TL;DR
- After a thorough review of the risks associated with activating the fee switch, we believe that the best path forward may be to implement new mechanisms for distributing protocol fees to specific persons, for instance to those who have “opted-in” by taking some action to benefit the Protocol.
- Given the extent of Uniswap’s decentralization (370k+ token holders, many anonymous and based around the globe), we do not feel comfortable recommending the creation of an alternative legal entity structure today, for the purposes of this proposal. This analysis was done with Uniswap DAO’s specific needs and makeup in mind; it is not a general assessment to be used for DAOs generally.
- The UF has already allocated 25% of our total Grants budget (spread across Protocol R&D, Incentive Program R&D, and Protocol Development) to support this area of R&D, which includes, amongst other things, new designs for fee collection, distribution, and for innovative applications of the UNI token. We explore this below, and in more detail in a new forum post here.
- We invite those interested in contributing to do the following:
- For those beginning to explore ideas, or who would like the community to consider an idea, share your ideas in this forum post (a follow-up post to this comment)
- For those who have an idea and are looking for support and financing to do the work, review the questions posed in this post, and apply for a grant here.
The Foundation has taken on this work as part of its broader mission to advance thinking around key aspects of decentralized finance. To the extent any community member might be affected by the issues discussed, they should consult with their own advisor.
Introduction
In late December, @Leighton wrote that the vote on the fee switch proposal would be delayed in order to try and address some compliance uncertainties highlighted by the community.
In the time since, the Uniswap Foundation has engaged in discussions with a diverse set of advisors knowledgeable in this area to explore how the community might address these uncertainties. In this post, we update the community on our assessment. We also discuss an opportunity that was highlighted by this work, to conduct research into and then implement enhancements to the Protocol’s fee accrual and distribution mechanisms, and to the design of the UNI token itself.
UF Analysis
Current tax laws in the US do not provide clarity on how the fees from a smart contract protocol, that can be directed to a DAO, should be treated. Although legislation has been introduced to address the issue, it has not passed Congress or been signed into law. The Treasury Department and the Internal Revenue Service (the “IRS”) have not issued guidance (or made any kind of public statement) as to the tax treatment of DAOs generally.
The UF, amongst other options, explored whether any prevalent legal entity structures could adequately address the aforementioned uncertainties. After extensive review, and while acknowledging the advantages of many of the structures we reviewed, we found that none of the structures were compatible with the specific organizational structure and needs of the Uniswap DAO.
Specifically, we highlight the extent of the Uniswap DAO’s decentralization. The Uniswap DAO currently comprises more than 370,000 token holders located across a large and unknowable number of jurisdictions. Many token holders are anonymous. Governance participation is highly fluid, and spread across the globe. These factors make it virtually impossible to choose a legal entity structure which provides a practically feasible and long-term solution for the purpose of this proposal, without limiting or putting at risk one or more core underlying attributes of the Uniswap DAO.
We will also note that, even if the community were to hypothetically opt into a particular legal entity option, or set up a separate legal entity for this purpose, it is not clear to what extent that step would be effective in addressing the aforementioned uncertainties, as these structures are untested in the context of large DAOs like Uniswap’s.
That being said, we want to make clear that this determination was made with the Uniswap DAO’s specific needs and makeup in mind. This is not intended to be a general assessment to be used by other DAOs. Alternatively, traditional legal entity structures may be suitable for other DAOs and in other situations, as many DAOs have already chosen to adopt these traditional entity structures with success. For those reading this post who are interested in learning about these structures, we invite you to review Paradigm’s DAO Legal Entity Matrix, and A16z’s Legal Framework for Decentralized Autonomous Organizations Part I and Part II.
UF Recommendation & Way Forward
Following a holistic analysis, we do not feel comfortable recommending the creation of a traditional legal entity structure, if the proposal were to be approved right now.
As pointed out by others before, the community should remain cognizant that doing so means the compliance uncertainties in question would remain unanswered if the proposal were to be approved today. This may present potential risks to the DAO and its token holders, particularly in the current environment of heightened regulatory scrutiny.
With this background in mind, we encourage the community to consider other alternative options. We have considered, for instance, an alternative strategy which would involve setting aside a portion of fees to a separate “reserve” smart contract to cover potential legal costs and liabilities that the DAO may be exposed to in the future. However, this approach may not alleviate the aforementioned compliance concerns.
As we detail in this follow-up post, much of our research and many of our discussions over the past several weeks have led us to the conclusion that implementing a programmatic distribution of fees directly to persons, for instance to those who have “opted in” through taking some beneficial action for the Protocol, may be a superior path forward. This kind of mechanism would represent a significant mitigation of risk for the Uniswap DAO because tax obligations would rightfully be the responsibility of the individual in their respective jurisdiction, among other potential benefits. If properly designed, this mechanism could further incentivize productive behavior to support the Protocol.
In the same vein, we have had many discussions with stakeholders who are excited to research new methods for accruing fees to the DAO, and to innovate upon the applications of the UNI token to support the protocol. This is an exciting area for future exploration, and has the potential to support the future growth, decentralization, and sustainability of the Uniswap Protocol. Please read our more detailed follow up post for more information, and ways to contribute to the conversation.
For those interested in contributing:
- If you would like to begin to explore an idea, or would like the community to consider an idea, share your ideas in this forum post
- For those who have an idea and are looking for support and financing to do the work, apply for a grant here
The Uniswap Foundation supports a community of individuals and organizations dedicated to a more open, fair and decentralized financial system through education around and broader adoption of blockchain technologies and smart contract-based decentralized protocols.
This post does not constitute, and is not intended to constitute, any kind of legal advice, and readers are not to construe the contents of this brief as legal, business, tax, accounting, investment, or other advice. Each UNI token holder should consult its own advisers as to legal, business, tax, accounting, and other related matters concerning the proposal in light of such token holder’s particular circumstances.