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Designing a Governance System for DAO: a Checklist for Web3 Founders

July 12, 2022

This article gives a detailed overview of the different elements of a DAO governance system, including DAO membership criteria, voting rights, decision-making processes, and the DAO Constitution. If you haven’t already read our article introducing DAO governance, you may find it useful to check it out first.

Let’s start by outlining the two stages of a DAO’s development, to better understand when a DAO requires its decentralized governance system to begin to operate.  

Pre-DAO and Post-DAO stages of a Web3 project

The development of each Web3 project can be conditionally divided into a Pre-DAO stage and a Post-DAO stage. Normally, at the Pre-DAO stage, the project’s tokenomics has been developed, the product hypotheses have been tested, and a blockchain network, in which the project’s smart contracts will be launched, has been chosen. At this stage, the management of the Web3 project is centralized, and the project itself is managed by founders who are looking for product and token market fit.

After the hypotheses are tested, smart contracts are launched, and tokens are issued, the founders prepare to “decentralize” the project ownership and management. They do this by implementing a decentralized governance system and selecting individuals to participate in the governance. This moment can be tentatively considered as the launch of the DAO, and the project then moves to a Post-DAO stage.

To properly prepare for it, the founders need to take care in developing a system of decentralized governance for their Web3 project. This will help to avoid imbalances within the ecosystem and also make the project more resistant to external factors.

Elements comprising the decentralized governance of a Web3 project

While working on the decentralized governance system for their Web3 project, founders need to do the following:

  1. identify the categories of participants of the Web3 ecosystem to whom governance rights will be vested, which requires defining the selection criteria for DAO members;
  2. determine the method of issuing voting rights to DAO members;
  3. decide on the list of decisions that will be made by the DAO;
  4. structure the procedure for putting forward proposals, voting for them, as well as implementing the adopted decisions;
  5. determine the structure of the DAO’s management bodies, as well as the powers and responsibilities of each of them; and
  6. put all of the above into a DAO Constitution.

Criteria for DAO members

In the process of determining which ecosystem participants will be considered DAO members, the means to prove it, and how voting rights will be granted, the founders need to decide on the criteria for selecting DAO members.

Some Web3 founders base it on a single criterion on whether a person holds the project’s tokens. In this instance, the founders may set the minimum number of tokens that a token holder must possess to be considered a DAO member. Other Web3 founders approach this issue in more detail, welcoming as DAO members only those participants who are contributors and play an important role in its work; as validators, oracles, or creators, for example.

Granting voting rights

After determining who the DAO members are, the founders move on to structuring their voting rights. Voting rights allow them to participate in the decentralized governance of the Web3 project. To confirm those rights, Web3 founders usually issue Liquidity Provider Tokens (LP tokens) to the DAO members as proof of the number of the project’s tokens staked by a DAO member. In other cases, founders may issue a separate type of governance token.

From a legal standpoint, both types of tokens must be non-transferable and non-tradable. If they are not, there is a high likelihood that these tokens may be considered as securities in most countries.

Read more: Token Types, Their Legal Status and Choosing the Country for Issuance.

Decisions made by the DAO

The ultimate goal of almost every Web3 project is to create a completely decentralized and autonomous project that will not require interference from the “real” outside world. Nevertheless, there are several issues that cannot be solved by automation at the early development stages. At the Pre-DAO stage, such decisions are made by the founders, while at the Post-DAO stage, the DAO members decide on them.

These decisions might include:

  • issuing additional tokens or burning some of the tokens issued before;
  • amending smart contracts’ rules of operation, in particular, to change the commissions that smart contracts take from each transaction for deductions made to the Treasury;
  • increasing the Liquidity Pool and/or Reserve Fund in the event of a threat to the price and liquidity of the token;
  • disposing of the Treasury, in particular by issuing grants to ecosystem participants

Making proposals, voting, and making decisions

After determining the decisions to be made by the DAO, it is necessary to think about the structure of the voting and decision-making procedure. Usually, it goes through the following stages:

  1. Creating a proposal to make a specific decision. Web3 founders need to determine which of the DAO members will have the right to create proposals and how many members must support it to put it to a vote of the entire DAO.
  2. Organizing the voting process. Here, it is necessary to think in detail about the time frame during which the supported proposal must be put to the vote, how long the voting will last, as well as how many votes will need to be collected for the decision to be considered adopted.
  3. Organizing the decision implementation process. It is important to determine those responsible for the implementation of adopted decisions, as well as the reporting procedure for such implementation.

Read more: The 5 Step Legal Roadmap for a Web3 Startup.

The structure of a DAO’s managing bodies

The primary source of the DAO’s will is its members, who have the right to create proposals and vote for them. However, in addition to DAO members, it is advised that founders also carefully consider the systems of DAO’s subsidiary bodies that will organize voting and enforce the decisions.

Those bodies include organs such as the:

  1. secretary—who is responsible for organizing the voting process and meeting deadlines;
  2. executive board—put in charge of the implementation of decisions made by the DAO;
  3. supervisor/guardian—who ensures that the executive board executes decisions made in the interests of the DAO and as per the will of its members; or
  4. treasurer—who takes orders from the executive board regarding the use of funds from the DAO Treasury according to the decisions of the DAO members.

DAO Constitution

Elements of the decentralized governance system listed above have to be detailed in a document to which all DAO members agree. Such a document is called the DAO Constitution, which in many respects resembles the constitutions of modern states. The DAO Constitution acts as a “public offer” or “social contract” between all DAO members, regulating interaction amongst them, and the order and degree of influence they have on the on-chain part of the Web3 project.

Additionally, it is of great importance for the Web3 founders to ensure that a portion of the DAO Constitution is reflected in the statutory documents of the DAO Legal Wrapper (Foundation or DAO LLC). This will give the decentralized governance system a legally-binding status, as well as provide more guarantees and legal protection for its members.

Read more: Setting up a DAO Legal Wrapper in Wyoming, USA.

Summary

Let’s recap the checklist for designing a decentralized governance in a DAO: 

  1. identify the categories of participants of the Web3 ecosystem to whom governance rights will be vested, which requires defining the selection criteria for DAO members;
  2. determine the method of issuing voting rights to DAO members;
  3. decide on the list of decisions that the DAO will make;
  4. structure the procedure for putting forward proposals, voting for them, and implementing the adopted decisions;
  5. determine the structure of the DAO’s management bodies, as well as the powers and responsibilities of each of them; and
  6. put all of the above into a DAO Constitution.

To make this system work from a legal point of view, DAO founders need to create a separate legal entity for their DAO (a DAO Legal Wrapper). This entity will have an ownerless structure of a DAO, help limit the liability of DAO members, and make the decentralized governance legally binding. 

At Legal Nodes, we help DAO founders create Legal Wrappers uniquely tailored to their needs by combining our expertise and knowledge of the most recent regulations that might affect DAOs—including understanding which countries are crypto-friendly–and choosing the most suitable lawyers to work on each case from our vast network of legal specialists situated in all parts of the world.

Start by booking a Legal Discovery Session ($100 for 1 hour) to get an intro to:

  • the most crypto-friendly countries for a DAO; 
  • a legal design of governance systems;
  • preparing a DAO Legal Wrapper roadmap for your project. 

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.

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Nestor is a Co-founder & COO of Legal Nodes. Having over seven years of legal consulting experience, Nestor loves working with innovative startups, helping them scale on global markets.

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