Lawsuits could be catastrophic for DAOs if denied ‘limited liability’

As a seasoned legal scholar with decades of experience under my belt, I find the recent California district court ruling in the ongoing Samuels v. Lido DAO case to be a stark reminder of the complexities and challenges faced by Decentralized Autonomous Organizations (DAOs) in today’s rapidly evolving digital landscape.


It’s unlikely that legal framework is your immediate thought concerning Decentralized Autonomous Organizations (DAOs), yet its significance might grow increasingly evident in the near future, sparking greater interest.

A protective structure, which shields its constituents from potentially devastating lawsuits through the provision of “limited liability,” is likely seen as indispensable.

In the year 2022, the prominent venture capital firm Andreessen Horowitz allocated a sum of $70 million towards purchasing LDO tokens, which are issued by Lido Decentralized Autonomous Organization (DAO).

In the year 2021, Paradigm Operations, a crypto investment company, acquired 100 million LDO tokens, representing 10% of all LDO tokens ever issued. Additionally, another venture capital firm, Dragonfly Digital Management, purchased $25 million worth of LDO tokens.

In just two years from now, on November 18, 2024, a court in northern California handed down a decision allowing an investor to file lawsuits against all three involved firms. This investor had suffered losses from his investment in LDO tokens. This verdict caused ripples of concern throughout the Decentralized Autonomous Organization (DAO) community.

Today, a California judge handed a significant setback to the concept of decentralized governance, according to Myles Jennings, legal advisor and leader of decentralization at a16z Crypto, an investment firm established by Andreessen Horowitz.

As a researcher, I find myself pondering over an intriguing point: The impact of a judicial decision from a district court in a specific U.S. state, primarily its northern region, might transcend national borders. It’s a perspective that, at first glance, could appear to be an exaggeration, but upon deeper examination, it seems plausible.

VCs took an “active role” in DAO management

Professor Jeff Strnad from Stanford University Law School stated that while the decision wasn’t entirely unexpected, it still holds great importance,” (when speaking to CryptoMoon).

In the legal case Samuels v. Lido DAO, as decided by the Northern District of California court, it was stated that these three investment firms played an active and significant role in managing Lido DAO, similar to being general partners. This position potentially holds them responsible for any potential losses, without a cap or limit on their liability.

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Strnad stated that this situation is not favorable for Decentralized Autonomous Organizations (DAOs) as venture capitalists tend to avoid investing in entities such as DAOs unless they are shielded by “limited liability.

This decision emphasizes the increasing judicial examination of Decentralized Autonomous Organizations (DAOs),” said Kevin Owocki, co-founder of Gitcoin and writer of the upcoming book titled How to DAO: Navigating the Future of Internet Coordination. “In essence, it indicates that courts are prepared to use conventional legal standards when dealing with innovative decentralized systems, which can sometimes lead to comparing dissimilar things.

The decision may hinder the advancement of DAO development if the subtleties of its design are not thoroughly grasped, as Owocki pointed out.

Most DAOs have no legal structure

Among the numerous Decentralized Autonomous Organizations (DAOs) out there, you’ll find a diverse range of legal structures. Some resemble corporations, while others function like Limited Liability Companies. A few operate as unincorporated nonprofit associations, and some even exist offshore.

According to Arina Shulga, a partner at Nelson Mullins, the majority of Decentralized Autonomous Organizations (DAOs) do not have any connection to a legal entity. This means that they are generally considered as partnerships and unincorporated associations by default.

“They still carry legal liability for the actions of their members, and since there is no limited liability shield, the group liability becomes the liability of each individual member of such DAO.”

In addition, Decentralized Autonomous Organizations (DAOs) operate on a global scale. While the main office of a DAO might be based in California, its membership could extend to countries such as Russia. A member from Russia could potentially take legal action against venture capitalists like Andreessen Horowitz if it is deemed that they are exercising control over organizations like Lido DAO.

For individuals who code, if your work ends up being utilized by a Decentralized Autonomous Organization (DAO) on GitHub, there could potentially arise legal issues, as Strnad pointed out. This situation, in essence, poses a challenge or obstacle to the progress of innovation.

An impact beyond California

Still, maybe this court ruling has limited application for California alone? 

According to Owocki, this decision, though confined to the Northern District of California, might serve as a model for other U.S. court rulings. Therefore, it’s important to keep an eye on it regardless of your location.

According to David Kerr, CEO of Cowrie, the operations under discussion did not take place within the U.S. The legal proceedings initiated in California were merely because some of the involved parties resided there. It’s possible that the plaintiff chose this court as a favorable venue for filing their lawsuit, Kerr suggested.

Location may not matter so much for decentralized organizations. “From a practical standpoint, being nowhere is simply shorthand for being everywhere,” Kerr added.

Essentially, Kerr advised against reading too much into the court’s ruling on the motion to dismiss the case. It’s important to note that this decision only pertained to the dismissal of the lawsuit, and it did not establish liability for holders of governance tokens in California.

Kerr stated, “This action is taken so they can be part of the investigation, as the court believes further investigation is required.

Are DUNAs the answer?

In Jennings’ post, cited above, the general counsel added: “It’s time to DUNA.”

In March, Wyoming legislature enacted a law introducing a novel legal structure for Decentralized Autonomous Organizations (DAOs), called the Decentralized Unincorporated Nonprofit Association (DUNA). This new entity would empower DAOs to enter into legally binding agreements with other entities. Furthermore, it offers legal safeguards for individual members within these organizations.

Owocki and Strnad agreed that DUNAs are a good solution for many DAOs’ legal vulnerabilities.  

While I acknowledge the potential benefits of the Wyoming DUNA, I must clarify that it’s not a universal solution for every issue. As an investor, I understand that finding solutions tailored to a project’s specific circumstances is key. The Wyoming DUNA serves as a useful tool in this regard, but like any tool, it requires careful handling to ensure it doesn’t complicate matters further if misused.

“FIT21 has nothing to do with liability”

Despite the recent California court ruling, some people believe that the Trump administration may introduce blockchain-friendly legislation within the year, which could potentially override or diminish the impact of this court decision.

Indeed, we can expect a more welcoming regulatory and policy environment soon, but for now, it hasn’t arrived as of yet,” Owocki explained.

In the meantime, it’s essential for those constructing Decentralized Autonomous Organizations (DAO) to carry on refining their legal and operational aspects. Simultaneously, they should keep pushing for more transparent and straightforward laws. By doing so, they can strengthen DAOs, ensuring their resilience regardless of changes in government or policy.

According to Strnad, it’s highly likely that a favorable regulatory framework for cryptocurrencies, such as FIT21, could be approved during the Trump administration. FIT21 grants powers to the Commodity Futures Trading Commission (CFTC) rather than the Securities and Exchange Commission (SEC).

DAOs, under the supervision of the Commodity Futures Trading Commission (CFTC), would not need to register nor submit regular quarterly reports, unlike those regulated by the Securities and Exchange Commission (SEC). However, it’s important to note that FIT21 is unrelated to liability matters, as pointed out by Strnad.

‘A tragedy that’s avoidable’

To summarize, the recent court decision in California regarding DAOs (Decentralized Autonomous Organizations) is a significant development in an ongoing legal case. Although its ultimate impact may be limited, this ruling raises a crucial question for all DAO operators and participants: Are participants protected by limited liability? As Strnad notes, this issue is distinct from questions related to market structure.

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The focus is more on aspects such as potential fines for members of a Decentralized Autonomous Organization (DAO), should things not go as planned. With limited liability, the fine would essentially equal an investor’s loss. However, if there’s unlimited liability, similar to what venture capital firms might experience in the case of Samuels v. Lido DAO, penalties could escalate to astronomical figures like $25 million or even larger amounts.

To put it simply, if you’re a Decentralized Autonomous Organization (DAO), it’s crucial to take steps to shield yourself from unlimited liability, according to Strnad. He emphasizes that such a situation should be prevented as it’s an unfortunate outcome that can be avoided.

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2024-11-27 17:33