Live Free or DAICO

If you want to lose your liberty in a hurry, there’s no better way to do it than a DAICO.

What’s a “DAICO,” I hear you ask? Well, it’s a new kind of automatic, Ethereum-based investment scheme that allegedly combines

  • “the best aspects of DAOs” – “distributed autonomous organizations,” a long-winded neologism for “software that runs on a blockchain” – and
  • ICOs, or “initial coin offerings,” schemes where companies launch their own “coins” and sell them as investments to the public without filing a registration statement or publishing a prospectus.

Oh, I should add that Vitalik came up with the DAICO concept. It is, therefore, automatically brilliant.

Except it isn’t.

Given the fact that the original DAO’s inflexibility caused its implosion, and given recent regulatory developments, I am astounded that anybody would think it prudent to launch one. But launch one they have.


The basic idea behind this new crypto hustle is that ICO investors can prevent their dev teams from absconding with investor funds, or withdrawing too much funding too quickly, by locking up the Ether they give to these developer teams in a smart contract, and granting the investors a right to vote to either

  • increase disbursements from the pool, or
  • blow up the deal and return the ICO funds to investors on a pro rata basis.

There are, of course, problems with this approach. The first is that tokenholders are generally passive rather than active investors: the original DAO could pass resolutions with a simple majority drawn from quorum of 20% (meaning as little as 10% +1 of the investors could bind the remaining 90%). No resolution ever passed because none of the tokenholders actually cared enough about what the DAO was doing in order to participate. Their primary motivation was to sit on their hands and wait for their investment to pay off.

When we consider that there are more responsive ways to ensure capital is used well (such as, say, putting an investor director with wide discretion and a veto power on a startup’s board) it strikes me that the existing solution is more responsive and fit for purpose than the quite binary, all-or-nothing DAO solution.

Second, I feel like I’m taking crazy pills here, because the SEC literally wrote a report about the original DAO scheme, likened it to a security, and cited as authority for this proposition not one but TWO cases relating to an infamous 1970s pyramid scheme that landed its promoter in federal prison for nearly a decade.

These facts diminished the ability of DAO Token holders to exercise meaningful control over the enterprise through the voting process, rendering the voting rights of DAO Token holders akin to those of a corporate shareholder. Steinhardt Group, Inc. v. Citicorp., 126 F.3d 144, 152 (3d Cir. 1997) (“It must be emphasized that the assignment of nominal or limited responsibilities to the participant does not negate the existence of an investment contract; where the duties assigned are so narrowly circumscribed as to involve little real choice of action … a security may be found to exist … .

[The] emphasis must be placed on economic reality.”) (citing SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 483 n. 14 (5th Cir. 1974)). By contract and in reality, DAO Token holders relied on the significant managerial efforts provided by and its co-founders, and The DAO’s Curators, as described above. Their efforts, not those of DAO Token holders, were the “undeniably significant” ones, essential to the overall success and profitability of any investment into The DAO. See Glenn W. Turner, 474 F.2d at 482.

To which the crypto world responded, “whatever, YOLO, we’ll just launch it in Switzerland.” Putting philosophical arguments about the moral case for exercising extraterritorial jurisdiction to one side for the moment, recent litigation in the ICO world has shown that U.S. federal courts are willing to reach across borders in securities litigation. Ignore America at your peril.

Third, if you haven’t seen Jay Clayton’s testimony before the Senate last week on ICOs, it was savage:

There should be no misunderstanding about the law. When investors are offered and sold securities – which to date ICOs have largely been –they are entitled to the benefits of state and federal securities laws and sellers and other market participants must follow these laws…

I believe every ICO I’ve seen is a security.

Unless you’re a tech journalist in which case it was “cautiously optimistic” – an opinion no lawyer I have spoken to since shares:

So where we’re left is this:
Most DAOs appear to be a legal no-no, per the SEC (and likely other national securities regulators as well).
Most ICOs appear to be a legal no-no, also per the SEC (and likely other national securities regulators as well).
Most DAO users are less interested in managing their chosen project than they are in offloading their coins at a massive profit on new entrants as quickly as possible.

To close, a DAICO is nothing more than a new acronym for the same old bad ideas. The broken DAO concept, in particular, requires extensive rethinking and movement onto private/permissioned blockchains in order to shed its pyramid scheme-like qualities and serve a useful function. On account of which I am completely amazed that anyone would want to combine the DAO and ICO concepts under any circumstances.

Be smart. Don’t let smooth-talking marketers convince you otherwise – find a straight-shooting lawyer who will tell you what you need to hear. (If you’re of two minds about it, I know a few good lawyers in this space and would be happy to point you in their direction.)

6 thoughts on “Live Free or DAICO”

  1. […] The DAO (decentralized autonomous organization) was the first major project to be launched on the Ethereum blockchain, complete with a novel governance structure that replaced a board of directors with a community-run model. It didn’t end well. A vulnerability in the code saw one third of the ether committed to the project stolen and The DAO collapsed. As prominent crypto critic and agent provocateur Preston Byrne explains: […]

  2. Hi Preston, first thank you for the article.

    Couldn’t the DAICO be improved in a sense that if done in legal framework, it could make participation in a governance process bit more easier compared to existing solutions (of if made more user friendly)?

    Secondly, isn’t the voting problem more generally rather than specific to DAICO? Voting system used can be improved. I don’t think DAICO as a general term insist on this specific implementation.

    1. Hi Peter! You’re most welcome and thanks for your thoughtful comment.

      Short answer: yes; long answer, it’s not as easy as it looks. The DAICO concept strikes me as quite a binary approach to corporate governance; either more money is given to the project, or the project is destroyed. In the real world there is considerably more latitude available to corporate and shareholders in their decisionmaking – they don’t fetter their discretion ahead of time. This “DAICO” does.

  3. Jay Clayton called out the so-called “gatekeepers”, the lawyers and auditors who have been advising the ICO teams for misleading their clients, so if this is truly the case, wouldn’t you agree that a more balanced criticism of the technologist who is merely trying to innovate better and more healthy startup protocol, should also mention the frictions within the legal community over their responsibility for advising their clients on these matters. If it seems like there is a shoe about to drop, why would you as a lawyer advise your client to still carry on? The reality is that a [name of firm redacted] attorney for instance probably has a lot more to lose by NOT pushing their clients forward at their own peril.

    1. In my experience the perceived friction is on account of a small but extremely vocal minority of “crypto-lawyers.” The view among securities lawyers I’ve spoken with on the subject has been more or less unanimously against unregistered ICO offerings.

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