What are Decentralized Autonomous Organizations and How are They Organized? A Judge’s Perspective on the Lido DAO Cryptocurrency

Samuels v. LIDO DAO (Case No. 23-cv-06492)  is a significant investor class action that has been filed in federal court alleging the Lido governance token LDO was sold to a class of cryptocurrency investors as an unregistered security.¹ A judge recently blocked Defendant’s motion-to-dismiss (“MTD”) the case by deciding that the Lido Decentralized Autonomous Organization (“DAO”) is comprised of individuals who can be held liable and accountable for investor losses under U.S. securities laws.²

It is worth taking a close look at this ruling as we head into 2025 since DAOs are one of the more prominent organizational forms for managing many cryptocurrencies, especially in the areas of Decentralized Finance (“DeFi”), one of the largest and fastest growing commercial activities for cryptocurrencies.

Readers following these types of investor class actions alleging cryptocurrencies are unregistered securities under U.S. securities laws would likely expect to see a vigorous debate invoking the Howey test which has long been the standard legal approach for defining a security.³

Instead, what is interesting about the Lido DAO investor class action is that neither Plaintiffs nor Defendants have invoked the Howey test nor, as the judge duly noted in his opinion, even disputed whether the Lido DAO governance token was a security. ⁴ The motions have instead delved into the specifics of the organizational form of the Lido DAO; and in relation to that form, how did it manifest itself in promoting the LDO governance token in the market for trading cryptocurrencies on market exchanges.

What is a Decentralized Autonomous Organization?

DAOs represent an innovative organizational form adopted by many businesses engaged in cryptocurrency activities to develop and implement managerial decisions. This is a popular form of cryptocurrency business organization whose underlying governance tokens collectively have a market capitalization of close to $50 billion.⁵

The basic management structure of a DAO is to issue special governance tokens that grant token-holders the right to participate in and vote on the management decisions of the DAO’s cryptocurrency business. The governance tokens are analogous to stocks issued by publicly traded corporations that give stock-holders control of the corporation. For example, the governance token-holders of a DAO engaged in cryptocurrency DeFi could propose and vote on decisions related to borrowing and lending cryptocurrencies, such as Lido whose business is to help finance proof-of-stake blockchain validation.⁶

Smart contracts built on a blockchain, e.g., Ethereum, then institute the decisions voted on and approved by governance token-holders. Smart contracts are essentially computer software programs written on the DAO’s supporting blockchain that recognize and execute the decisions of governance token-holders. Since all DAO token-holders have the right to propose, view and approve managerial changes, decision-making is viewed as decentralized and automated, hence the name Decentralized Autonomous Organization.

While both traditional corporations that issue stock shares as well as cryptocurrency DAOs that issue governance tokens are based on a certain organizational structure for managing their business, DAOs promote themselves as a fully decentralized and democratic form of decision-making.

This characterization can be pushed to the extreme in certain legal contexts, such as when a DAO has been accused of violating U.S. securities laws, and the DAO offers as a defense that it is inherently software, i.e., smart contracts, such that no defendant entity exists who can be held liable for the alleged violation nor responsible for investor losses. This is the position taken by Lido DAO Defendants, which the judge refused to accept as discussed next.

The Judge’s Opinion to Deny Defendants’ Motion-to-Dismiss in Samuels v. LIDO DAO

In Samuels v. LIDO DAO, the judge’s ruling against Defendants’ MTD focused on two main issues. Was the Lido DAO an organization under California law, specifically a general partnership. And if so, was the Lido DAO accountable for investor losses who purchased the LDO governance token LDO when it was an unlawfully issued security, i.e., not registered with the Securities Exchange Commission (“SEC”) as required under U.S securities laws.

What is interesting about this investor class action, as the judge pointed out in his ruling, is that neither party disputed that the LDO governance token is a security. The determination of a cryptocurrency as a security based on the Howey test criteria generally plays a central role in establishing liability in many cryptocurrency investor class actions and SEC enforcement actions.

As readers are no doubt aware, the Howey test has long been the standard for determining whether an asset is a security. The Howey test specifies four main characteristics that define a security: (1) an investment of money; (2) in a common enterprise; (3) with a reasonable expectation of profits; and (4) to be derived from the efforts of others.

Given that neither party disputed in the first place whether LDO was a security, why then did the judge feel compelled to explain in detail his rationale that the Lido DAO was an enterprise, specifically a general partnership, when neither party disputed the Howey test criterion of a common enterprise (or indeed disputed any of the criteria for a security under the Howey test).

Part of the judge’s extensive rationale appears to be motivated by his view for the tendency of “people in the crypto world to inoculate themselves from liability by creating novel legal arrangements to profit from exotic financial instruments.”⁷

Indeed, the Defendants, four named investors, argued they did not and could not appear in court because they did not exist. Paradoxically, to provide a unified voice of their non-existence, they contrived an entirely new entity named Dolphin CL LLC that inserted itself into the judicial proceedings to act on behalf of Defendants’ in submitting their MTD. One has to wonder if this new entity and its unexpected participation in the proceedings was embedded in the very smart contract that Defendants (or in the same circular manner the Dolphin entity) asserts its non-existence and hence immunity from liability.

The judge’s ruling sends a clear signal that while a DAO may have a highly decentralized managerial structure whose operation relies heavily on autonomous self-activating software, it is still an organization “run by people.”⁸

Another key decision in the judge’s ruling that is crucial for DAOs issuing cryptocurrency tokens for exchange trading is to what extent the DAO promoted or solicited any of the investors in the proposed class.

According to the judge, the fact that Plaintiff investor Samuels purchased LDO tokens on a cryptocurrency exchange and not as part of an Initial Coin Offering (“ICO”), does not allow Defendants to escape liability for investor losses.

Here the judge’s ruling recited the facts pled by Plaintiff as adequately demonstrating that while Samuels may not have transacted directly in Defendants’ ICO, the Defendants belonging to the Lido DAO general partnership solicited broad investor interest in the marketplace. This is also consistent with the view emphasized by the judge that Lido DAO is not merely software but was an organization actively managed and promoted by Defendants with the expectation of selling tokens to reap a future return.

The Contract Economics of Smart Contracts

As an economic principle, it is not optimally efficient for a contract, including a smart contract, to anticipate or explicitly specify all possible contingencies governing a business arrangement.

One reason is that economic actors do not have complete information about how best to run a business or contract with other businesses which are endeavors where a certain amount of trial-and-error is unavoidable. Nor do economic actors have perfect foresight about the many possible future events that could materialize and alter the incentives or ability of parties to perform according to plans.

More generally, business and market information is a scarce resource, and its abundance is subject to the same economic laws of supply and demand that govern markets for all goods and services, including cryptocurrency commerce. As transaction cost economists have recognized, it can therefore be more economically efficient not to specify all contingencies in a contract (or computer software code) and to instead resolve or adapt a commercial arrangement to unforeseen events if and when they arise.⁹

Unforeseen events are, by definition, not built into business plans, contractual arrangements or software code. Some form of human intervention is thus both optimal and economically rationale for managing organizations, including cryptocurrency DAOs. The judge’s ruling denying Defendants’ MTD in Samuels v. LIDO DAO recognizes this basic economic principle.

Summary

In summary, the investor securities class action against Lido has flown over the step of disputing whether or not the LDO governance token is a security and adopted the operative assumption that it is, at least for now.

It will be interesting to see if Defendants attempt to revisit this issue, notably since the incoming SEC Chair Paul Atkins is widely expected to have more favorable policy views of cryptocurrencies. Such favorable views could translate into an SEC shift away from broadly categorizing many cryptocurrencies as securities – which it has vigorously pursued during the last four years under now outgoing SEC Chair Gary Gensler.

For the year 2025, the Lido DAO securities class action is at the forefront of this legal debate, whose momentum so far favors the investor class in claiming liability and potential economic loss damages against the Lido Defendants for issuing and trading an unregistered security.