Reality Intrudes on a Utopian Crypto Vision

WASHINGTON — American CryptoFed is a new kind of company spawned by the advent of cryptocurrency — one that claims, in a way, not to be a company at all.

There are no owners, officers or employees, according to its stated plan. Instead, American CryptoFed is a “decentralized autonomous organization” that is supposed to be steered automatically by computer code and governed by a community of users who vote on proposals with crypto tokens.

To their proponents, these types of ventures, known as DAOs, are a new model for commerce, one that could democratize business enterprises and break the hold that big tech and other entrenched middlemen have over innovation in the information age. Already, a rapidly growing number of these upstart organizations have emerged online, including financial services operations, news hubs and social clubs.

But they are also coming under fire from multiple angles, reflecting both the disruptive force of the crypto phenomenon and the struggle to prove its practical use beyond financial speculation.

Members of DAOs are clashing with one another about how to balance the need for skilled and experienced managers against the idealistic vision of communal decision-making. In some cases, crypto investors and regulators say, the ventures amount to Ponzi schemes intended to do little more than bolster the value of the digital tokens they sell.

And regulators are swooping in amid concern about how to protect investors in organizations that do not adopt traditional business and accounting practices.

Just four months after the launch of American CryptoFed DAO, which planned to create a crypto payments system, the Securities and Exchange Commission in November effectively shut it down, saying that the enterprise was “materially misleading” the public with contradictory filings that failed to disclose key information such as audited financial statements.

Hester M. Peirce, a commissioner on the Securities and Exchange Commission, called the surge in DAO activity somewhat overwhelming.

“The last year or so has been a big period for DAOs and people are doing a lot of experimentation,” said Ms. Peirce. “Just trying to even grapple with what this actually means is hard because everything’s moving so fast.”

Many DAOs are wrestling with challenges, including huge financial losses from software flaws and hacks, internal divisions that threaten some entities’ continued existence and allegations of improper diversion of community funds. Others have struggled with low turnout among members when it comes to voting on a strategy or business decision, effectively leaving control in the hands of the investors who put up money to help start them.

This messy gestation has fueled a debate: Are these ventures simply vehicles to enrich insiders and exploit consumers, or early experiments in a new way of doing business?

The value of cryptocurrencies held in more than 4,000 different DAO treasuries rose 3,200 percent in 2021, hitting more than $13 billion by December, according to a tracking website called DeepDAO, although the figures fluctuate considerably with swings in crypto values.

There are already a wide array of projects run by DAOs, including decentralized financial services like Compound and SushiSwap, investment pools like Red DAO, where fashion enthusiasts join to buy digital collectibles, and social clubs like Friends with Benefits, whose token holders gather virtually and in person.

The concept has been embraced by individual crypto investors and some of the biggest industry players alike, including the Silicon Valley venture capital firm Andreessen Horowitz, which has billions of dollars backing blockchain projects. And industry lobbyists and lawyers, including from Andreessen and American CryptoFed, are already working in Washington and state capitals, pushing for recognition of DAOs and updates to what they call “antiquated” laws.

For now, federal regulators have little clear legal authority to oversee these entities, unless a DAO appears to be violating securities laws. Ms. Peirce at the S.E.C. said the result was a recipe for confusion and constant conflict as regulators struggle to police the new entities.

Perhaps the most promising and fraught aspect of DAOs is their approach to making business decisions.

Although DAOs may select leadership groups or hire staff, the major decision-making power is theoretically left to the members, ensuring in theory that choices serve the majority of participants.

“The virtual world in your hands,” is the slogan at Decentraland, a virtual game space, which, like most DAOs, relies on online voting forums to make decisions. Players can use tokens to buy “land” or costumes, and hang out as an avatar at virtual social events.

Eyal Eithcowich, the founder of the tracking website DeepDao, cited Decentraland and DXDAO as examples of DAOs that appear to be living up to the ideal. Decentraland alone has had more than 1,000 different referendums on topics such as “should wearables including guns be allowed?”

“You have had internet forums before where there are debates and you can feel part of a community,” Mr. Eithcowich said. “But here, you don’t just get a sense of ownership. You actually do own part of the platform and your votes have a direct effect on it. That is the beauty of it to me.”

Major corporate players are also getting involved, like JPMorgan Chase which opened an outpost in Decentraland, a “lounge” to promote its Onyx payment network that includes a digital portrait of its chief executive, Jamie Dimon.

But the reality of setting up and running these DAOs has often been complicated.

OlympusDAO, born a year ago, drew international attention and skepticism for boasting extraordinarily high rates of return to crypto holders who commit tokens to the system for a specific time. At one point it offered an annual yield of up to nearly 8,000 percent.

The platform holds regular online votes on proposals like one in January weighing an alliance with JonesDAO, a start-up that allows users to invest in higher-risk crypto derivatives and futures.

But Olympus is largely controlled by its pseudonymous founder, Zeus, whose statements about the business model have baffled industry insiders. The result has been to leave even crypto enthusiasts musing publicly that the operation is probably a Ponzi scheme entirely reliant on participants’ continual faith and inflows of crypto to stay afloat.

Without the traditional disclosures required from a public company or even a private one raising public funds, little is known about OlympusDAO, said Jordi Alexander, an executive at the digital asset trading firm Selini Capital.

“No one is ultimately auditing it to make sure that the statements are true,” Mr. Alexander said from his base in Singapore, elaborating on a Medium post he wrote raising questions about Olympus’s strategy.

Having reached a high of about $1,400, an Olympus token is now worth only about $30, a loss of nearly $4 billion in value. (An individual representing himself as Zeus defended the project in an interview, saying “I just always tried to act authentically and honestly.”)

Community strife has also prompted a price crash at Wonderland DAO, whose founder was recently forced to disclose that the platform’s treasurer, known as Sifu, was actually a man going by the name Michael Patryn. Mr. Patryn was previously convicted of financial crimes in the United States and Canada and was a co-founder of the failed Canadian cryptocurrency exchange QuadrigaCX, whose other founder’s mysterious death has left law enforcement suspicious and customers out about $135 million in crypto.

Among the topics debated since then on the Wonderland governance forum are whether the DAO should dissolve, or transform into something more like a classic corporation, by hiring “a team of professionals that have background checks” including chief financial, legal and operating officers.

The problems that have emerged often stem from the anonymous nature of DAOs and cryptocurrency.

This anonymity can undermine accountability and facilitate what critics call abuses of power, like at SushiSwap, where its creator, who goes by Chef Nomi, left the project abruptly, cashing out on nearly $13 million worth of tokens amid infighting.

A developer who goes by OxMaki and who was involved in starting SushiSwap told The Times in a Telegram chat that the DAO’s strengths — diversity and decentralization — also turned out to be weaknesses.

“It was formed from a wild spectrum of people worldwide without relation between all the parties. The vision and direction being different for each group. It was never fully decided internally. Which was a mistake,” he wrote, adding that he never met other Sushi team members in person. (OxMaki, who called himself an “anarcho-capitalist,” declined to disclose his real name.)

American CryptoFed calls itself the first legally sanctioned DAO in the United States. It was registered in Wyoming, which passed the first state law formally recognizing DAOs and exempting crypto tokens from state securities laws.

In September, it notified the S.E.C. that it would create two new cryptocurrencies for payments and governance in its internal economy, both of which would first be distributed to the public and then later bought, sold and traded.

But the S.E.C. in November quickly moved to block the issuance, asserting in a complaint that this was an illegal securities offering, a move that the DAO is now fighting.

Fearing S.E.C. enforcement, start-ups aiming for decentralization have increasingly turned to private equity funds for capital, giving big investors a large chunk of tokens.

Venture capitalists like Andreessen Horowitz, as a result, have ended up in some cases playing a disproportionate role in decision-making.

Venture funds, founders, core team members and other insiders controlled nearly 50 percent of the Solana platform’s token, SOL, upon its initial release, giving them a large governance stake in the DAO, said Ryan Watkins, a crypto industry analyst.

This insider problem is exacerbated by the often low voter turnouts of individual token holders, making it easy for big players to influence outcomes.

“The more concentrated the token supply is, the more problematic it will be,” said Mr. Watkins, who recently left the crypto data firm Messari, which tracks these trends. “It raises the question, is this really a DAO or is it just like some rich guys deciding what to do?”

Some DAOs are realizing that running a truly decentralized entity can be hard and are moving to form leadership committees that oversee certain key operations, again resembling a more traditional corporate structure, Mr. Watkins said.

But that too can be a fraught process. Last summer, the DAO for Uniswap, a decentralized crypto exchange, voted to form and back a lobbying group, the DeFi Education Fund, yet struggled when the new group moved much faster than promised to sell off millions of dollars worth of tokens, provoking a community backlash.

Insiders with large stakes, like Uniswap investors Andreessen Horowitz, pushed the proposal, said Chris Blec, the founder of DeFi Watch, a crypto news site promoting transparency. “Basically, they proposed and voted through this thing that ended up being like a legal slush fund for them,” he said. “The whole thing is intended to further their corporate interests.”

Miles Jennings, a lawyer at Andreessen Horowitz leading its drive for formal federal recognition of DAOs, said concerns about insider control were legitimate.

“Healthy skepticism is warranted,” Mr. Jennings said. “We’re still in a very early stage.”

Ventures based in the digital world, he added, are connected to the real world. “And laws and regulations,” he said, “are going to need to apply.”

David Yaffe-Bellany contributed reporting.