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New Hampshire Has a Better Approach to DAOs

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New Hampshire Has a Better Approach to DAOs

The world’s legal systems are straining to adapt to transactions facilitated by smart contracts, cryptocurrencies, digital assets, and other developing blockchain technologies. One of these innovation — commonly known as “Decentralized Autonomous Organizations” or “DAOs” — offers potentially revolutionary mechanisms for conducting governance and transactions among participants.

Keith Ammon is a four-term elected Representative in the New Hampshire State Legislature. Bill Ardinger has practiced law in NH for almost 40 years, representing businesses on tax and transactional matters and seeking policy improvements. Both served on the New Hampshire Commission on Cryptocurrencies and Digital Assets.

New Hampshire is considering legislation (HB 645) to enact a new legal entity law for DAOs. This essential legal innovation, which was recommended by the 2022 New Hampshire Commission on Cryptocurrencies and Digital Assets (on which the authors served), would not “piggyback” on other legal entity laws, such as laws for “limited liability companies,” as some other states have done. Instead, it proposes a new form of legal status for DAOs listed on a public registry, including granting the enterprise legal personhood and limited liability for its participants.

Traditional centralized legal entities and true DAOs

Traditionally, legal entities such as corporations operate by delegating decision-making power from more diverse participants (e.g., shareholders) to centralized executive authorities (e.g., officers or agents) that determine and execute entity operations.

DAOs offer a different approach. from these more traditional forms of community-delegated actions. DAOs are enterprises that enable a diverse group of participants to conduct transactions as a coordinated unit according to software code implemented on a public blockchain (e.g., smart contracts) without the need for delegations to a board, officers, or other centralized executives. Once actions are approved through distributed governance, they can be executed automatically (“autonomously”) by the code without further executive action by centralized executives.

While some DAOs are subject to control by a limited group of developers or participants and continue to rely on the traditional model of delegated authority to centralized executives, other genuinely decentralized autonomous organizations represent a potentially revolutionary innovation in how governance and economic decisions are made. Blockchain technology, with its unique attributes of flexibility, transparency, auditability and security, can be deployed to empower widely diverse groups of humans with shared values to accomplish common goals at the worldwide scale of the internet. We remain at the very earliest stages of development of the potential for widely-distributed DAOs to impact our societies and economies.

HB 645 aims explicitly to promote this “genuine” DAO model, limiting the new enterprise form only to DAOs that satisfy standards for diversification and transparency.

Uncertain legal status for DAO participants

While technical innovations for DAOs continue, the legal system remains lodged in the world of traditional centralized entities. The lack of appropriate legal rules for DAOs creates uncertainty and risk that hampers innovation and undermines the ability of DAOs to operate in the traditional world.

The most significant legal risk is that DAO developers, administrators, and participants are subject to joint and several liability for losses realized by a DAO. In contrast, shareholders of corporations (and other legal entities) enjoy “limited liability.” That is, if a corporate shareholder invests $100, the shareholder (in most cases) is only exposed to losing that investment due to corporate activities, and the rest of the shareholder’s assets are protected. This limited liability for shareholders, first adopted for general corporations by New York State in 1811, is a legal innovation that has powered today’s Western economies.

The risk to a participant’s non-DAO assets is not academic. In September 2022, the CFTC took enforcement action against Ooki DAO, treating the DAO as similar to an unincorporated association and asserting that active members are jointly and severally liable for all of the obligations, liabilities and debts of the DAO. The lack of limited liability is the death knell for robust development of DAO technologies.

Another legal uncertainty for DAOs is their lack of recognition as a “legal person” who can engage in transactions in the traditional world. A corporation can own assets, sue in its own capacity to enforce a contract and may be sued if it violates a law or contract. Under current laws, DAOs do not have similar legal clarity. If a DAO engages in transactions, it may not be able to enforce rights in court or before a regulatory authority.

Other legal uncertainties exist for DAOs (for example, securities, antitrust, tax). However, the conceptual starting point should be to enact a legal framework that recognizes DAOs as legal entities and grants its participants limited liability.

New Hampshire’s answer: HB 645

As stated in the Final NH Commission Report, New Hampshire intends to become a leader in establishing sound and flexible rules governing the legal status of DAOs. Following the Commission’s recommendation, Representative Ammon introduced House Bill 645, which would establish the “New Hampshire Decentralized Organization Act.” The NH DAO Act would recognize a registered NH DAO as a distinct legal entity and grant limited liability protection to its developers, participants, administrators, and legal representatives.

First introduced in 2023, the initial version of HB 645 implemented the COALA Model Law. This choice signaled an intent to create an entirely new legal entity that reflects the unique characteristics of DAOs as opposed to trying to jury-rig an existing approach for traditionally centralized entities (as other states have done by extending their LLC statutes to DAOs). The House Commerce Committee recommended an amendment to the bill that adopts some more traditional legal entity provisions (such as name and registered agent requirements) while preserving the creative, “DAO-unique” aspects of the COALA Model. On February 6, 2024, the full House voted to approve the amended bill by a bipartisan 340-33 vote. The Senate will now review the bill, with hearings before the Senate Commerce Committee during April.

Key aspects of the bill

While it is beyond the scope of this article to provide a detailed description of the bill, the following highlights are essential:

(1) Legal Personhood and Limited Liability. As noted, the Act would acknowledge legal personhood and grant limited liability to NH DAOs listed on a public NH DAO Registry.

(2) Public NH DOA Registry. The Act would require the Secretary of State to establish and oversee a registry of NH DAOs that satisfy certain “listing” requirements. The Act directs the Secretary of State to engage a qualified Registry Administrator and directs the Administrator to undertake reasonable efforts to maintain the Registry as a blockchain system.

(3) Registry Listing Requirements. The Act would require a NH DAO to satisfy 11 “listing” requirements. These include being deployed on a permissionless blockchain, using open-source software, having public, plain language bylaws that accurately reflect the rules of the software code that govern the NH DAO, providing evidence of quality assurance testing, and having decentralized networks and governance.

(4) Authorization of Agents. The Act would expressly recognize the legal positions of “administrators,” “developers,” “participants,” and “legal representatives,” authorizing an NH DAO to designate such persons to perform off-chain functions and operations on behalf of the NH DAO.

(5) Governance and Economic Rights. The Act would require NH DAO bylaws to specify the rules for determining participants’ governance and economic rights and responsibilities. While the bylaws must address such material rights, the Act emphasizes that its policy is to give maximum effect to the principle of freedom of contract and to recognize that rights of participants will be determined by the governing software code (the “intent of code is law”).

(6) Indemnification and Waiver Powers. Similar to laws establishing other legal entities, the Act expressly empowers NH DAOs to indemnify and limit liability for participants, administrators, and other persons.

(7) Flexibility. Following the COALA Model approach, the Act would allow significant variability and flexibility in the structure of particular NH DAOs. The public registry approach seeks to take advantage of DAOs’ public, open-source nature and avoid filing requirements typical for traditional legal entities.

New Hampshire’s motto “Live Free or Die” celebrates independence, freedom and individual rights. Our state has a well-deserved reputation for supporting innovators and entrepreneurs with flexible and modern legal systems. By attracting successful creators with sound laws, New Hampshire continues to enjoy diverse economic growth that benefits our citizens and their communities. Consistent with the recommendations of New Hampshire’s 2022 Commission, the Legislature is making significant progress in enacting a unique legal entity statute specifically built for DAOs.

The authors encourage readers to contribute to this vital effort to enact legal innovations that support this critical blockchain technology’s further development and growth.