How the law was made and what it means for decentralized business

In March, the Utah State Legislature passed the Utah DAO Act, granting legal recognition and limited liability protections to decentralized autonomous organizations (DAO) in the state.

DAOs by default are not recognized as legal entities, and giving these organizations legal status in Utah could help clear up regulatory concerns. 

David Lemke, chief financial officer at crypto wallet Giddy — and member of Utah’s Blockchain and Digital Innovation Task Force — and Utah Representative Trevor Lee both authored the bill before it was presented to the Utah State Legislature.

“Our goal was to create a regulatory framework that supports the growth and development of DAOs in Utah,” Lemke told Cointelegraph, adding, “The Act allows DAOs to become a legal entity, apply for a tax ID number, open a bank account, own property, deal with non-DAO businesses, run payroll, and exist in the ‘real’ world as opposed to on-chain only.”

Lemke and Lee sat down with Cointelegraph to talk about how the law came into effect and what they think it means for the future of the crypto industry in Utah.

How the Utah DAO Act came to be

So, what were the origins of the Utah DAO Act, and how did Lemke and Lee bring this legislation to life?

According to Lemke, there was a “need for a regulatory framework that supported the growth and development of DAOs” and that industry particapants wanted to set better standards and protections for DAOs and tokenholders.

The Utah DAO Act, per Lee, was the result of a long effort from the state’s Blockchain and Digital Innovation task force — which got its stamp of approval from the governor in May 2022 — to create a “regulatory framework that supports the growth and development of DAOs in Utah.”

Lemke said that the task force “was ground zero” for developing new language for the law. In addition to legislators, members also included local attorneys who consult with DAOs and “members of Web3 companies here in Utah who either are in DAOs or work closely with DAOs.”

Initially, the task force researched laws pertaining to DAOs from around the world and applied them to its first drafts of the Utah DAO Act. The task force started meeting regularly during the summer of 2022 to discuss and revise the bill internally.

By early this year, the bill had been ready to take to lawmakers at the committee level. “The law was discussed within the task force as a whole and as a subcommittee, with multiple revisions and tweaks made along the way,” Lemke said.

The final draft was further discussed among lawmakers in the state House and Senate and regulators from the Department of Financial Services and the Department of Taxation. Lee said:

“After rigorous discussions and revisions, the Utah DAO Act was ultimately passed with few concessions.”

The bill, which was signed by the governor on April 10, will give come into force in 2024, which will “give the government enough time to prepare for the certification requirements needed to prove that an entity is indeed a DAO,” Lemke said.

Challenges of getting the act passed

But no law gets passed without its fair share of obstacles and hurdles, be they political or technical.

According to Lee, one of the biggest challenges the task force faced was “educating lawmakers” about the underlying blockchain technology and how it enables DAOs to exist. He said that many lawmakers who had never dealt with blockchain technology before “felt uncomfortable” voting for or against it.

To better educate lawmakers, Lee and Lemke met with representatives and senators in committee meetings dedicated to the industry and explained the impact that DAOs could have on the state. They also met with the heads of various departments, such as finance and taxation, to address their concerns.

“Another obstacle was the issue of DAO anonymity,” Lee said. “Initially, lawmakers were not comfortable with giving an entity the blessing of a state organization without having any recourse whatsoever to determine who organized or founded it.”

They came to an agreement with the lawmakers, ensuring that the registrar would be known to the state, but the names of the founders would be redacted prior to publishing to protect their anonymity. Lee told Cointelegraph, “We were able to find common ground and address these concerns, ultimately resulting in successfully passing the Utah DAO Act.”

Liability, anonymity and taxes

According to its authors, the new law has several benefits that it offers to decentralized autonomous organizations.

“The Utah DAO Act provides a new legal entity type for DAOs, called the Limited Liability DAO (LLD). With this entity type, organizers and tokenholders of DAOs are not personally liable for the acts of the business, just like an LLC or a corporation,” Lemke said.

He noted that this is “a significant improvement” from the current situation where tokenholders may be personally liable for the actions of the DAO, like with the recent court action against Ooki DAO.

Lee mentioned that the Utah DAO Act recognizes the importance of DAO-compliant anonymity and provides certain protections for organizers and operators of DAOs.

The law’s provisions for organizers and tokenholders to refrain from disclosing themselves allows DAOs to operate within the law without compromising individuals’ privacy. However, the law requires at least one individual organizer to be listed when they submit the bylaws of the DAO, but the organizer does not have to be a Utah resident or even a United States citizen.

“Before the DAO’s information gets published on the Utah Division of Corporations’ website, the state redacts all names and personal information related to the LLD,” Lee said. This compromise allows organizers and operators of DAOs to remain anonymous while also allowing the government to have some information about the entity.

The Utah DAO Act is further expected to have an impact on the tax treatment of DAOs. For example, if an unregistered DAO pays U.S. programmers to write code, it should file payroll tax returns and probably apportion some of its revenues to the United States.

Lemke said that any business that has income that is effectively connected with a U.S. trade or business has to file a tax return, regardless of whether the entity is legally organized in the United States.

Lemke clarified that the Utah DAO Act allows a DAO to organize itself as a legal entity, obtain a U.S. tax ID number, and file its tax returns. This will enable DAOs to operate legally and “avoid accruing massive tax liabilities.” The Utah DAO Act also gives DAOs the option to pick the type of entity that best suits their business plan, just like an LLC can elect its tax treatment.

Lee explained, “Essentially, the bill provides a way for DAOs to generate revenue for the state while protecting the DAOs from having an unlimited tax burden.”

What does the law mean for Utah?

Lee explained that the law can make the state more competitive for Web3 development. He said that most businesses organized in the U.S. select either their home state or Delaware, with its bipartisan political consensus to keep corporate law and statutes modern, stating, “Our goal as a task force was to make Utah become the Delaware of Web3 businesses, including DAOs.”

Lawmakers and task force members further hope that the law can attract DAOs from overseas. Lemke noted, “I’ve spoken with programmers from existing DAOs about the Utah DAO Act, and while they applaud the state for passing meaningful legislation that protects tokenholders and DAO organizers in a significant way, they hesitate to step foot in the United States legally (regardless of which state) because of the open attacks from the SEC and CFTC based on laws written almost 100 years ago.”

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Lee continued to state that most DAOs operate outside the U.S. due to regulatory uncertainty. “Team members on our task force include members that have helped structure these DAOs overseas. But we wanted to reduce the complexity of organizing DAOs and bring that business back into the United States, and this law draws upon the best DAO laws around the world,” he said.

Nevertheless, Lemkee said that “they’re encouraged by Utah’s DAO Act” because oftentimes, laws get passed at the Federal government level after enough states pass laws at the state level:

“Utah’s DAO Act is a glimmer of hope going in the face of Federal anti-crypto sentiment that may begin to turn the tide.”