A business model is a deciding factor for the legal qualification of any venture. The business model of the organization is a combination of how it makes money and then handles that money, including incomes and expenses. For example, if an organization earns money from the sale of its own goods and services in order to further distribute it among its own beneficiaries, then it is a commercial trading company.
In another example, if an organization receives investors’ contributions for their further management with the aim of multiplying them and making profit from such activities, both for the investors and itself, it is a fund. And if an organization raises donations for their further use in the form of grants and charitable assistance, or is a professional association of experts in a certain niche, it is a charity or an association respectively.
Types of DAOs depending on the sources of income to the DAO Treasury and the ways the Treasury can use that income
This approach to the legal qualification of organizations is valid for both Web2 and Web3 organizations, DAOs. There is, however, one important difference. As the assets of a Web3 organization are usually stored on-chain and are managed by a decentralized community of DAO members rather than directors and shareholders–like in Web2 organizations–they are called a ‘DAO Treasury’.
Thus, depending on the business model, or, in other words, the types of income to the DAO Treasury and methods of their disposal, all DAOs can be conventionally classified into the following types:
- Community / Protocol DAO;
- Service DAO; and
- Investment DAO.
Community / Protocol DAOs
The main goals of a Community / Protocol DAO is, firstly, to unite the community of contributors, creators, entrepreneurs, and other enthusiasts around a decentralized blockchain protocol. Secondly, The Community DAO or Protocol DAO has a goal of motivating (incentivizing) their ecosystem of contributors to support the work of the decentralized protocol, build their own decentralized applications on it, issue NFT, or pursue some other activity.
To implement a motivation system for the participants of the blockchain protocol ecosystem, special tokenomics is developed. Rewards for contributors (DAO members) may include staking / yielding token rewards; minting tokens for performing ecosystem tasks, for example, confirming transactions; issuing grants to founders using blockchain protocol for launching DApps; and more.
Community DAOs are usually registered in the form of Foundations / Non-Profit LLCs, which have a defined statutory purpose; the development and support of the ecosystem around the blockchain protocol. These types of DAO registration entities also issue grants to the participants of their ecosystems to support their initiatives.
Treasury formation of Community DAOs
The source of the initial contribution of tokens to the Treasury of this type of DAO is the community token pool, which the Token Issuer Company transfers to the on-chain DAO Treasury at the time of initial token distribution. In the future, the DAO Treasury can be replenished thanks to on-chain deductions of commissions from blockchain protocol transactions, from the operation of various DeFi protocols, or other activities.
It is important to emphasize that the DAO Treasury is stored on-chain and is controlled by an autonomous smart contract. This means that since the DAO Treasury is under the control of an on-chain smart contract, which is an autonomous algorithm in the blockchain network, no member of the DAO has direct access to the DAO Treasury and cannot bypass the DAO members to dispose of the assets in it. Instead, the DAO members can publish proposals on how they would like to dispose of the DAO Treasury, and if such proposals are supported by a sufficient number of DAO members, the smart contract will autonomously make transactions from such DAO Treasury depending on the will of the DAO members according to the results of their voting.
In this regard, it is important to emphasize that the DAO Treasury is NOT owned by the DAO company and is not on its balance sheet. Instead, the role of the DAO Company is to be a governance wrapper for DAO members, and organize the process of decentralized on-chain management of the DAO Treasury through the on-chain voting by the DAO members.
The main purpose of a Service DAO is to gather a community of people on a professional basis, and to enable them to collaborate with each other to provide services more efficiently. This is achieved, for example, by enabling them to support larger projects from clients, or close complex client cases through a combination of niche industry knowledge. This model falls back on the idea of medieval craft guilds and manufactories.
The operation of the Service DAO usually involves the receipt of revenue from the provision of services to the general asset pool (Treasury) of the DAO, with the subsequent distribution of the revenue among the DAO as a whole and the DAO members, who are the providers of services that brought this revenue to the DAO. The former is usually used to build and maintain the infrastructure of the DAO, such as the purchase of IT systems for better service provision or payment of administrative staff, as well as for the promotion of the recognition and services of the DAO.
Service DAOs are usually registered in the form of For-profit LLP / LLC, where the Partnership / Operating Agreement performs the function of the DAO Constitution and regulates relations between DAO members, the procedure for the collective management of the Treasury, etc. An important step in the process of creating a Service DAO is the analysis of the type of services that will be provided by the DAO, in terms of whether they will be qualified as regulated activities. Examples of such services include financial, medical, insurance, and other regulated services. If the answer to this question is ‘yes’, such a DAO will need to obtain additional permits / licenses to undertake regulated services.
The main goal of an Investment DAO is to help people pool their assets to buy or invest in objects that they would not be able to finance on their own. The investment DAO can also conventionally be called a crowdfunding vehicle or a collective investment scheme. The investors who have joined a given crowdfunding campaign have the opportunity not only to receive benefits from their own investment, such as dividends, but in some cases also have the opportunity to use collectively-funded objects (for example, a real estate-oriented DAO), as well as collectively make decisions about trading such assets or other ways of managing them.
From a legal point of view, an important aspect that the founders of Investment DAOs should consider is that this DAO’s business model triggers regulation pertaining to both VASP (Virtual Assets Service Providers), as well as the asset management and financial markets regulators. It is especially important if the DAO concerns systematic fundraising and the subsequent management of those funds. This means that in most cases of launching an Investment DAO, the founders will need to obtain a VASP Authorization and Collective Investment Scheme License, as well as to implement financial compliance measures, conduct annual audits, and fulfill other regulatory requirements of such authorizations / licenses.
DAO Treasuries, although part of a decentralized organization, must adhere to regulation
Every organization comprises a group of people united by a common goal. This goal motivates people to join forces to collaboratively create value within the organization. As a result, at a certain moment of its existence, every organization will have assets resulting from the joint efforts of its members. The place where these assets are stored can be conventionally called the organization’s Treasury.
In Web2 organizations, assets usually include items such as intellectual property, goodwill, physical assets, and fiat assets. Accordingly, their Treasury, in which these assets are stored, usually comprises bank accounts, physical storage, and company servers. Instead, the Treasury of a Web3 organization includes virtual assets and protocol tokens, and the DAO Treasury itself exists and functions completely on-chain.
However, the on-chain nature of the DAO Treasury does not release the founders of such a DAO from the obligation to analyze in detail the types of earnings and spendings of the DAO, as well as to determine what requirements may be imposed by regulators on their business model and which legal form is best suited for its registration.
Find the best DAO type for your Web3 project
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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.