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Decentralized Payroll Management for DAOs

DAOs are one of the greatest inventions to emerge with the advent of decentralized technologies, which should be in the center of attention when it comes to governance, including payroll management.

In a nutshell:

  • DAOs are unique in that the company is self-reliant (autonomous) and there is no central governing authority (decentralized). They have emerged with the rise of decentralized technologies where governance is most important.
  • In return for contributor's contributions and value, financial incentives and a novel compensation mechanism must be introduced.
  • There are several ways to achieve a novel salary/compensation distribution, but it is important to keep in mind the potential legal implications of pay through DAO. 

Why do DAOs need to pay salaries/compensation? 

Since creative work can be done from anywhere in the digital age, the gig economy has adapted to Web 3, also known as the creator economy. Whether it's a protocol DAO, like Yearn and Sushi, that want to create a new paradigm in financial technology, or social DAOs, like Friends with Benefits and Bankless DAO, that want to spread culture, there are many ways to contribute and add value.
Contributors in this economy can be developers, community managers, content creators, designers, operators & facilitators, treasury management, DAO -specific roles & committees (e.g. Yearn needs Vault strategists to optimize returns, Aave needs risk assessors), etc. 

Because community and value creation are core elements of a fully functioning DAO, payment via DAO may require some level of commitment and upfront work for contributors to first prove their value. In return for the time, energy, contributions, and value creation, a novel compensation mechanism and financial incentives are required for a long-term relationship, as discussed below.

How do DAOs pay salaries/compensation?

Appropriate incentives and rewards for contributors is an area of DAO governance structure that has been in the spotlight for some time. As more questions are raised about managing payroll for DAOs, new products are being developed with different distribution mechanisms for financial incentives. Since there is no one way to have a financial incentive distribution mechanism, this section will be discussed along with specific projects with different mechanisms.

What are the different financial incentives and salary administration mechanisms that DAOs use?

  • Growth Incentives

Compound developed a novel token distribution model that was intended to both incentivize capital growth within the protocol and provide users with better pricing on loans. This model involved the continuous distribution of Compound's native tokens (COMP) to users who added liquidity to and borrowed from the protocol. Each user of Compound immediately became a stakeholder, and some of them became active contributors and voters. Compound's distribution offered a glimpse of the decentralized dream - control over the protocol (and its cash flows) by users of the protocol.1

  • Contributor interaction and social graphs 

Yearn Finance, where all tokens are distributed to funders and none to developers, shifted the narrative away from the traditional VC -funded project zone to the community-funded project zone. For Yearn DAO, governance-weighted salaries were proposed by community members, which required active management and did not scale well. Then the team built Coordinape, where anyone who wants to contribute to Yearn (or to their own DAO) can register and select the team members they have worked and interacted with, so that each member has a set number of allocation points. This is another method of distributing financial incentives to participants.

Utopiaa payroll and expense management system, allows managers of DAO to set recurring payments (e.g., salaries), receive payment/reimbursement requests from members, and create an annotated transaction history for approved and denied payments, hopefully making it easier for larger DAOs to pay financial incentives to contributors. The next big feature of Utopia, which is still in development, is the ability to pay employees in a way that conforms to traditional payroll. Then employees can have taxes withheld and health insurance and other benefits. Utopia is also working on a feature that will allow team leaders to make payments within their portion of the budget without having access to all funds. Finally, Utopia is working on a feature that will allow DAO to pay for transactions directly, so expenses never have to leave the employee's personal wallet in order to manage things from the company's perspective.

According to Utopia's website, the process for payment requests is as follows. Vault signers approve the link between the Utopia app and the selected vault, Utopia generates links for payment requests, vault signers share the link for payment requests with other members, members use UI to specify the date, receiving address ETH, amount and details, and upload invoices for reimbursement or payment request, vault signers accept or reject the payment requests.

As the ecosystem is expanding with new projects on payroll management and distribution of financial incentives, legal concerns are being raised with them.

What are the legal concerns regarding payments by DAOs?

  • General taxes under U.S. laws

Depending on the entity a DAO ultimately takes will dictate the types of taxes it will pay. Some entities, such as corporations, pay taxes at the entity level. Other organizations have "pass-through" taxation that is paid at the individual member level. Among the types of profits that a DAO might have are profits from treasury management. This triggers difficult discussions about how to provide DAO members with the necessary information to pay the required taxes.

  • Employment taxes under U.S. law

Even if you are not a contributor, completing tasks for a DAO and receiving rewards in the form of tokens can trigger a traditional employment relationship. 

If members of a DAO are considered as employees, DAOs need to figure out how to pay DAO 's share of taxes, including but not limited to state employment taxes, federal employment taxes such as Social Security, and withholding of wages for state and federal taxes for employees.

DAOs are opening a new chapter in the history of decentralized technology. Although the extent to which they will upend all forms of human organization is yet to be seen, the governance model DAO has proven particularly successful for crypto-based communities.

But as with any invention in the crypto world, there are no safe, universal rules for payroll and its potential legal implications. Until there is a legal way for insurance companies, banks, government authorities to recognize DAOs, and regulators point to specific rules, employers will have to rely on traditional organizations that can act as their employers in terms of tax administration and healthcare. With the corresponding development of De-Fi, it is expected that upcoming projects will try to address the issues discussed.