For many, the legal structure of decentralized autonomous organizations (DAOs) might not be the first consideration when discussing their future. Yet, as recent legal developments suggest, this seemingly peripheral issue could soon dominate conversations within the DAO community. The concept of “limited liability”, which shields members from devastating lawsuits, appears increasingly critical, as a recent California court ruling highlights the potential risks of lacking such protection.
A Case That Shook the DAO Landscape
In recent years, DAOs have captured the attention of major players in the venture capital world. For instance, in 2022, Andreessen Horowitz made headlines by investing $70 million in LDO tokens issued by Lido DAO. A year earlier, Paradigm Operations, another crypto investment heavyweight, had acquired 100 million LDO tokens, representing 10% of the total supply, while Dragonfly Digital Management followed suit with a $25 million investment. Yet, this collective enthusiasm clashed with the sobering reality of legal liability when, fast forward to November 2024, a federal district court in Northern California ruled that all three firms could be sued by an investor who claimed to have suffered financial losses from their LDO token investment.
The ruling sent shockwaves throughout the DAO ecosystem, with Myles Jennings, general counsel and head of decentralization at a16z Crypto, describing it as a “huge blow to decentralized governance.” Legal experts echoed this sentiment, underscoring the implications of treating DAOs like traditional general partnerships-a framework that results in participants facing unlimited liability.
DAOs and Active VC Involvement
The court’s reasoning in the case, Samuels v. Lido DAO, shed light on why the firms faced potential liability. According to the court, the VC firms had played an “active role” in managing the DAO, effectively acting as general partners. This involvement placed them in the crosshairs of lawsuits, exposing them to almost limitless financial damages. Stanford University law professor Jeff Strnad remarked, “It’s not terribly surprising, but it is significant.” He explained that having limited liability protections is essential for encouraging VC investment in decentralized projects. Without it, DAOs risk scaring off critical funding sources. Kevin Owocki, co-founder of Gitcoin, further elaborated on the case in an interview, noting that this ruling reflected a startling willingness by courts to apply traditional legal frameworks to novel decentralized governance models. Describing it as treating “apples as oranges,” he warned that these legal interpretations, if misunderstood, could stifle innovation rather than foster it.
The Absence of Legal Structure in Most DAOs
One of the most fundamental challenges lies in the lack of formal legal structure within most DAOs. While some entities align themselves with established formats like corporations, limited liability companies, or offshore entities, the majority remain unincorporated. According to Arina Shulga, a partner at the law firm Nelson Mullins, DAOs without legal frameworks default to being general partnerships. By law, this means liability for the actions of the DAO is shared among its members, putting individual participants at significant legal and financial risk.
This lack of protection becomes especially precarious in an international context. A DAO headquartered in California might have members scattered across the globe, from Russia to South Africa. In such scenarios, a non-U.S. member could theoretically sue other participants or entities like Andreessen Horowitz for alleged mismanagement or damages. The risks extend beyond active participants: even developers unaffiliated with the organization may find themselves in legal jeopardy if the code they publish on platforms like GitHub is later adopted by a DAO, Strnad warned. This creates a chilling effect, potentially undermining the innovative spirit that DAOs were intended to foster.
Potential Impacts Across Jurisdictions
While the California ruling technically applies only within the jurisdiction of the Northern District of California, its implications could ripple through other U.S. courts. Kevin Owocki pointed out that this case might establish a precedent, compelling other jurisdictions to reevaluate the legal status of DAOs and their members. However, David Kerr, CEO of Cowrie, noted that the plaintiff in this case likely chose California as the venue because it was perceived to be favorable for the lawsuit. Still, Kerr emphasized that for decentralized organizations, geographic location becomes largely irrelevant. “Being nowhere is simply shorthand for being everywhere,” he explained, highlighting how DAO operations transcend national boundaries.
Despite the potential gravity of the ruling, Kerr urged caution against overreaction. He clarified that the California ruling represented only one step in a broader legal process—it did not yet hold governance token holders liable. Instead, the court simply allowed the case to advance into the discovery phase, enabling further investigation into the roles of the VC firms involved.
Could DUNAs Solve DAO Weaknesses?
Amid the legal uncertainty, a potential solution may lie in the form of Decentralized Unincorporated Nonprofit Associations (DUNAs). Wyoming, a state known for its pro-blockchain legislation, passed a law in 2023 creating this novel legal structure. DUNAs not only provide DAOs with the ability to engage in legal contracts but also offer the much-needed shield of limited liability for their members. Advocates like Owocki and Strnad view the DUNA framework as a promising step toward addressing DAOs’ vulnerabilities.
However, as Kerr pointed out, DUNAs are not a one-size-fits-all solution. The effectiveness of any legal structure depends heavily on the specific facts and circumstances of each project. Misapplying tools like DUNAs could potentially exacerbate risks rather than resolve them. Nonetheless, they represent a valuable addition to the toolkit for DAO operators seeking greater legal certainty.
The Path Forward: Resilience and Advocacy
In the backdrop of this legal turbulence, some speculate that federal blockchain-friendly legislation, such as a crypto market framework called FIT21, could change the game. By granting regulatory authority to the Commodity Futures Trading Commission (CFTC) instead of the Securities and Exchange Commission (SEC), FIT21 could alleviate some compliance burdens on DAOs. Yet, as Strnad emphasized, even if such legislation passes, limited liability issues will remain unaddressed. “FIT21 has nothing to do with liability,” he noted.
For now, DAO builders must double down on developing robust operational and legal protections. Owocki stressed the importance of ongoing advocacy for regulatory clarity, which will ultimately make DAOs more resilient to external pressures. The current legal ambiguity need not spell disaster for DAOs, but proactive efforts to address vulnerabilities will be vital to their sustainability.
An Avoidable Tragedy
Ultimately, the California district court ruling underscores an essential question for DAOs: Do members have limited liability? The answer to this question could mean the difference between a manageable fine and potentially catastrophic financial consequences. Left unchecked, the latter scenario-such as the $25 million penalties faced by venture capital firms in the Lido DAO case-could deter future participation and investment in DAOs altogether.
As Strnad cautioned, if you’re managing a DAO, “you better do something to protect yourself from unlimited liability.” It’s a tragedy that is entirely avoidable, provided that DAO operators prioritize implementing legal safeguards and adapting to the evolving regulatory landscape.
