Exclusive Report: Solving the Riddle of the DAO with Colorado's Cooperative Laws
DAOs should memorialize their cooperative structures in legal entities that protect members from liability, the authors say in this research piece.DeFi News
Self-governing entities like Decentralized Autonomous Organizations (DAOs) are unique and largely incompatible with traditional U.S. legal entities.
Absent the adoption of a new legal entity structure that serves the novel needs of DAOs, we discuss why we believe, at present, the Limited Cooperative Association (LCA) provides the most ideologically aligned legal framework for DAOs.
The LCA integrates cooperative principles and values that are similar to core DAO principles and provides a legal framework for DAOs seeking to wrap a portion or all of their related activities in a legal structure.
I. Evolution of the Corporate Form
The corporation is one of the most significant inventions in history. Corporations allow people to create entities legally distinct from themselves, while giving those entities similar rights attributed to natural persons, including the ability to own assets, pay taxes, enter into contracts, and have legal standing independently of their owners.
Cooperatives, as a form of corporation, have been part of the U.S. economic landscape since the 1700s, but modern cooperative organizations began to flourish in the 19th century. Cooperatives have been created across all business sectors, from producers to consumers, workers to multi-stakeholders and multi-sector coops, and are now present in the digital realm in the form of “Platform Cooperatives,” like Stocksy United1, Savvy Cooperative2 and Fairbnb.coop3.
Cooperatives differ from other corporate models, because they are formed by members, and for members. Even when investors participate, a cooperative must be controlled by its members, and members participate in the governance of the cooperative. Ultimately, a cooperative is a business owned and controlled by the people using it, distinguishing it from traditional business organizations.
The first set of formal cooperative principles, the Rochdale Principles of 1844, led to the following tenets defining cooperatives:
1. Voluntary and open membership,
2. Democratic member control (of the organization by members),
3. Member economic participation (in profits generated by the members’ activities and losses),
4. Autonomy and independence (from investors control),
5. Education, training, and information (on co-op governance training and co-op-alignment political values),
6. Cooperation among cooperatives, and
7. Concern for the community.
DAOs represent a further evolution of the corporate form, fostering the creation of disintermediated communities and networks where participants control decision-making and their assets. There is no consistent bright line legal definition for a DAO but, at a rudimentary level, a DAO is a nimble group of people who act together in a joint enterprise for a common purpose. Given the commonalities between DAOs and traditional cooperatives, we will argue that the cooperative is the safest and most ideologically suitable corporate structure for DAOs.
II. The Colorado DAO Co-op
The most recent and helpful update to the cooperative model, especially for DAOs, is the limited cooperative association (LCA).
The LCA is a hybrid between a limited liability company (LLC) and a corporation. It is an entity built on the law of unincorporated entities. Like LLCs, it allows for investor members, returns on investment to patrons and non-patrons, and voting rights for investors, while adhering to cooperative principles. Where it differs from an LLC is in the distribution of financial returns based on patronage activity, voting based on membership (one-member, one vote) or based on patronage, which allows for the integration of DAO based governance principles, such as rage quitting and quadratic voting.
Just as startups from all over the world choose Delaware as their preferred jurisdiction for incorporation or formation, the same will be true for DAOs and Colorado.
The DAOification of decentralized resource coordination may fit most naturally within the Colorado cooperative statutes, specifically the Uniform Limited Cooperative Association Act (CULCAA). And, just as startups from all over the world choose Delaware as their preferred jurisdiction for incorporation or formation, the same will be true for DAOs and the CULCAA — you do not need to reside in Colorado, or even the United States, to form a Colorado LCA4, making it even more appropriate for global decentralized networks.5
The principles of the CULCAA overlap meaningfully with those of DAOs:
• They take the original Rochdale Principles (listed above) and apply them to modern affinity networks with a permissioned set of rules.
• They are built on democratic voting principles.
• They bestow limited liability to their members, promoting the use of the organization’s resources.
• They have the ability to embed autonomous governance traits into their governance documents.
• They have the ability to raise patron-member6 capital and issue digital tokens as a unit of account tied to patronage with built-in limited exemptions from state and federal securities registration.
• And, critically, DAO governance protocols can be architected into a cooperative’s bylaws, allowing token-based quorum voting, holographic consensus, a permissioned relative majority (Moloch DAOs), or conviction voting. In fact, decision-making can and does occur both on and off-chain, with “major decisions” recorded or simply memorialized on-chain.
III. Converting DAOs Into Cooperatives
The Colorado cooperative statutes can be used in any industry, and groups have been formed in industries from retail to housing, construction to craft beer, and many others. Colorado DAO co-ops, in the form of LCAs, already exist for freelancers, NFT holders, environmental incubators and other worker and project-based initiatives.
Here are examples of different types of traditional cooperative categories, and how they can be adapted for use by DAOs:
• Consumer Cooperatives: these co-ops sell goods and/or services to members, similar to REI, the popular outdoor goods co-op.
DAO Example: A DAO of NFT buyers, potentially similar to Flamingo DAO, sets up a co-op that buys NFTs. Those NFT buyers are the members of the DAO, and they can in turn purchase NFTs directly from the DAO.
• Producer Cooperatives: these co-ops are typically structured as selling or marketing tools for their members.
DAO Example: NFT artists form a co-op, of which they are the members, and then collectively produce NFTs. The co-op sells the NFTs on their behalf and distributes the revenue back to the artists.
• Worker Cooperatives: these co-ops hire workers, whether employees or independent contractors.
DAO Example: Designers form a co-op, of which they are the members, and that co-op contracts to third party projects, similar to the way in which Raid Guild and dOrg work. The designers are paid hourly for their contributions to the co-op’s work and also receive patronage distributions of the surplus (profit after expenses) resulting from their labor.
• Purchasing or Shared Services Cooperatives: these co-ops function as a B2B collective purchasing vehicles for their members, which are typically corporate entities.
DAO Example: Small crypto companies form a co-op through which they acquire benefits at a substantially better price for their employees.
• Multi-stakeholder Cooperatives: these are co-ops that combine two or more classes of members, including from the different types illustrated above. The membership classes have different roles and interests in the joint enterprise that broadly benefit all of them.
DAO Example: A worker co-op, similar to the one described above, could allow a class of non-designer members, for instance by permitting a consumer or investor class.
DAOs can employ cooperative structures to all or just a portion of their activities, which can be unwrapped or wrapped into distinct legal entities for different operational purposes, such as licensing, holding rights to intellectual property, hiring employees and contractors, distributing grants or paying taxes. This effect can also be achieved with a federated cooperative7 , which is a cooperative made up of member-cooperatives. Under this structure, activities can be siloed across separate member-cooperatives serving the core cooperative.
IV. Current DAO Co-op Use Cases Under the ULCAA
Two recent examples from our work with DAOs are the Employment Commons LCA and the SongADAO Co-op LCA.
Employment Commons LCA
The Employment Commons LCA (the “Commons”) was structured as a multi-stakeholder shared services cooperative. The stated purpose of this DAO co-op is “to host a decentralized technological and legal framework which is supported by an employment cooperative with a sustainable purpose and member benevolence better aligning the incentives of ecosystem players in a sustainable, user driven, network-based public utility employment infrastructure.”8
The Commons has two classes of members: employee9 and coalition10 members. Employees are individuals who, using an LLC or corporation legal shield, provide services to other businesses (like independent contractors) and have joined the DAO co-op in order to become eligible for payroll processing and a myriad of employee-related benefits, such as health insurance.
The Commons business activities are akin to that of a professional employer organization (PEO) where the DAO co-op functions as a co-employer. By acting as a co-employer for its members, it can negotiate on behalf of those members to acquire and provide employee benefits, bringing incentive alignment to the traditional, but broken employment sector. Coalition members, on the other hand, are individuals or entities who satisfy the DAO co-op’s patronage requirements by making referrals of new Employee Members, helping expand the network effect of the DAO co-op. The DAO co-op rewards both classes of members with native tokens called $WORK, which is a unit of account tied to payroll volume and designed to reward all member patrons in the Commons’ ecosystem.
SongADAO Co-op LCA’s business purpose is “to help the Song A Day to be heard by as many people as possible and to spread the meme of daily creativity.”11 SongADAO was structured as a consumer cooperative. The artist founder of the DAO co-op creates daily songs and transfers them to the DAO. The DAO mints these songs into NFTs and then sells the NFTs on to consumer-purchasers. Consumers who are willing to have their identity certified by a platform become eligible for membership and may also become voting members. Both member classes are consumer classes but the level of identifying information they are willing to provide alters their voting power and whether or not they can vote on the use of the DAO co-op’s treasury funds.
While being innovative in adopting DAO values to their structure and format, the activities of these DAO co-ops can be translated into business activities and entity-member relationships that fit well-established cooperative forms.
V. Is the LCA Structure a Blueprint for a Liability Resistant DAO?
The digital community has sounded a clarion call for the creation and legal codification of an entirely novel legal framework to meet the needs of internet or smart contract-governed communities, for affording digital legal personhood, limited liability protection, delineation of fiduciary duties, and clear guidelines for issuing compliant tokens and the treatment of community treasuries.
Until that framework is built, we believe the LCA cooperative structure is the best and most flexible legal choice for many DAOs. Coupled with other solutions (community legal indemnity funds and/or captive insurance for instance), the LCA model has the potential to keep DAOs true to their ideals yet on safe legal ground. We will continue exploring and developing solutions based on that structure and, if you’d like to participate or have questions about how this might work for your DAO, email us at email@example.com or find us on twitter @JacqR5 and @MuchnikYev.
We hope that this paper can serve as a reference, giving you initial direction on general aspects of the DAO co-op hybrid. In our experience, however, pure cooperatives, pure DAOs and DAO cooperatives can never be completely generalized, and you will need to discuss your particular structure with an experienced attorney to address entity design aspects that are specific to your DAO and your project.
We acknowledge the support of the DAO Research Collective in the preparation of this paper. The authors would like to thank Connor Spelliscy, Sam Vance-Law, Spencer Graham, Bill Warren, Auryn Macmillan, David Kerr, Morshed Mannan, Erika Sato, Samuel Gray, Adam Kay, Nathan Schneider, for their helpful review and input.
DISCLAIMER: This analysis should not be construed as legal advice for any particular facts or circumstances and is not meant to replace competent counsel. None of the opinions or positions provided hereby are intended to be treated as legal advice or to create an attorney-client relationship. This analysis might not reflect all current updates to applicable laws or interpretive guidance and the authors disclaim any obligation to update this paper. We strongly advise you to contact a reputable attorney in your jurisdiction for any questions or concerns.
1. Which offers a “highly curated collection of royalty-free stock photography and video footage.”2. A multi-stakeholder patient owned research cooperative that enables industry and start-up tech companies to easily conduct user research with patients to ensure the products that go to market are patient-centric and focused on patient need. 3. A more fair and equitable alternative to Airbnb. 4. See Jason Wiener, Linda Phillips, Colorado - “The Delaware of Cooperative Law,” Benefits of Incorporating a Worker Cooperative in Colorado, Fifty By Fifty: Employee Ownership News (May 29, 2018), https://medium.com/fifty-by-fifty/colorado-the-delaware-of-cooperative-law-babedc9e88eb 5. We are of the opinion that these communities do not need to be concerned by laws varying from state-to-state; they can operate in any state and still be formed under the law of the State of Colorado, in which case they will have to adopt a foreign entity form in the states where they have employees, but will be subject internally to the laws of Colorado. 6. In a cooperative, a patron is a person who purchases (or uses, or sells, or provides) products or services from (or to) the cooperative. 7. Federated cooperatives can be used as a central structure to provide services to the cooperative members (e.g. HR, accounting, industry training, to all coop entities who are members), as a centralized purchasing arm (e.g. buying paper, or other goods or services that all members need for their own business), and other uses that capitalize on the pooled resources and energy of the cooperative members. 8. Per bylaws. 9. Defined as a limited liability company or other corporate legal entity that meets the requirements of membership. 10. Defined as a natural person or entity that meets the requirements of membership. 11. As stated in the Bylaws adopted on 11/05/2021.