How Menagerie Upgrades Compliance with the Emerging DAO Regulatory Landscape in the United States

16 Jun How Menagerie Upgrades Compliance with the Emerging DAO Regulatory Landscape in the United States

 Menagerie Response to SEC shutdown of American CryptoFed DAO in Wyoming

Lessons from SEC’s Anti-DAO Moves

Menagerie was built to avoid the shoals American CryptoFed DAO hit

The SEC just made a pioneering Wyoming DAO’s life more than difficult. Some of their reasoning provides little to no clarity to the DAO communities (how exactly does a pre-launch DAO have audited financial statements?), but on the off chance the American CryptoFed DAO survives, its court battles will be long and expensive. 

The core lesson is that while DAO regulatory environments are still in flux worldwide, the safest path is to keep reputation tokens thoroughly distant from anything that can be bought and sold – which just happens to be the core distinctive philosophy of the Menagerie DAO model.

You’ll find a more in-depth analysis of the specific case below. But an important takeaway is that this action was just as inevitable as it was unpredictable. The specific agency and victim couldn’t be forecast. But with a patchwork global regulatory climate, and the radical changes DAOs bring, if it didn’t happen in Wyoming, it would have happened somewhere else. If it wasn’t for audited financial statements, it would be for some other inane pretext. 

We can rage on all we want on Telegram and Twitter about short-sighted bureaucrats and regulatory capture by incumbents. But we live in an industry full of rug pulls and Ponzi schemes. We have to accept that eventually someone will pay the price of overreaction – and do our best to not be immortalized in case of law precedents.

Menagerie’s model was built from the ground up to anticipate this type of obstacle. We focus on the utility first, making non-fungible, non-transferable reputation the core and lifeblood of the decentralized community. There’s no way to buy or sell reputation, ensuring it always passes the Howey test. Financial transactions are of course important as well, but in our model the payment rails are secondary – so they are flexible and responsive to the shifting regulatory climate and the core of the DAO is never dependent on the crypto or fiat mechanism used to compensate participants. 

Does this guarantee that a Menagerie client will never cross a regulator? Probably not. But the odds of being in trouble with a regulator are much, much lower. And more likely than not, some other, more poorly designed DAO will take the brunt of the first roundup of regulatory scapegoats. 

There’s an old anecdote about someone doing stretches and putting on running shoes before going on a hike in bear country. His friend says “you can’t outrun a bear anyway” and the runner replies “I don’t have to outrun the bear – I just have to outrun you.” Similarly here, the goal is not to win against regulatory arbitrariness – the goal is to have someone else be the easier target.

With that preface, let’s get into exactly what happened and how our model would have helped American CryptoFed DAO avoid it. 

SEC Shuts Down Wyoming’s American CryptoFed DAO

The Securities and Exchange Commission (SEC) has issued a stop order suspending American CryptoFed DAO’s registration statement due to the omission of required information, including audited financial statements. American CryptoFed DAO claims that generating these financial statements before the DAO is operational is impossible, leading to a Catch-22 situation. In addition, the company faces challenges related to the classification of its tokens as securities and the absence of legal counsel opinions. This article evaluates how the Menagerie token governance accounting design provides a compliant upgrade for DAO design in the US in light of the recent SEC shutdown of American CryptoFed DAO. 

Challenges with Audited Financial Statements

In its response to the SEC action, American CryptoFed DAO’s Chief Financial Officer, Xiaomeng Zhou, highlighted the difficulty of producing audited financial statements without transaction records, which in their response creates a compliance Catch-22 in the US. The company intends to petition Judge Foelak for guidance on how to fulfill this requirement in the absence of operational data. While the Token Safe Harbor Proposal 2.0, updated by SEC Commissioner Hester Peirce in 2021, offers some potential relief by providing a time-limited exemption for network developers, it is crucial to note that the proposal is still in the early stages and may not address all of the registration issues faced by American CryptoFed DAO.

Failing the Howey Test and Token Classification

One of the key points of contention between American CryptoFed DAO and the SEC is the classification of its tokens as securities. American CryptoFed DAO asserts that its tokens do not meet the criteria set by the Howey Test, which defines securities based on: 1. Investment, 2. common enterprise, 3. expectation of profits, and 4. reliance on others’ efforts. Like so many other crypto ventures that got into trouble with the regulators, the company argues that their tokens have utility and should not be considered securities. However, the SEC’s current and ever evolving position seems to suggest that any token obtained through cash or other assets may be classified as a security, regardless of its intended purpose.

American CryptoFed DAO’s Objectives and Potential Impact

American CryptoFed DAO aims to revolutionize payment systems by providing a frictionless platform that allows merchants to bypass traditional credit card companies. With its parent company MShift, which serves major banks and credit unions, American CryptoFed DAO expected to make a significant impact on the payments industry. The adoption of Wyoming’s stable token, backed by short-term treasuries, could generate substantial interest earnings and benefit both American CryptoFed DAO and the state.

Navigating the Evolving Regulatory Landscape

To address the regulatory hurdles they face, American CryptoFed DAO plans to engage legal counsel once they have completed the necessary steps and sought guidance from the SEC. The company intends to file a “void for vagueness” lawsuit, drawing inspiration from Ripple Labs’ ongoing case against the SEC. The recent ruling in the Ripple case, allowing public access to previously sealed documents, has implications for other cryptocurrency and digital asset companies, including Coinbase.

American CryptoFed DAO’s journey highlights the complexities and challenges faced by decentralized autonomous organizations operating in a rapidly evolving regulatory landscape. The suspension of their registration statement, the classification of their tokens as securities, and the absence of audited financial statements present significant obstacles. However, through seeking guidance from the SEC, engaging legal counsel, and monitoring ongoing cases like Ripple’s, American CryptoFed DAO may find a path forward. These developments will not only shape the future of American CryptoFed DAO but also contribute to the broader understanding and acceptance of decentralized finance in the mainstream financial industry.

Menagerie’s Contribution to the Evolving Regulatory DAO Landscape

In the world of Decentralized Autonomous Organizations (DAOs), Menagerie’s reputation-based governance is emerging as a compelling alternative to traditional utility token and securities-based models. With the evolving regulatory landscape and the issues identified in the recent SEC action in American CryptoFed DAO, emerging DAOs are well advised to explore governance mechanisms that prioritize transparency, decentralization, and active participation while avoiding the complexities and compliance challenges associated with securities. This article explores why reputation-based models, such as the one offered by Menagerie, provide a viable alternative to traditional securities-based models in the context of DAO governance.

Decentralization and Trust

Reputation-based governance promotes decentralization, aligning with the core principles of DAOs. Unlike traditional securities-based models that often rely on centralized authorities, reputation-based systems distribute decision-making power among participants based on their demonstrated contributions and reputation scores. This decentralized approach instills trust and fosters a community-driven environment where decisions are made collectively, rather than being dictated by a central authority.

Alignment with Token Utility

Menagerie’s reputation-based models align with the utility-focused nature of tokens in DAOs. While traditional securities are primarily investment contracts, reputation-based models emphasize the utility and functionality of tokens within the DAO ecosystem. Participants acquire reputation scores through active engagement and positive contributions, which can grant them voting power and influence over decision-making processes. This alignment reinforces the notion that tokens serve as tools for governance and participation rather than investment instruments.

Active Participation and Meritocracy

Menagerie’s reputation-based governance model encourages active participation from DAO members, fostering a meritocratic environment. Participants are incentivized to contribute positively to the DAO’s goals and objectives as their reputation scores directly impact their influence within the community. This approach ensures that decisions are made by individuals who have demonstrated expertise, dedication, and a vested interest in the DAO’s success. The focus of the governance model moves away from investment interest of whales to a focus on compensation structures for DAO members based on their merit contributions. Meritocratic decision-making enhances the quality of outcomes and fosters a sense of ownership and accountability within the DAO community.

Transparent and Inclusive Decision-Making

Menagerie’s reputation-based models promote transparency and inclusivity in decision-making processes. Participants can track their reputation scores, understand how they are calculated, and witness the contributions that led to their scores. Transparent reputation systems enable individuals to evaluate the expertise and trustworthiness of others, facilitating informed decision-making. Moreover, reputation-based governance encourages broader community involvement, as participants have a clear understanding of how their contributions can shape the DAO’s direction.

Regulatory Compliance and Flexibility

Menagerie’s reputation-based models offer flexibility in governance that aligns with existing regulations in the ever evolving US regulatory landscape. By focusing on utility and participant engagement, DAOs in the Menagerie governance model can argue that their governance models do not fall within the realm of securities under the Howey test. This approach reduces the compliance burden and potential legal risks associated with traditional securities-based models, providing a more accessible and scalable framework for DAO operations.

The Menagerie token governance accounting system uses blockchain technology in a multichain design to track and score the performance of individuals or organizations. It is designed to be a fair and transparent system that rewards hard work and provides a platform for people to showcase their skills and achievements.

The Menagerie platform uses a reputation token, which is a digital asset that represents a user’s performance score on the platform. Unlike the majority of utility tokens available in the current market, and unlike the token design that got American CryptoFed DAO into trouble with the SEC, the Menagerie governance token is non-transferable, non-fungible, and only used for merit scoring and accounting. This means that users cannot sell or exchange their reputation token for any other form of value, and its value is tied directly to the performance score it represents. As a matter of fact, the individual DAO governance token for each Menagerie ecosystem DAO cannot be valued and, thus, is removed from the nature of an investment through the lack of value. 

Instead, the reputation token is earned by users through their performance in the respective Menagerie DAO communities. Users can participate in various activities, such as competitions, challenges, and collaborations, and earn points based on their performance. These points are then converted into reputation tokens, which are added to the user’s account.
Menagerie provides a Community as a Service License (CaaS) to its licensed communities. The Menagerie design excludes it from the application of the the principles of the Howey Test, which is the legal test used by the SEC to determine whether a particular asset qualifies as a security. The Howey Test consists of four elements, and if all four are met, then the asset in question is considered a security.

Menagerie’s Howey Test Compliance

Investment of Money

The first element of the Howey Test is an investment of money. This means that the asset in question must be purchased or acquired through an investment of money. In the case of the Menagerie reputation token, users do not purchase or invest money in the token. Instead, they earn it through their performance on the platform.

Common Enterprise

The second element of the Howey Test is a common enterprise. This means that the asset in question must be part of a larger group or organization that is working together to achieve a common goal. In the case of the Menagerie platform, there is no common enterprise involved. Each user is responsible for their own performance and does not rely on the performance of others to earn their reputation score. The isolation of individual merit accounting for each user in the Menagerie voting system removes it from the application of the common enterprise logic under Howey.

Expectation of Profits

The third element of the Howey Test is the expectation of profits. This means that the asset in question must be purchased or acquired with the expectation of making a profit. In the case of the Menagerie reputation token, there is no expectation of profits associated with it. The token is only used for merit scoring and accounting and cannot be exchanged for any other form of value. However, in some organizations members will be compensated proportional to their reputation token holdings. This will come in the form of a different method of payment like a transferable token or fiat. But the reputation tokens themselves will never be sold for a profit themselves.

Efforts of Another

The fourth and final element of the Howey Test is the efforts of others. This means that the profits from the asset in question must come solely from the efforts of others. In the case of the Menagerie platform, ther reputation token itself does not generate a profit as it does not have a discernable value by itself. Users earn their reputation score through their own efforts and performance. There is no reliance on the efforts of others to earn a profit.

Based on these four elements of the Howey Test, the Menagerie reputation token does not meet the criteria for a security. It is not an investment of money, there is no common enterprise involved, there is no expectation of profits associated with it, and its value is not solely derived from the efforts of others as there is no value for the reputation token.

Use Cases

The Menagerie reputation token accounting system and its reputation tokens in diverse communities have many potential use cases. For example, it could be used to track and score the performance of students in an educational setting, athletes in a sports league, or employees in a workplace. The system could also be used to incentivize and reward good behavior in social media or online communities.

Overall, the Menagerie accounting system is a unique and innovative platform that uses data storage settings in databases or via blockchain technology and a reputation token to track and score performance. The non-transferable, non-fungible nature of the token, along with its sole purpose of merit scoring and accounting, make it a distinct asset that does not meet the criteria for a security under the Howey Test. This allows for a fair and transparent system that rewards excellence and provides a platform for people to showcase their skills and achievements. With its potential use cases in various fields, the Menagerie platform has the potential to revolutionize the way we measure and incentivize performance.

Conclusion

Reputation-based governance presents a viable alternative to traditional securities-based models for DAOs. By prioritizing decentralization, trust, active participation, and transparency, Menagerie’s reputation-based models align with the core principles of DAOs and promote a more inclusive and decentralized decision-making process. Furthermore, Menagerie’s reputation-based governance enables DAOs to navigate the regulatory landscape more effectively by emphasizing token utility and community-driven participation. As the DAO ecosystem continues to evolve, reputation-based governance is poised to play a crucial role in driving the growth and sustainability of decentralized organizations.