provide clarity in an uncertain tax environment. By paying taxes somewhere and having it be within the scope of US taxation, the DAO is able to resolve the huge unknowns surrounding its operations and member risks.

7. Why don’t more DAOs adopt UNA entities?

Since the DUNA structure was introduced only recently, there has not yet been any in-depth criticism of the structure. However, several arguments have been made against the use of UNAs (the legal predecessor to DUNA) before this. The following is a summary of these arguments and the corresponding counter-arguments in light of Wyoming’s passage of DUNA.

In short, the arguments against the use of UNAs are either addressed by DUNA or unconvincing. While DAOs will indeed continue to face uncertainty despite the adoption of the DUNA structure, it is undeniable that the uncertainty surrounding DAOs will be greatly reduced. While some may wish for a perfect legal entity structure to emerge that provides legal special treatment for DAOs and blockchain technology, this is an unrealistic approach that will hinder their advancement from the beginning.

· Nonprofit status limits flexibility. Some argue that UNA is not a suitable structure for a DAO due to its nonprofit nature. This is a fundamental misunderstanding of the “nonprofit” designation. Both UNA and DUNA can engage in for-profit activities under statute. In addition, they are permitted to pay compensation to members. Wyoming’s DUNA statute explicitly states that reasonable compensation is permitted (including in exchange for participation in DUNA governance).

· Undermines decentralization. Some argue that UNA introduces centralization risks. While UNAs typically rely on “administrators” to manage the day-to-day affairs of the UNA, DAOs can easily limit these powers. Regardless, any concerns about centralization are addressed by DUNA, which is designed specifically for large decentralized organizations. It applies whether the number of members is 1,000 or 10 million. In addition, DUNA contemplates a baseline structure that does not include management functions, and it allows administrators with limited authority to be selected to perform specific tasks authorized by members. For most DAOs, this type of activity is already exercised by the protocol foundation and does not pose a greater risk of centralization. Therefore, this classification makes DUNA meet the applicable standard of decentralization under US securities laws.

· Jurisdiction Choice. Some people believe that DAOs are not located in any jurisdiction and therefore should not choose to establish entities in any jurisdiction (including UNA). There are many problems with this argument. Simply put, it is a fantasy that does not consider the consequences it brings. Not utilizing the laws of any one jurisdiction means that one may be subject to the laws of all jurisdictions. Therefore, this approach favors potential attackers (including individual plaintiffs and governments) by enabling them to sue in the jurisdiction that is most favorable to them. This is not a theoretical discussion, it has already begun to play out in regulatory proceedings against Ooki DAO, as well as class actions against Compound DAO, Lido DAO and others. These actions are currently mainly carried out in California, based on the theory that such DAOs are general partnerships. In the case of Ooki DAO, the court has ruled that Ooki DAO is a general partnership, and if this decision is widely replicated, it will be the death knell of decentralized governance on web3. If DAO ignores this risk, it will be ignoring the risk.

· Undermining Permissionlessness. Some argue that the use of a legal entity undermines the permissionlessness of a DAO because it requires DAO members to join a legal entity. This is incorrect based on the definition of a DUNA. Holders of a DAO’s digital assets are not required to join its DUNA and are free to choose not to. Rather, the DAO determines the terms of membership in the DUNA based on the DAO’s governing principles.

· Unclear Use Case/Untested by the Courts. Some argue that because existing UNA legislation does not contemplate the use of blockchain networks, state legislatures may not have intended blockchain networks to use this structure, and the use of UNAs by blockchain networks has not been tested in the courts. These arguments are no longer relevant because DUNAs were designed specifically for decentralized organizations and with blockchain networks in mind. Furthermore, the use of a disembodied structure by a DAO has already led courts to apply it to general partnership statutes, which should be a significant risk to the DAO remaining disembodied.

8. How does A16Z CRYPTO plan to support the adoption of DUNA?

a16z crypto will work to promote the widespread adoption of DUNA in web3 and make it an industry standard. These efforts will include:

1) Develop decentralized governance proposals for DAOs we currently participate in to help them adopt DUNA.

2) Assist our existing portfolio companies in adopting DUNA structures related to their decentralization goals.

3) Where appropriate, as a condition of investment, require its potential portfolio companies in the United States to agree to adopt the DUNA structure when decentralizing and adopting decentralized governance. In addition, a16z crypto also intends to devote a lot of energy to providing resources to entrepreneurs, law firms, accounting firms, and other advisors to promote the adoption of the DUNA structure.

Adopting a DUNA entity structure can solve most of the uncertainties that DAO members currently face when participating in DAO activities. Therefore, we hope that through our efforts, DAO members can make more contributions and enhance the fundamental principle of decentralization in Crypto. For a16z crypto, this means unleashing the full potential of its engineering and research teams to promote the interests of DAOs.

9. Where can I learn more?

For background and more information on DAOs, UNAs, and DUNAs, see:

· A Legal Framework for DAOs (October 2021). Provides background on DAOs, explores the challenges they face, introduces the UNA as an excellent choice for a DAO structure, and reviews the history of the structure.

· A Legal Framework for DAOs – Part II: A Framework for Entity Selection (June 2022). Provides a comprehensive argument for why a UNA is the only appropriate entity structure for a blockchain network DAO.

· A Legal Framework for DAOs – Part III: Model Decentralized Unincorporated Nonprofit Association Law (March 2024). Introduces the DUNA, proposes model legislation for adopting the DUNA, and provides a detailed analysis of the provisions of the model legislation.

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