DAO Legal Status and Liability Risks Explained

A federal class-action lawsuit is testing whether Decentralized Autonomous Organization (DAO) token-holders can be held personally liable for the actions of their protocols, potentially treating them as members of a general partnership. This legal challenge, which follows a US$55 million hack of the bZx protocol, threatens the core premise of DAOs as entities that operate without centralized leadership or individual liability [1].

The bZx test case

The Sarcuni et al. v. bZx DAO case, filed in the US District Court for the Southern District of California, marks the first time a court has been asked to determine if a DAO’s governance structure constitutes a de facto general partnership [1]. In a general partnership, owners are jointly and severally liable for the entity's debts and actions, a status that lacks the protections typically afforded by corporations or limited liability companies (LLCs) [1]. The plaintiffs argue that because the DAO lacks state registration, its governance token-holders—who share in potential profits and responsibility—should be treated as partners [1].

The case stems from a 2022 phishing attack where a private key, which retained governance rights over the bZx protocol, was compromised [1]. While the protocol was marketed as non-custodial, the plaintiffs allege the DAO functioned as a custodian because the founding team retained control over the keys, leading to the loss of US$55 million [1]. The ambiguity of the complaint has drawn scrutiny, as it remains unclear whether all token-holders are considered partners, or if the plaintiffs—who were themselves users of the protocol—might inadvertently be naming themselves as defendants [1].

Emerging legal frameworks

While federal courts weigh these liability questions, some states are moving to provide formal recognition for decentralized entities. On March 7, 2024, Wyoming implemented a law creating the Decentralized Unincorporated Nonprofit Association (DUNA) [3]. This framework allows DAOs to exist as legal entities separate from their members, potentially shielding individual participants from the personal liability risks currently being tested in the bZx litigation [3].

The DUNA status enables DAOs to manage third-party contracts, maintain bank accounts, and fulfill tax obligations [3]. While some industry observers initially questioned whether this nonprofit status would restrict for-profit initiatives, legal counsel has clarified that Wyoming-headquartered DAOs are not prohibited from participating in for-profit activities [3].

What to watch

• Court Rulings: Monitor the Sarcuni v. bZx DAO proceedings for any judicial determination on whether DAO token-holders qualify as general partners, which could set a precedent for future liability claims [1].
• DUNA Adoption: Observe whether other jurisdictions follow Wyoming’s lead in creating legal wrappers for DAOs to mitigate the risks of "piercing the veil" of decentralized governance [3].
• Governance Shifts: Watch for changes in how DAOs manage private keys and administrative rights, as the bZx case highlights the legal dangers of retaining centralized control over protocols that claim to be decentralized [1].

The outcome of the bZx litigation will likely define the boundaries of DAO liability for the foreseeable future. Until clear legal standards are established, the tension between the decentralized nature of these organizations and the requirements of traditional corporate law remains a significant uncertainty for participants.