In the latest episode of the hugely popular Cummings Pepperdine's Crypto Questions, we dive into the world of decentralized autonomous organizations (DAOs) and how they are shaking up the virtual asset space. Today's expert guest is Edward Noyons.
Edward is director of the web3 consultancy firm, Marfire and co-Founder of the professional service provider, Autonomous.
Connect with Edward here.
Essential listening for the crypto funds industry.
Covered in today's episode:
- Introduction to Web3 and digital asset-focused DAOs
- The concept of a ‘perfect’ DAO and its decentralized decision-making
- Advantages and challenges of DAOs
- Types of DAOs and their functions, e.g. protocol, grant, social/collector/venture DAOs
- Examples of DAOs in action, e.g. Constitution DAO, Links DAO
- Legal structuring for DAOs and the use of foundation companies
- Regulation of DAOs and the role of service providers in the Cayman Islands
- Roles needed for a foundation company to exist/function and their availability in the Cayman Islands
- Services offered by Marfire and Autonomous
Cummings Pepperdine provide relationship-based holistic solutions linking law, tax and FCA compliance. Specialising in these three key areas allows us to offer clients a wide breadth of assistance to cater to their core business needs.
Visit www.cummingspepperdine.com for more information.
For a transcript of this episode, please click here.
New transcripts being added weekly.
Ian Gobin [00:00:00]: Hello and welcome to another podcast from Cummings Pepperdine. My name is Ian Gobin. I am a co-owner and partner working alongside Claire Cummings. Today we are chatting with Eddie Noyons of Marfire, all about DAO’s. Eddie, hello.
Edward Nyons [00:00:18]: Hi, Ian. How's it going? Good.
Ian Gobin [00:00:20]: So, tell us briefly about Marfire.
Edward Nyons [00:00:23]: Yeah, sure. So Marfire was founded actually two years to the day. It's our second year anniversary today, believe it or not. So, good timing with the congratulations. Thank you. Yeah. Our founder started about two years ago with a vision to really bring institutional grade professionals into the Web Three space and offer a boutique hard touch fiduciary service to DAO’s and their underlying foundations and funds that have an underlying Web Three or digital asset strategy.
Ian Gobin [00:01:01]: That's great. So today we're talking about DAO’s decentralized autonomous organizations. Eddie, what are they and why do we care about them?
Edward Nyons [00:01:10]: So, Coin Telegraph wrote a really good article about this a few years ago. I point anyone to go have a read of that if they want to get a bit more in depth insight into this. But very simply put, and I'm thinking of this from the perspective of what a perfect DAO would look like, is that the idea came from Vitalik in 2014 in a paper he wrote. But a perfect DAO is a vehicle that doesn't have any central leadership. The decisions are made by the underlying token holders via voting, and then the outcomes of those votes are run via an automated smart contract on a blockchain. So, this setup really has some very key advantages which has led to DAO’s becoming as prominent as they are. And I think I'll just start off by running through some of those advantages and we can maybe chat a little bit about some of the challenges as well. So, a very key thing about DAO’s and why they've become popular is the concept of trust. So, in a traditional business, you have shareholders who are providing value and then you typically have a very small group of informed individuals who are making the decisions and putting those shareholders value at risk. We've seen many examples across history where that's been unsuccessful. There are obviously very good success stories as well, but the crypto community especially wanted to create something where that trust mechanism was different. So, a DAO really resolves this in that principle or agent dilemma is taken away in that the power and decision-making rests with all the members of the DAO. And members are typically the people that hold the underlying token that the DAO is minted. So, it fosters collaboration between all the token holders. They can make decisions together. And that lack of hierarchy means that a very innovative idea can be put forward by any token holder. The whole group can consider it, improve on it, and then vote on it and implement it. And then the DAO can implement that through whatever strategy it's doing. And then I think the last thing that's really critical is this concept of the implementation being on a blockchain via smart contract. So smart contracts and blockchains are typically open source. They're verifiable. Anyone can go look at the address and read the code if you're so inclined, and they can be audited, so everybody knows up front what the execution of that vote will look like. And that adds a major level of transparency. So, it's these key things or concepts of having power shared by all the interested parties and then having their decisions executed in an automated, decentralized manner, kind of leading to the word DAO.
Ian Gobin [00:04:36]: Do you see them as the next sort of evolutionary step in the commerce of humankind?
Edward Nyons [00:04:46]: I'd sure like to think so. DAO are still in their first innings. They're quite young. I'd say they've only become mainstream in the last few years. So, I'm sure we're going to have different iterations of them as we move forward. And maybe that's a good time to just bring up a few of the challenges that we typically see and how they might evolve over time, and then hopefully they'll become more prominent in our marketplace and help with a lot of the challenges.
Ian Gobin [00:05:19]: So, some of them, they started off badly, or rather, there was an immediate evolutionary step when the first one was created. So perhaps you'll touch on that with the challenges around them in the early days.
Edward Nyons [00:05:36]: Yeah, I think people often confuse DAO with the Dow, which eventually led to Ethereum, effectively forking back in the day. So, yes, I think if you think of it from that perspective, they had that rocky start you may be mentioned, but the DAO was quite separate and was one entity, if you will, versus what we see now, which is a collective of DAO’s that are operating in various ecosystems and in different ways as well, which I'll get to in a bit. But some of the challenges that certain DAO’s face is having a legal personality. So, if a DAO is not structured right, most jurisdictions don't recognize them as a having legal personality. So, if you're a DAO that needs that, and your intention is to be able to enter into contracts, enter into agreements with service providers, hold real world assets, you have to structure in a way that there is an underlying legal wrapper to allow you to enter into those contracts.
Ian Gobin [00:06:49]: Yeah, if you don't go into the wrapper, jurisdictions will deem your Dow to be a general partnership.
Edward Nyons [00:06:57]: Exactly.
Ian Gobin [00:06:57]: And as such, you're going to have unlimited liability as a member, as a general partner of that partnership. That's what you're alluding to now. So, it's a question of how do we structure to avoid that situation.
Edward Nyons [00:07:14]: Yeah, and you hit the nail on the head there. There's a few cases open at the moment where all the token holders are being pulled into lawsuits and structuring a DAO. If you need that kind of legal personality becomes critical and we'll chat in a bit about how that structuring can look. But that's one of the challenges that DAO’s face is knowing what their purpose is. Some DAO’s don't need that legal structuring. They're just a small group of people that want to do something. They can fund a smart contract with ethereum and they can execute. They don't need to enter into contracts, et cetera. That works for certain types of DAO’s. But you get other DAO’s that are much larger. They need legal representation, they need service providers, those dials need to structure right to facilitate that. And we'll talk about the structuring in a minute. Other challenges DAO’s have and this is an area that's really being worked on right now is concentration risk. So, a key advantage of a DAO, as we said earlier, was removing that trust and having the power be dispersed to make decisions amongst token holders. There's obviously a challenge where token holders could accumulate such large positions of the total token supply that they could in effect have one or two people holding the majority of the supply and that way can make decisions anyway, which kind of takes away the purpose. So, this is a very topical area. There are people talking about it all the time in the space and something that we need to be aware of and think how do we make that better if we want the space to keep succeeding? And there's lots of good things coming out of that based on an example of delegating your votes. So maybe small groups of smaller token holders who have a very similar way of thinking can connect and then delegate their votes together to give themselves a larger pool to make decisions. That's something that's being done way more commonly now in DAO’s and I think will be a good step in fixing that. And then the last thing I'll touch on, and we're seeing this especially in the DFI space fairly often, is because a DAO in a perfect world, it's running on an underlying smart contract. Those smart contracts are obviously susceptible to hacks and this is why it's super important to have good fiduciaries in place and ensure that your smart contract is being audited more than once and that it's going through constant audits through its life cycle as changes are made. So those are a few of the things that are larger challenges and the people that work in this space are really working on making those things better.
Ian Gobin [00:10:10]: Let's throw some kind of business cases out there for DAO’s. What can they be used for and what are they being used for?
Edward Nyons [00:10:19]: Yeah, that's a great question. I think this area is kind of open and limitless. I probably focus on the kinds of dials we typically see and then maybe throw in some real-world examples. So, I think the big categories of DAO’s really starts with protocol. DAO’s so these are DAO’s that govern a decentralized protocol such as a DFI application where you can exchange assets or stake assets. There's typically a DAO overseeing the decision making of that protocol and monitoring what it's doing and where it's going. Similar to an NFT project, for example, the board AP Yacht Club, there's a DAO governing the decisions and business runway of what the Ape Foundation is doing with the underlying NFTs. Another very common type of DAO is the grant style. And this is a dial where you have a protocol such as ethereum. They can create a foundation; have a DAO and they can provide grants to developers in that ecosystem to fund them in developing and growing that specific underlying ecosystem via that system's token. So, it's really effectively just a funding mechanism to ensure growth and development on that specific chain. Very common. And a lot of the DAO’s from a volume perspective that we see are grant DAO’s by nature. And then you get this group of DAO’s. You can call them social collector venture DOA’s, where people are effectively just pooling resources together, typically like-minded people, and then using those resources to make investments or for social purposes and then voting based on the tokens how to disperse those resources to charities or whatever investments they want to make. So, a few well-known examples. Here is the constitution. DAO. So, I think it was in 2021 they raised close to $50 million worth of Ethereum and they at a Sotheby's auction were bidding to buy an original copy of the US constitution. They sprung that up super quickly. They were able to pool resources, have an underlying smart contract and then could enter into a real-world transaction to buy something that's tangible. Another cool one that actually happened very recently is a dial called Link style where again a group of like-minded people that are all golfers, they pulled money together and they've just successfully purchased or I think they're going through the mechanism of purchasing a golf course in Scotland. I assume all the members are going to have to be able to play there and automatically be members of the golf course. So just two really cool uses of what a DAO can do in the real world.
Ian Gobin [00:13:41]: You mentioned investment. I'll jump in on that straight away. Do you sort of see these as one day replacing traditional corporate LP structures in the world of hedge funds and private equity or do you think they'll stay in a very sort of niche market?
Edward Nyons [00:14:05]: I think if anything, they will likely complement the asset management space that already exists. I think the asset management space has proven its resiliency and it's pretty strong. But what's really cool on the DAO side is that typically smaller groups of very like-minded individuals that have a very common philosophy and that it’s hard to sometimes implement in a very large asset manager that's kind of open to the general public. So, investments become very broad and it's hard to manage a very small fund without having that scale in a profitable manner where DAO is able to do that. So, I think it gives a lot of flexibility. There's obviously very careful legal structuring when you're doing an investment type DAO. You don't want to land in a situation where you are effectively actually a fund and you should have registered that way in whatever jurisdiction you're in. So, I think there's some careful legal considerations when you're doing an investment DAO.
Ian Gobin [00:15:21]: So how and why structure through Cayman when it comes to DAO’s? I know what you're going to say, but walk us through the options and roughly why one particular entity is really the vehicle of choice behind a DAO.
Edward Nyons [00:15:45]: Yeah, sure. And just I think to bring it back, we've spoken about some of the attractive reasons why DAOs exist. It's super critical though, that for DAO that intends to enter into real world transactions, contract with service providers, that they are structured in a way that allows them to do that, and that they're structured in a jurisdiction that's got clear regulations and is open to Web Three innovation. So, I'd focus more on what I'm familiar with day to day, which is foundation companies, specifically in the Cayman Islands where we are based. So, foundation companies began in Switzerland. They were seen as an alternative to a trust, but they had legal personality. The crypto industry or Web Three industry really became attracted to them on the basis that they don't have or don't need to have shareholders in that you could have a group of founders who wanted to create this DAO, set it up, do the initial funding and cost of getting it set up, and then they could step away from it. They didn't have to be shareholders. Once the tokens were minted and dispersed, those founders that started it can step away and hand over the reins to those underlying token holders, giving the DAO the D and A of its namesake, being decentralized and automated. So, the foundation company structure allowed the Cayman Islands to have its own foundations company act, which I think has really facilitated a lot of DAO’s and the underlying foundations being domiciled in Cayman. But beyond that, I think Cayman has also become the favoured jurisdiction beyond, say, Switzerland and Dubai, on the basis that Cayman's got a very established financial base in terms of asset management, there are very clear regulations related to foundation companies, but also digital assets. Through the VAS Act, you have a lot of service providers that are native to the industry, such as ourselves, that are already based here. So, it creates a really good environment that fosters that kind of innovation.
Ian Gobin [00:18:33]: It's curious, isn't it, because the foundations act itself, wasn't dreamt up with Web Three in mind, and yet it's the perfect vehicle to use when you are in the Web Three space. It's one of the few times you kind of see that. Whereas normally the whole Web Three and crypto doesn't fit in with structured regulatory environments, and yet foundations are absolutely perfect for DAO’s.
Edward Nyons [00:19:10]: Yeah, exactly right. As I said, just piggybacked essentially off a structure that was initially to be used as an alternative to a trust that happened to just work out really well, and that everything that goes with the foundation company is very suited to the Web Three space. So, I mean, building on that, you've got the situation where you don't need shareholders, so the founders don't need to be running it day to day and can separate themselves from a tax and regulatory perspective. But then beyond that, the constitutional documents of a foundation, and especially the Bar laws, are a side document that determine what the foundation is doing, what it should be doing, how voting will occur, and the mechanism of governance. So having a separate bylaw document gave Web Three companies a lot of flexibility and that they could determine how they wanted the foundation to operate, and that you can also amend those bylaws as the DAO and its underlying foundation kind of goes down this decentralization roadmap over its life cycle. So, the whole structure just really lent itself really well for Web Three companies to use.
Ian Gobin [00:20:39]: You've got your Cayman Foundation in place. What else do you need to consider from a Cayman regulatory perspective?
Edward Nyons [00:20:48]: Yeah, sure. So, there are certain roles that need to be fulfilled in order for foundation companies to exist. They include a secretary, a registered office, a supervisor, and directors. These are roles that are quite easily filled in the Cayman Islands. There are various service providers providing each of those, and you have options across each of those as well, which I think again is a reason why Cayman has been popular as a jurisdiction for these, because you have so much depth of experience in people that can fulfil those roles. And there's multiple law firms based in Cayman that have been structuring these for a long time and are just very familiar with the ins and outs of that.
Ian Gobin [00:21:35]: And I'll throw another acronym at you, vast.
Edward Nyons [00:21:38]: Yeah, the virtual asset service provider’s law.
Ian Gobin [00:21:44]: What have we got to do with that in terms of a DAO?
Edward Nyons [00:21:49]: Yeah, we're talking mostly here about Web Three or digital asset DAO’s. So, by nature they are operating in the virtual asset space. So, depending on what they do, those DAO’s need to ensure that they've done an analysis of whether their activity could be construed as a virtual asset activity and therefore be pulled into the vast act of the Cayman Islands or the BBR? if they have a subsidiary within the structure that's based in the BBR? Again, there's a lot of service providers in Cayman that typically help founders or DAO’s with regulatory memos to determine if the underlying protocol, how the revenue flows, where the RP sits, would have pulled them into being a vast. And if so, again, those same service providers will help them navigate that registration and the licensing regime.
Ian Gobin [00:23:03]: Ultimately. How can you and Martha help clients when it comes to them looking at putting a DAO together?
Edward Nyons [00:23:12]: Yeah, so it's super critical to remember you've got the DAO and then next to it sits the foundation. That's the underlying legal wrapper, if you will, that allows the DAO to operate in the real world. But at the end of the day, a perfect DAO down the road needs to become more decentralized and more automated. Otherwise, we're just in the traditional company sphere. So, we have two companies, one called Marfire, one called Autonomous, and they both fulfil a function of helping these entities become a true DAO. So Marfire, as I alluded to earlier, is a boutique professional directorship firm. We provide a director to sit on the board of the foundation company, which is one of the required roles. And really our role there is to ensure that the Right Guardrails are in place for the foundation to monitor its compliance with Cayman law and to ensure that the governance of the foundation and it's the DAO that sits next to is being done in accordance with its constitutional documents. So, we have a team of individuals that are very Web Three or crypto native. We come from backgrounds of being lawyers at large firms in Cayman, from being at big four auditing firms in Cayman or being investment professionals at family offices in Cayman. We've put together what we really believe is the largest and fastest growing team in Cayman that's Web Three native and has a real passion for serving the Web Three industry, whether that's foundation companies and their DAO’s or funds that have a Web Three trading strategy and then Autonomous. So Marfire is really about putting the governance and the guardrails in place, whereas our affiliated entity, Autonomous, is all about helping a DAO becoming truly decentralized so that it's not those initial founders that are doing the day-to-day management or operations of the DAO. So Autonomous provides an outsourced service for DAO’s. We help DAO’s with their internal finances, so typical record keeping and payments. We help them with their operations, which could be setting up bank accounts or exchange accounts, monitoring and engaging service providers, and then a little bit more down the Web Three rabbit hole. We help foundations and their DAO’s with their grants and governance programs, where we effectively act as a manager to facilitate grants and their governance process. There's a bunch of other stuff that we do on an ad hoc basis. A very common thing that foundations struggle with is opening bank accounts because they are set up in such a way that they don't have shareholders. There's no UBO, and that's a very tricky concept for a traditional bank to deal with because foundation companies have historically really struggled to get banked and autonomous. One of the first things we do, and something we've become very good at, is helping them get banking relationships.
Ian Gobin [00:26:53]: Banking relationships is obviously highly topical at the moment, given the sort of situation that's been blowing up both in the States and also in Europe. Thankfully, the banking options are still there, but I would imagine it is going to become increasingly more difficult to find banking partners.
Edward Nyons [00:27:11]: Yeah. And beyond just finding banking partners, I think it's also going to become more important to find the right banking partners that are committed to the Web Three space come good or bad times and ensuring that the right due diligence is done on those partners, especially with all the liquidity issues we're seeing.
Ian Gobin [00:27:37]: I know we colleagues and friends in the industry that we always go to for our clients who always try to help out. So, a quick shout out to them.
Edward Nyons [00:27:46]: Yeah. Awesome.
Ian Gobin [00:27:48]: Eddie, thank you very much for your time today, sharing your expertise with us. Really appreciate it, and I'm sure we appreciate it by our listeners.
Edward Nyons [00:27:55]: Thank you, Ian. Thanks so much. It was a real pleasure joining you today, and I hope we can do this again in the future.
Ian Gobin [00:28:03]: I'm sure we will. So, please, if anyone's interested in getting in touch with Eddie, please do so directly or through us here at Cummings Pepperdine. Thank you very much.
Edward Nyons [00:28:13]: Thanks, Ian.