On June 7, U.S. Senators Cynthia Lummis and Kirsten Gillibrand unveiled the eagerly awaited Responsible Financial Innovation Act, which calls for a comprehensive set of rules to address some of the most pressing issues the digital assets industry is currently grappling with. The bill offers a bipartisan response to President Biden’s call for a whole-of-government approach to regulating cryptocurrency by offering comprehensive guidance to the quickly expanding industry.
Among its many recommendations, the bill establishes fundamental definitions, grants an exemption for transactions involving digital currencies, and harmonizes the functions of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), drawing regulatory boundaries and giving the CFTC a sizable increase in jurisdiction.
The bill could be most effectively viewed as a call for further discussion. Its success or failure in the upcoming months will be largely based on the intensity of the debates it sparks. The industry has already responded strongly to it. Decentralized autonomous organizations are one of the laws’s most contentious—and potentially significant—sections (DAOs). Although some aspects of DAO policy are helpfully clarified by the act, more action is needed to address any remaining concerns with regard to legal status, applicable laws, and jurisdictional authority.
Why is this regulation important? What are DAOs?
DAOs are organizations that pool resources, manage tasks, and make decisions collectively using blockchains, digital assets, and related technologies. DAOs provide a way to decentralize the management of businesses by opening up operational and financial information to the public and giving members the power to suggest, vote on, and ratify changes to organizations directly. The ground-breaking Responsible Financial Innovation Act would address fundamental issues with DAO policy, such as defining DAOs, creating incentives for incorporation, and incorporating them into the tax code.
The number of DAOs has dramatically increased in recent years. The total value of DAO treasuries soared fortyfold in 2021, from $400 million to $16 billion, and the number of participants increased 130x, from 13,000 to 1.6 million, according to the data analytics website DeepDAO. Today, DAOs are being created to accomplish a variety of goals, such as managing charitable endeavors, regulating financial services, and facilitating networking. Even in war zones, DAOs are being used to provide assistance.
With DAOs expanding so quickly, some analysts believe the novel organizational structure could reach one trillion dollars in assets under management by 2032, having an impact on industries as varied as investment, research, and philanthropy. DAOs can provide a variety of advantages, such as increased equity and lessened censorship.
According to a recent report by the World Economic Forum and Wharton, decentralized autonomous organizations (DAOs) may provide a way to increase transparency, adaptability, trust, and speed relative to traditional organizations like corporations. Similar to this, DAOs enable quick experimentation and can be used to achieve a number of objectives, including prosocial ones. However, modern DAOs face difficulties with voter participation, governance, power concentration, and cybersecurity.
Related: Current Web3 concerns, decentralization, and DAOs
The regulatory fragmentation and uncertainty DAOs face are arguably the most significant. For instance, DAOs in the US must navigate a confusing legislative environment characterized by numerous conflicting state-level frameworks. While these legislative strategies can give DAOs flexibility, they also present a compliance challenge, and many have come under fire for their flaws. DAOs face operational restrictions, are unable to pay taxes, and run the risk of subjecting members to limitless liability in the absence of a clear legal status.
How will DAOs be impacted by the Lummis-Gillibrand Act?
Given the ambiguity of DAO policy, the Lummis-Gillibrand act may have a special significance for the new type. DAOs are organizations that are governed “[….]primarily on a distributed basis,” are duly incorporated, and use smart contracts, which automatically execute promissory code, to generate collective action. This bill would amend the Internal Revenue Code of 1986 to include DAOs. Although this attempt to define DAOs may initially seem insignificant, its effects could be extensive.
The bill defines DAOs critically in the context of changing the tax code. The establishment of taxation requirements for DAOs could give the novel form legitimacy. However, doing so might also entail new responsibilities, such as being incorporated under particular jurisdictions, which might be difficult for DAOs with international reach. The impact of the bill on DAOs is being interpreted in a variety of ways by experts.
While some claim, for instance, that incorporation could impose requirements on DAOs, others contend that the bill only provides the option for incorporation to those DAOs who want to take advantage of tax advantages. The ultimate significance of the bill for DAOs is not entirely clear, as this discussion indicates. In fact, many of its ramifications will depend on the results of various review and voting processes.
Senators Lummis and Gillibrand have stated that up to four Senate committees would ultimately have control over the legislation, despite the fact that the bill has been introduced by a bipartisan pair of legislators who sit on important committees like the Senate Agriculture and Banking Committees. Even so, the bill’s very existence is commendable for its effort to give the emerging sector clarity.
The bill, according to Senator Lummis, “is an important step towards securing America’s financial leadership for generations to come,” she asserted in a recent statement. The legislation has already advanced by offering thorough guidance on digital assets.
For DAOs, it has started to provide answers to many of the issues that builders have been debating for years. The DAO policy, among other issues, will need to be debated and, ultimately, meaningfully advanced if the Senators’ vision is to be realized. Industry leaders, decision-makers, and other stakeholders in the ecosystem must now collaborate to create the efficient, fit-for-purpose policy necessary for this developing organizational structure to succeed.
There are no recommendations or investment advice in this article. Every trading and investment decision carries risk, so readers should do their own research before choosing.
The World Economic Forum’s Accelerator for Cryptocurrency Impact and Sustainability is led by Aiden Slavin. He directs initiatives at the Forum to advance the Web3 policy and impact agenda across the public and private sectors. He oversaw the policy and partnership programs at ID2020, an organization devoted to maximizing the advantages of blockchain-based digital ID, before joining the World Economic Forum. He graduated from Columbia University with a BA and the University of Oxford with an MSc.