Decentralization is a cornerstone of transforming a Web3 project into a DAO. In order to decentralize a centralized Web3 ecosystem, founders need to transfer their ownership and control over the project to the project’s community. This includes decentralizing token issuance, the business model and commission, on-chain protocol, and building a system of decentralized governance.
Stages of Creating a DAO
The process of creating a DAO can be more or less depicted in the following way:
- Initial community building, which will become the DAO in the future;
- The initial formation of a DAO Treasury; and
- Creating the DAO by giving community members the status of ‘DAO members’ through the implementation of decentralized governance and DAO Treasury management. The latter is, in fact, the transfer of ownership and control over the project and its assets from the founders to the DAO.
Each of these stages needs to be addressed carefully, and requires important legal work to successfully create a DAO. The three stages are explored below.
Stage 1: using an initial token distribution to build a community of future DAO members
One of the most effective tools for building a community and motivating it, is launching a project's token and organizing its initial distribution. Therefore, as the first stage of building their DAO, Web3 founders often plan initial token distribution. To do this, a Token Company is registered, which takes care of the initial issue and distribution of tokens.
The primary distribution of tokens includes both a centralized distribution of tokens for collaborators (founders, team, advisors, and investors, who receive tokens under Token Vesting Agreements or SAFTs/Private Token Sale Agreements), and a Public Token Distribution Campaign.
A Public Token Distribution Campaign can be structured as IDOs, Initial Dex Offerings; or LBPs, Liquidity Bootstrapping Pools (for paid token distribution); or airdrops (for unpaid token distribution). At this stage, tokens from the community pool are distributed by the Token Company.
Stage 2: the initial formation of the DAO Treasury
At the Token Cap Table preparation stage, most Web3 founders allocate only a fraction of their community pool for their Public Token Distribution campaign. The other part is usually reserved for the initial formation of the DAO Treasury. In the future, the latter might be spent on incentives for DAO validators/contributors, or used for staking rewards, or other purposes.
For the initial formation of the DAO Treasury, the tokens that were reserved in the community pool for the DAO are then transferred from the Token Company to the on-chain treasury. The moment this transfer takes place pinpoints the initial formation of DAO Treasury, and it is usually executed as part of Token Grant / Escrow.
As the second stage of the DAO formation comes to an end, the newly-formed DAO now possesses the following characteristics:
- A community of tokenholders, based on the results of the Public Token Distribution Campaign (IDO / LBP / Airdrop). The DAO founders can make these tokenholders into DAO members; and
- An on-chain token Treasury that has been reserved for the community. The management of the on-chain token treasury must be transferred to the community, which in turn enables the community to manage the treasury.
Stage 3: creating a DAO by implementing decentralized governance, Treasury management, and creating a community of DAO members
After the Web3 founders have built the community and allocated the pool of tokens for the future DAO Treasury, they move to the actual stage of creating a DAO.
To create a Web3 DAO, the founders should keep in mind this checklist of important steps:
- developing the DAO membership structure, which includes defining categories and criteria for tokenholders, which will entitle the latter to join the DAO as members and receive the right to participate in decentralized governance;
- developing the structure of DAO management bodies (Supervisors, Guardians, Treasurers, Secretary, Executive / Advisory Board, Council, etc.);
- developing the decision-making process, including the rules for publication of proposals, quorum, voting process, decision-making, and implementation;
- determining the purposes for which the DAO Treasury can be used, sources of future incomes to the DAO Treasury, and how they can be further used; and
- creating a legal wrapper for DAO, meaning incorporating a legal entity to legalize the DAO.
Why is this DAO creation checklist important?
The first 3 items of the checklist can roughly be grouped into tasks to develop the decentralized governance of DAO, including specifying the DAO’s details in the DAO Constitution, as well as reflecting them in the statutory documents of the DAO company.
The penultimate item on the checklist is important for qualifying the DAO’s business model as either a Community DAO, a Service DAO, or an Investment DAO. This, in turn, will affect which regulatory requirements the DAO must fulfill, in order to function in a legally compliant way.
The final item is important for creating a legal personality for the DAO. This way, the DAO can interact with the off-chain world, sign legal documents, etc. It also protects the DAO members from unlimited liability, which usually arises among members of unregistered DAOs.
Transfer of Ownership and Control over the Web3 Project from the Founders to the DAO
As the third stage of the DAO formation is finished, the ownership and control over the Web3 project and its assets is transferred from the founders to the DAO. From this moment, the founders no longer control how the tokens from the DAO treasury should be issued, burned, and distributed. The founders also can no longer determine the protocol fees and other types of income of the DAO Treasury or make decisions about the strategic development of the DAO.
These decisions, depending on the level of decentralization and the decentralized governance model, are made by the DAO itself. From this moment on, the Web3 project can be considered a decentralized autonomous (ownerless) organization, and the Web3 founders join the DAO as one of its members. In many cases, they also take positions in the structure of the decentralized management bodies of the DAO.
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Disclaimer: the information in this guide is provided for informational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice. Mentioning any of the assets in this article is not an endorsement to purchase them.
Nestor is a Co-founder & Head of Web3 Legal at Legal Nodes. Having over seven years of legal consulting experience, Nestor loves working with innovative startups and Web3 projects, helping them navigate the regulations and scale on global markets.