Decentralized Autonomous Organizations: An Overview of an Emerging Corporate Governance Structure
- masonwimberley
- 3 hours ago
- 10 min read
Jarrett Mendoza*
Associate at BakerHostetler
ISSUE 17 | SPRING 2025 | AI |
I. Introduction
In May 2016, with the goal of creating a revolutionary venture capital fund, a small group of cryptocurrency investors launched the first Decentralized Autonomous Organization (DAO).¹ Conveniently, they named their venture capital fund “The DAO.”² The seeding stage of The DAO, where venture capital funds raise their initial capital to invest, was an unexpected success.³ The DAO raised approximately $150 million from both institutional investors and retail investors, making it one of the biggest crowdfunding campaigns in history.⁴ The shocking crowdfunding victory spurred a frenzy of other investors that aimed to capitalize on the innovative venture capital model.⁵
Unfortunately, the successes of The DAO didn’t last long. In June 2016, a hacker found a loophole in the coding that allowed him to drain funds from The DAO.⁶ In the first few hours of the cyberattack, the hacker stole about $70 million from the investors.⁷ Although most of the stolen money was soon recovered, and investors received a portion of their money back, the event scared many affiliated business partners of The DAO.⁸ By late 2016, many cryptocurrency exchange platforms delisted The DAO from their platforms, making it harder for investors to do business with The DAO.⁹ The Crypto community quickly moved on from The DAO experiment, in search of the next big thing.
Nonetheless, The DAO’s revolutionary governance procedures, explained below, inspired many emerging companies to imitate DAO, unperturbed by the demise.¹⁰
II. What Are Decentralized Autonomous Organizations?
Put simply, a DAO is an organization that runs on a blockchain platform, where the owners of the business directly make decisions that are automatically executed by smart contracts.¹¹ Blockchains can be thought of as virtual ledgers, where each and every transaction or proposal within a business is recorded and stored.¹² The blockchain records and stores each transaction to ensure security and accuracy among owners, investors, and managers.¹³
A DAO is identified by the company’s decision-making processes.¹⁴ The inner workings of a DAO can vary from company to company.¹⁵ As of the publication date of this article, there are approximately 20,000 DAOs in existence.¹⁶ Over the past few years, since the fall of The DAO, these types of organizations have become increasingly complex and diverse. However, all DAOs have a few things in common: decentralization and automaticity.¹⁷
A. Decentralization
The concept of decentralization refers to where the decision-making power within a company resides.¹⁸ In a DAO, there are often no boards of directors, officers, or managers. Instead, each person that owns ‘tokens’ of the DAO has a role in the decision-making process.¹⁹ This concept spreads the power across the entirety of the token-holders of the organization, rather than giving power to a singular decision-making body.²⁰
For example, if there were 100 outstanding tokens of my personal DAO, Mendaoza Inc., and I owned ten Mendaoza tokens, I would effectively have 10% of the decision-making power. If the other ninety outstanding tokens were owned by my nine closest friends in equal amounts, each of us would have equal decision-making authority.
B. Automaticity
The concept of automaticity refers to how the decision-making process is carried out—automatically.²¹ While it varies from DAO to DAO, certain token-holders of a DAO can usually introduce a proposal to vote on.²² The proposal is then sent to the other token-holders of the DAO with a deadline to vote on the proposal.²³ As soon as the proposal has a majority of votes for a singular action (approving or denying the proposal), the proposal will self-execute, and the proposal will be integrated into the DAO.²⁴ The integration process of an approved proposal is executed through a series of smart contracts.²⁵
Smart contracts are agreements that automatically execute and perform when certain conditions are met.²⁶ Entities use smart contracts for many purposes, such as automated tracking throughout supply chains, creating secure voting environments, and streamlining payment systems.²⁷ As they pertain to DAOs, smart contracts automate many aspects of the business and are stored on the blockchain, reviewable by any token-holder within the DAO.²⁸
Using the same example as above, if I wanted to propose that Mendaoza, Inc. invest in a flashy new startup, I would write up the proposal and send it to my nine closest friends (the other token-holders) with a deadline to vote. The proposal would be detailed and have a step-by-step on how to make the investment happen through a series of smart contracts. My fellow token-holders would consider the proposal and vote accordingly. However, as soon as the proposal receives more than five votes to approve, the proposal would automatically execute, and the details contained within the proposal would begin to self-execute. I wouldn’t have to wait for my slower moving friends to vote because I already received the requisite number of votes.
C. Transparency
When a DAO approves a proposal, and the smart contracts begin to put the proposal into action, the agreements are transcribed on the blockchain for present and future token-holders to review.²⁹ All token-holders within a DAO have access to past agreements that self-execute, making it easier to analyze the performance of the business.³⁰ Further, the transparency that the blockchain provides builds trust and accountability for token-holders and investors.³¹ Because each and every proposal of a DAO is recorded, and because a DAO can’t make business decisions without a proposal, DAOs are easily audited.³² This transparency can be attractive when investors consider the risks of investment in a DAO.
III. How DAOS Differ FROM Typical Corporate Structure
A DAO’s constitution is a document that establishes the rules and governance system for the DAO.³³ It is a contract between the DAO’s members that regulates how they interact and influence the business. In other words, the DAO’s constitution defines who can join the DAO as a member, the conditions of such membership, how proposals regarding protocol are published, and how voting is organized.³⁴
A. The DAO Constitution
The constitution of a DAO is the equivalent of an operating agreement to an LLC or the bylaws of a corporation. While operating agreements may appoint managers, stipulate voting procedures, and allocate liability, DAO constitutions allow the same flexibility for token-holders to maintain the DAO as they see fit.³⁵
B. Shareholder Governance vs. Token Governance
In a typical corporate structure, shareholders own the corporation.³⁶ Shareholders vote to elect a Board of Directors to manage the business and day-to-day affairs of the corporation.³⁷ The Board also appoints officers of the company such as the chief executive officer, the treasurer, and the secretary.³⁸ With this structure, there is a clear chain of responsibilities from the shareholders to the officers.³⁹
In a DAO, the decision-making authority over day-to-day affairs lies with the token-holders⁴⁰ These decisions are automatically executed by smart contracts, rather than officers of a corporation acting to uphold shareholder wishes.⁴¹
IV. An Example of Modern DAO: Arbitrum DAO
The Arbitrum DAO manages different programs in a variety of tech-related areas.⁴² For example, the Arbitrum DAO manages Arbitrum Rollup, which is a protocol that aims to make Ethereum transactions faster and cheaper.⁴³ The DAO also manages Arbitrum Nova; a blockchain that helps developers build user-friendly decentralized apps.⁴⁴ The Arbitrum DAO launched its governance token through an airdrop in March of 2023.⁴⁵ Investors who wished to have a say in the governance of the Arbitrum DAO could purchase $ARB tokens.⁴⁶
To cut down on a potential flood of proposals, the Arbitrum DAO also utilizes a ‘temperature check’ stage for proposals.⁴⁷ Proposals are first submitted to the Arbitrum DAO governance forum for community discussion and debate.⁴⁸ These forum submissions are usually accompanied by a Snapshot poll that gauges the community’s interest in the proposal without a formal vote.⁴⁹ If the proposal passes the temperature check, it will move on to a formal voting process, needing a simple majority to pass.⁵⁰
The bylaws of the Arbitrum Foundation state that it focuses on fostering, developing, authorizing, and governing Arbitrum DAO-approved blockchains, however, the Arbitrum DAO also takes a proactive approach by funding research and development projects.⁵¹ The decision of which research and development projects to fund, much like many other decisions within the DAO, is left to the token-holders.⁵²
In an effort to avoid similar pitfalls of the aforementioned The DAO, the Arbitrum DAO utilizes a security council to address critical risks associated with the Arbitrum protocol and its ecosystem.⁵³ This 12-member security council is responsible for making emergency response decisions that protect the interests of the DAO, its members, and the broader Arbitrum community.⁵⁴ According to the Arbitrum DAO’s governance documents, the security council is subject to the oversight and control of the DAO’s token-holders, who have the power to remove security council members if they are not acting in the best interests of the DAO.⁵⁵
V. Investments in a DAO
With the fall of The DAO in 2016, the Securities and Exchange Commission (SEC) took a particular interest in DAOs as a whole. Like other crypto investments, the SEC was concerned that retail investors were unprepared for the degree of risk that a DAO could present.⁵⁶ This necessitated the question of whether DAO tokens should be considered commodities or securities. If the DAO tokens were labeled securities, the SEC would have jurisdiction to regulate the sale and distribution of all DAO tokens.⁵⁷
In July 2017, the SEC released “The DAO Report,” which labeled DAO tokens as “investment contracts” subject to U.S. securities regulations.⁵⁸ The SEC analyzed DAO tokens under the Howey test to reach their conclusion, specifically looking at whether the token-holders expected any profits to be generated by the “efforts of others."⁵⁹ The SEC reasoned that, because there is often insufficient information to make informed decisions and the ability to communicate and coordinate effectively is limited, DAO tokens satisfy at least one requirement of the Howey test.⁶⁰
Because DAO tokens are generally considered securities, the projects issuing DAO tokens must typically register their offerings with the SEC before selling them to the public.⁶¹ If a DAO issues tokens without proper registration, the SEC could take enforcement actions against the DAO developers, marketers, or organizers.⁶² The SEC’s goal is to protect investors, prevent fraudulent practices, and ensure transparency in the market through mandatory disclosure requirements.⁶³
VI. Conclusion
Decentralized Autonomous Organizations bring fresh ideas to corporate governance. Their decentralization offers direct decision-making, and their automaticity offers instantaneous execution. While there have been prime examples of failure in the DAO community, there are also prime examples of potential success. The SEC aims to regulate these emerging organizations to protect investors, but ultimately time will tell whether DAOs serve a future purpose in the crypto sphere.
Suggested Citation: Jarrett Mendoza, Decentralized Autonomous Organizations: An Overview of an Emerging Corporate Governance Structure, ACCESSIBLE LAW, Spring 2025, at 1.
Sources:
* Jarrett Mendoza is a UNT Dallas College of Law alumni and an Associate at Baker Hostetler, where his focus areas are business and mergers and acquisitions.
[1] See Samuel Falkon, The Story of the DAO – Its History and Consequences, Medium (Dec. 24, 2017), https://medium.com/swlh/the-story-of-the-dao-its-history-and-consequences-71e6a8a551ee.
[2] Id.
[3] Id.
[4] Id.
[5] See Guilio Prisco, The DAO Raises More Than $117 Million in World’s Largest Crowdfunding to Date, Bitcoin Mag. (May 16, 2016), https://bitcoinmagazine.com/business/the-dao-raises-more-than-million-in-world-s-largest-crowdfunding-to-date-1463422191.
[6] See Ernesto Frontera, A History of ‘The DAO’ Hack, CoinMarketCap (2022), https://coinmarketcap.com/academy/article/a-history-of-the-dao-hack.
[7] Falkon, supra note 1.
[8] Frontera, supra note 6.
[9] Falkon, supra note 1.
[10] Usman W. Chohan, Decentralized Autonomous Organizations (DAOs): Their Present and Future 5–6, https://ssrn.com/abstract=3082055.
[11] Id.
[12] Blockchain platforms are the technology that support a program to function, similar to how Apple’s Internal Operating System (iOS) supports certain apps to function. Sinclair Davidson et al., Disrupting Governance: The New Institutional Economics of Distributed Ledger Technology 4, https://dx.doi.org/10.2139/ssrn.2811995.
[13] There are various blockchain platforms, with Bitcoin and Ethereum being the most well-known. According to recent data, most DAOs run off the Ethereum blockchain platform. See Gail Weinstein et al., A Primer on DAOs, Harv. L. Sch. F. on Corp. Governance (Sept. 17, 2022), https://corpgov.law.harvard.edu/2022/09/17/a-primer-on-daos/.
[14] Preeta Singh, So, what’s happening with DAOs?, Medium (Mar. 10, 2024), https://medium.com/@preeta.singh/so-whats-happening-with-daos-778256c94543.
[15] Chohan, supra note 10, at 4–5.
[16] Singh, supra note 14.
[17] See Chohan, supra note 10, at 2.
[18] Singh, supra note 14.
[19] See Singh, supra note 14. (Tokens in the present context can be loosely translatable to voting and ownership shares of a corporation).
[20] See Chohan, supra note 10, at 4–6.
[21] See Chohan, supra note 10, at 4–6.
[22] Robert Leonhard, Corporate Governance on Ethereum’s Blockchain 16, https://dx.doi.org/10.2139/ssrn.2977522.
[23] Id.
[24] Id. at 16–17.
[25] Id. at 6–7.
[26] Vitalik Buterin, Ethereum: A Next-Generation Smart Cont. & Decentralized Application Platform 13 (2013), https://blockchainlab.com/pdf/Ethereum_white_paper-a_next_generation_smart_contract_and_decentralized_application_platform-vitalik-buterin.pdf.
[27] See id at 1.
[28] Id. at 18.
[29] Falkon, supra note 1.
[30] Falkon, supra note 1.
[31] Falkon, supra note 1.
[32] Falkon, supra note 1.
[33] Paul van Vulpen et al., Building the Foundation: a Constitutional Framework for Decentralized Autonomous Organizations 1, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4831039.
[34]DAO Constitution and Token Foundation: Structuring Fundraising for a DAO + DAO Constitution Template, Legal Nodes (Mar. 23, 2023), https://legalnodes.com/template/dao-constitution-token-foundation.
[35] Vulpen, supra note 33, at 2.
[36] Oberly v. Kirby, 592 A.2d 445, 458 (Del. 1991); see Grimes v. Donald, No. CIV.A. 13358, 1995 WL 54441, at *7 (Del. Ch. Jan. 11, 1995), aff’d, 673 A.2d 1207 (Del. 1996).
[37] MM Cos., Inc. v. Liquid Audio, Inc., 813 A.2d 1118, 1126–27 (Del. 2003), holding modified by Coster v. UIP Cos., Inc., 300 A.3d 656 (Del. 2023).
[38] Grimes, 1995 WL 54441, at *8 (“[T]he law recognizes that corporate boards … may satisfy their obligations by thoughtfully appointing officers ….”).
[39] See Williamson v. Cox Commc'ns, Inc., No. CIV.A. 1663-N, 2006 WL 1586375, at *4 (Del. Ch. June 5, 2006) (“A shareholder is a ‘controlling’ one in a corporation if she owns more than 50% of the voting power in a corporation or if she ‘exercises control over the business and affairs of the corporation.’”); Board of Directors and Corporate Structure: Directors, Officers, and Shareholders, FindLaw, https://www.findlaw.com/smallbusiness/incorporation-and-legal-structures/corporate-structure-directors-to-shareholders.html (May 22, 2024).
[40] Vulpen, supra note 33, at 1.
[41] Vulpen, supra note 33, at 13.
[42] A gentle introduction to the Arbitrum DAO, Arbitrum DAO – Governance Docs [hereinafter Arbitrum DAO], https://docs.arbitrum.foundation/gentle-intro-dao-governance (last visited Mar. 23, 2025).
[43] Id.
[44] Id.
[45] Arbitrum DAO, supra note 42; An airdrop is a marketing tactic where a blockchain project distributes free tokens to a large number of wallet addresses, usually to raise awareness about their project, attract new users, and build a community by giving people a small amount of their tokens for free. What is a crypto airdrop?, Fidelity (Jan. 3, 2024), https://www.fidelity.com/learning-center/trading-investing/crypto-airdrop.
[46] Under the Arbitrum DAO’s constitution, to submit a proposal, a token-holder must have at least 1 million votable tokens. This serves as a deterrent from the system being flooded with endless arbitrary proposals. Arbitrum DAO, supra note 42.
[47] Arbitrum DAO, supra note 42.
[48] Arbitrum DAO, supra note 42.
[49] Arbitrum DAO, supra note 42.
[50] Arbitrum DAO, supra note 42.
[51] Arbitrum DAO, supra note 42.
[52] Arbitrum DAO, supra note 42.
[53] Arbitrum DAO, supra note 42.
[54] Arbitrum DAO, supra note 42.
[55] To ensure maximum security and fairness, each security council member is elected by $ARB token-holders. Arbitrum DAO, supra note 42.
[56] Securities, Regulations, and DAOs, O’Melveny (May 19, 2022) [hereinafter O’Melveny], https://www.omm.com/insights/alerts-publications/securities-regulations-and-daos.
[57] Id.
[58] Id.
[59] O’Melveny supra note 56; see SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946).
[60] O’Melveny supra note 56; see W.J. Howey Co., 328 U.S. at 301.
[61] A Brief History of Securities Regulation, Wis. Dep’t of Fin. Insts., https://dfi.wi.gov/Pages/Securities/Filings/SecuritiesRegulationHistory.aspx (last visited Feb. 18, 2025).
[62] Id.
[63] Id.
