DAO: What is it? What does it mean for nonprofits?

In the past week, ConstitutionDAO raised over $45 million to bid for a first edition copy of the United States Constitution. Ultimately, they did not win the auction held by Sotheby’s on Thursday, but they put the power and influence of DAOs on the map with heavy national news coverage.

Notice from ConstitutionDAO

We did not win the bid for the copy of the U.S. constitution.

While this wasn’t the outcome we hoped for, we still made history tonight with ConstitutionDAO. This is the largest crowdfund for a physical object that we are aware of—crypto or fiat. We are so incredibly grateful to have done this together with you all and are still in shock that we even got this far.

Sotheby’s has never worked with a DAO community before. We broke records for the most money crowdfunded in less than 72 hours. We have educated an entire cohort of people around the world – from museum curators and art directors to our grandmothers asking us what eth is when they read about us in the news – about the possibilities of web3. And, on the flip side, many of you have learned about what it means to steward an asset like the U.S. constitution across museums and collections, or watched an art auction for the first time.

We had 17,437 donors, with a median donation size of $206.26. A significant percentage of these donations came from wallets that were initialized for the first time.

You will be able to get a refund of your pro rata amount (effectively minus gas fees) through Juicebox. Please expect more details from us about this shortly – our team has not slept in the past week, and we are giving people a night to get some rest.

Every one of you were a part of this. We want to also thank our partners in this work: Alameda Research, Endaoment, FTX US, Juicebox, Morning Brew, and SyndicateDAO


What is a DAO?

Decentralised Autonomous Organisations (DAOs) are organisations whose rules and governance (the parameters by which they operate and stakeholders interact) are encoded in a blockchain (i.e., in a computer program rather than set out in a typical paper based governance document such as a shareholder’s agreement).

Demystifying DAOs (Finextra)

A DAO’s financial transactions and rules are recorded on a blockchain. This eliminates the need to involve a third party in a financial transaction, simplifying those transactions through smart contracts. The firmness of a DAO is a smart contract. The smart contract represents the rules of the organization and holds the Organization’s storage. No one can edit the rules without people noticing, because DAOs are transparent and public.

What Are DAOs And Why You Should Pay Attention (Forbes)

The use of technology allows a DAO to be able to operate without managers or a governing body pursuant to rules and decisions made by its members. Hierarchy is not eliminated, however, because certain members may hold more tokens, which represent the membership and voting interests. And some form of management may be required to ensure legal compliance and equity concerns, which a simple democratic vote may not take into account.

A DAO’s legal status may also depend on what jurisdiction is involved. Because a DAO may commonly run with little regard for where its members are located, jurisdictional issues may be thorny. To the extent that a DAO may be held responsible for a legal obligation, it may be considered in certain states to be operating as an unincorporated association or partnership.

In addition, there are securities laws concerns about whether a DAO is structured in a manner that doesn’t make it an unlawful offerer of unregistered securities. Registration of tokens may also be complex and subject to rejection by the Securities and Exchange Commission (SEC). See, e.g., Registration of Two Digital Tokens Halted (SEC Press Release, Nov. 10, 2021).

For DAOs with a primary common purpose other than to operate a business for profit (e.g., organized and operated for primarily charitable and educational purposes), in California, it may be considered an unincorporated nonprofit association (sometimes referred to as an “UNA”). Unlike the case with typical unincorporated associations and general partnerships, members of a California unincorporated nonprofit association have some degree of limited liability protection.

DAO and 501(c)(3)

If the DAO is structured as an unincorporated nonprofit association, it’s possible for it to apply for and obtain IRS recognition of its exemption under Section 501(c)(3) of the Internal Revenue Code, assuming it meets all of the requirements. However, because the IRS application and reports generally look for information about the governing body, it may be difficult to receive a favorable determination absent a centralized governance structure (i.e., a board), particularly if there are more than just a few members.

Nonprofit Corporation

For greater limited liability protection, a nonprofit corporate structure may be preferred, particularly in states without limited liability protection provisions for unincorporated nonprofit associations. While there may be some feeling among DAO organizers that the “D” in DAO (decentralized) could be lost, that may be the necessary trade-off to better protect those who accepted fiduciary positions as directors (i.e., board members).

DAO members could still be structured as statutory voting members of a nonprofit corporation. In such structure, the members would typically have the same types of rights as a shareholder of a for-profit corporation other than the right to distributions. For example, members would have the right to elect directors, amend the bylaws, and approve major corporate changes like amendments to the articles of incorporation, mergers, transfers of substantially all assets, and dissolutions. In addition, each member would have standing to sue the directors derivatively on behalf the corporation.

The bylaws of the corporation could provide additional powers to the members. Even though there may be greater exposure to liability associated with greater powers, this could create more of the distributed power structure contemplated by a DAO.

In California, there are requirements for electronic transmissions by and to the corporation that would need to be factored into the programming and the bylaws. Some of the perhaps antiquated requirements are the right of the member to receive paper copies of electronic transmissions by the corporation (including of written ballots, which represent an alternative way for members to take action other than at a meeting) and the right of a member to require an in-person membership meeting if a membership meeting is necessary or held.

An alternative structure would be having the DAO, as an unincorporated nonprofit association, set up as the sole member of a new nonprofit corporation. This would need to be structured very carefully as only donors directly donating assets to the 501(c)(3) nonprofit corporation would be eligible to receive the benefit of a charitable contribution deduction, and only agents of such nonprofit corporation may be able to lawfully fundraise for the charitable assets.

Fiscal Sponsorship

If a nonprofit corporation isn’t a desirable structure for a DAO with a charitable purpose, one particularly attractive alternative may be fiscal sponsorship – specifically comprehensive (or Model A) fiscal sponsorship. In such structure, the fundraising and charitable programming would be housed in the fiscal sponsor (which is a public charity). The DAO would serve as a noncommercial vehicle to convey the funds from donors to the fiscal sponsor and may allow token holders to have advisory privileges relating to the charitable programs.

In the comprehensive model [of fiscal sponsorship], the party entering into the fiscal sponsorship agreement with the fiscal sponsor is generally giving up all ownership and control of the project to the sponsor and retaining only the right to enforce, amend, or terminate the agreement and have the project transferred to another qualified fiscal sponsor. In contrast to the fiscal sponsor, the other party to the agreement is not a tax-exempt entity able to directly receive deductible charitable contributions and is likely not properly registered to solicit charitable funds or assets. Most often, it’s just some form of steering committee with minimal activity of its own, which helps minimize any risk that might otherwise be borne by its members.

When working on the fiscally sponsored project, the individuals associated with the other party to the agreement serve as employees, volunteers, or other agents of the fiscal sponsor. Accordingly, if they are fundraising for the project, they are fundraising on behalf of the fiscal sponsor as agents of the fiscal sponsor. Similarly, if they are managing the activities and affairs of the project, they are doing so as agents of the fiscal sponsor, which may afford them the protection of the sponsor’s insurance.

In the comprehensive model, the assets and liabilities of the project are the assets and liabilities of the fiscal sponsor. The fiscal sponsor takes on the project, and all of its risks, because it advances the sponsor’s own charitable mission. Typically, in light of all of the administrative burdens and costs associated with the project and to ensure its own organizational health, the fiscal sponsor charges an intra-organizational administrative fee to the restricted fund dedicated to the project’s charitable purposes.

Fiscal Sponsorship: A Balanced Overview (Nonprofit Quarterly)

Comprehensive fiscal sponsorship is commonly structured in a manner that creates very problematic legal issues. Some keys to doing it right:

  • Understanding that the fiscal sponsor isn’t legally responsible for the other party to the fiscal sponsorship agreement (e.g., the DAO) and such other party may need to take care of any of its own legal obligations;
  • Minimizing what the other party to the fiscal sponsorship agreement does to help mitigate the risk of that other party (e.g., the other party simply enters into the agreement and gives nonbinding advice to the fiscal sponsor);
  • Structuring individuals associated with the other party to the fiscal sponsorship agreement as authorized agents of the fiscal sponsor with respect to the project’s fundraising, management, and operation (to the extent it’s not automated);
  • Ensuring legal ownership of the funds flows from donor to fiscal sponsor, with any other party (e.g., the DAO) only facilitating the transfer and being careful of becoming a regulated broker or professional fundraiser;
  • Avoiding misrepresentations to the DAO members / fiscal sponsor donors, regulators, other stakeholders, and the general public about the relationship between the DAO and the fiscal sponsor (e.g., do not conflate the DAO with the fiscally sponsored project – use slightly different nomenclature); and
  • Allowing, in the termination provisions of the fiscal sponsorship agreement, for the other party to set up a separate 501(c)(3) nonprofit organization to succeed to the assets, rights, liabilities, and obligations of the fiscally sponsored project.

ConstitutionDAO entered into a fiscal sponsorship agreement with a 501(c)(3) nonprofit corporation for purposes of bidding on the Constitution and, had the bid been successful, ensuring the Constitution would be held under charitable trust.

Additional Resources

Check back for resources as we expect more developments on DAOs, nonprofits, and applicable laws over the coming months.