[AUTHOR’S NOTE - Decentralization is a good thing.  The evolution of DAOs is a good thing.  Collective human behavior and decision making is evolving at a rapid pace and is positively correlated to the rate of Web 3.0 innovations.]

Decentralization and statelessness are increasingly becoming priorities for founders and communities across the ecosystem as an approach to hedge away from the reach of the Howey Test.  There is a lot of focus on the four prongs of Howey and implications with respect to tokens, and rightfully so.  The test's prongs embody an expansive web of concepts that regulators can use and employ in scrutinizing protocols.  However, focusing on Howey limits founding teams from seeing the field, so to speak.  These conversations are accelerating across the legal community and with founding teams, so it is appropriate to explore a hasty framework and approach below to address decentralization and identify a few regulatory concerns for founding teams:

  1. Structure > Jurisdiction [LEGAL] - What is the corporate structure of your operation?  THIS MATTERS from day 0!  Is there a development or operating company that employs or pays the founding team and others?  Is the protocol spun up outside of this entity and seeded by technology from, and controlled by, the operating company?  If there are tokens, what is their purpose (governance vs. utility), where are they issued from and what are they claims of?  Is this in or through a separate entity?  In any structure, what is the jurisdictional nexus (i.e. ‘location’) of your filed entity, and what other jurisdictions can claim nexus due to users, activity, or access to product?
  2. Token Issuance / Unregistered Securities Offering [FUNDRAISING] - Were tokens issued or minted and do they qualify as securities AND/OR an unregistered securities offering.  Does an exemption apply (i.e. sale to accredited investors, or international investors exclusively)?
  3. Exchange Registration (DEXs, Deposits, Lending, Derivatives) [PRODUCT] - Is value in the form of assets, tokens, streams, etc. circulated on your protocol?  Is their a lending, derivative, or securitization aspect or feature?  Is there an opportunity to register your exchange or leverage an ATS exemption?  What makes sense from a product point of view, COB vs. AMM?  This matters.
  4. Decentralization / Statelessness [PRODUCT, DESIGN, GOVERNANCE] - What does the cap table look like and what will it look like at the point of open source automation?  How decentralized is governance, code commits (on chain, and UX), value circulation, etc.?  How large is the user base and what does concentration look like?

A Layer Deeper - Legal Theories and Prophylactic (preventative) Devices

  1. Agency Liability - Regulators are trained to hone in on a root cause, and in this case, a core person.  Regardless of stage, legal structure, and level of decentralization in the life of the protocol or token, regulators of all kinds need a lightning rod.  There is NO UNIFORM precedence or safe harbors (YET) and agencies are coming online, so leaving in play liability blockers around teams and communities is key during the life cycle.
  2. General Partnership Issues - In a world of statelessness, default legal and tax classification of an association of members and users is a General Partnership.  This implies unlimited and several liability to ALL members.  DAO communities are not considering this risk generally, where community transparency and narrative will be key in educating your user base. 
  3. Lack of KYC - Can be a risk for both core teams and on the product front.  If it exists, there is a strong case to leave it.  If it does not, it should be considered for the product roadmap.  This is a check the box in terms of meeting regulators where they are.  The window is closing to get ahead of regulatory guardrails, so set this in place or not, but be deliberate about why and what it means in a world of consumer protections and future ubiquitous regulation.
  4. Untenable Decentralization - Decentralization is a noble reaction to shifting human behavior, technological innovation, and Web 3.0.  BUT, it may not always be tenable.  There is a reason traditional models and governments are centralized (dare I say!), you can move quickly and efficiently in the chosen direction.  Lets see where this narrative goes, but know that pure decentralization rarely exists at scale in nature and in business, and there are likely reasons for that.
  5. Decentralized UX - Open source code commits.  Get there!  It's a hot topic across the board but it is the end game for decentralization.  To the extent core teams still have to intervene on product or protocol and are pressing the button, agency attaches (back up to #1).

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*Note, this does not constitute legal, accounting, or tax advice of any kind and should not be relied upon as such.  Opinions are my own and are for discussion purposes only.  This does not represent the views of Decentral Park Capital or its affiliates.

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