DAOs: What are they and why should accountants care?by
The UK government’s renewed focus on the crypto industry could result in recognition for Decentralised Autonomous Organisations, a new type of legal entity that uses blockchain technology to make decisions.
At Innovate Finance’s April trade conference, Chancellor Rishi Sunak announced his intention for the UK to become the world’s leading crypto hub.
This may result in the recognition of Decentralised Autonomous Organisations (DAOs) in the UK, a new type of blockchain-based legal entity, which would require accountants to get to grips with new accounting standards and tax rules.
The possibility of DAOs is already being looked at, with the Treasury recently having asked the Law Commission to consider their legal status.
The recognition of DAOs could potentially act as a magnet for economic activity and investment in UK plc. In America, Wyoming and Tennessee have passed legislation for DAOs, with one of the first examples including CityDAO, which initially purchased 40 acres of land.
What are DAOs?
DAOs have been around since 2016 but only started to become popular at the end of 2021.
They are a new type of legal organisation that uses blockchain technology to make decisions. DAOs tend to be formed for a common purpose or special interest, such as owning land or investing in non-fungible tokens (NFTs) or startups.
Their governance is considered to be more democratic than traditional companies as decisions are made collectively by token holders, rather than a board of directors.
“As accountants, we can think of DAOs as a next-generation Special Purpose Vehicle (SPV),” commented Gavin Brown, associate professor in financial technology at the University of Liverpool. “But they are an SPV that is community-led, democratically controlled, pre-programmable as well as capable of evolving with the changing needs of the economy and token holders who own it.”
The influence individuals have is proportionate to the number of tokens they hold. Group actions, such as the decision to purchase an NFT, are executed via smart contracts and are stored permanently on the blockchain.
What are the benefits?
Unlike early-stage high-growth startups, it’s reasonably easy for individuals to participate in DAOs. Individuals don’t need large pools of money if they invest in DAOs soon after they are formed, and being able to access opportunities is not reliant on exclusive networks in specific geographical locations.
All stakeholders in DAOs that meet certain conditions (such as holding a certain number of tokens) can table governance proposals and take them to votes. This is more democratic than traditional companies, which offer everyday shareholders rare and limited options (for example at AGMs) to make decisions.
Trust and transparency
DAO participants don’t need to know each other as the rules of engagement and decisions are immutable and recorded on the blockchain. This means no individual participant can make changes without a majority, resulting in the DAO advancing the collective interest of the group.
DAOs in the USA
DAOs are now legally recognised in Wyoming and Tennessee. It is hoped that this will attract investment to the two different states, as well as founders moving to the area to form new DAOs.
CityDAO, one of the first DAOs in Wyoming, was founded by Scott Fitisomes, a San Francisco startup founder. The DAO has initially purchased a piece of land in Wyoming and plans to mint it into an NFT. Token holders will decide how to use the land and ensure sustainable measures.
Legal framework concerns
While Wyoming and Tennessee legal frameworks are a big step for the crypto industry, there are various unknowns and the law does not address some fundamental questions.
For example, Tennessee law states that a smart contract-managed DAO may be formed only if the underlying smart contracts are able to be amended. How this would work in reality for a decentralised organisation is unclear.
A further issue is DAOs having to register separate LLCs (the American equivalent of limited companies) to fully operate, because registration makes it difficult to keep business decisions truly decentralised.
However, we’re starting to see some of these issues being solved. The Marshall Islands have just become the first sovereign nation to grant DAOs the same rights as limited corporations. This means DAOs don’t have to register separate LLCs and allows DAOs the ability to hold real estate.
What are the implications for accountants?
The development of DAOs is rapidly evolving and poses a whole set of questions for accountants related to their treatment. We’ll likely see new accounting, tax, insolvency and audit laws.
A number of these issues came to light recently following the failure of ConstitutionDAO. This was a project from 2021 that raised $50m to unsuccessfully try to purchase a copy of the US Constitution. The DAO is now in the process of being wound down with the tokens being returned. However, returning the money was tricky due to the high transaction fees of open-source blockchain, Ethereum.
Over the past 12 months, DAOs have caught the imagination of early adopters, who are coming up with a number of uses for this new type of blockchain organisation.
Their ease of accessing finance and fast growth means their rise cannot be ignored by proactive firms, and now is the time for accountants to educate themselves. DAOs are fast-moving and represent a major opportunity for proactive firms. The need to understand DAOs will only become heightened if they achieve legal status in the UK.
AccountingWEB Live’s latest episode of Tech Pulse covers all things cryptocurrency for accountants, touching on the tax and accounting implications in the space, speaking with accountants currently working with crypto clients and providing real-life examples of client work. To watch the show on demand click here and register: Crypto client confidential
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Dudley is a Chartered Accountant formerly with KPMG and Moore Kingston Smith. He founded Audapio, a solution leveraging Open Banking to improve audit quality and efficiency before joining Circit as VP of business development.