How SwiftDao Automated Exit Sidesteps The SEC, All While Reducing Real Fraud

Automated exit for inactive members is the primary feature for every SwiftDao (register at swiftdao.com to join the beta if you haven’t already). Members who vote less than 4 times in the last 6 months are required to sell their tokens in the monthly auction. Automated exit solves two problems holding back Daos:

  1. Securities regulation, and
  2. Fraud from the principal-agent problem.

Depending on who you ask, either securities regulation or fraud ended the ICO boom. Longhash, discussing the SEC, noted in June 2019:
“A lack of clear guidance surrounding securities offerings is a serious risk. While a project may not believe its coin offering functions as a security, the SEC could disagree and take legal action.”

Of course, the SEC’s regulatory action took place across a background of fraud. Meanwhile, many fake blockchain projects had their founders and early investors cash out at the expense of latecomers. The sale of tokens wrongfully earned may have precipitated the cryptocurrency crash as capital rushed to the exits, forcing even legitimate projects to liquidate token holdings to maintain positive cash flow.

Bringing Back The Boom

A solution to both regulation and fraud would reinvigorate the flow of capital into the blockchain space. Experiments over the last two years have demonstrated a simple solution that solves both regulatory and fraud issues: Automated Exit.

MolochDao was the first to experiment with exit as a feature rather than a problem. According to Simon de la Rouviere, MolochDao founder:

Moloch DAO incentivizes coordination by collapsing traditionally separate parts of a company into one process, and by creating additional incentives for defectors to defect and exit. The latter is meaningful since it keeps the core owners more gainfully committed.”

Exit from a MolochDao removes less interested members, leaving only the most committed in the Dao. Anyone who disagreed with the decisions by the community would leave on their own. The result has been massively successful at funding the Ethereum ecosystem. MolochDao’s initial members were most interested in supporting Ethereum. Members who were not interested in this mission left the organization, leaving behind only the most committed members. The result has been over $120k in grants to fund Eth 2.0 and other Ethereum projects in less than a year since founding. For a non-profit institution in an emerging space, these results are astounding.

Automated Exit For Profit

How can the exit model be extended to for-profit Daos? The answer lies in the traditional investment club, a common for-profit legal structure in the USA. Investment clubs do not have to register with the SEC as long as members do not “expect to make a profit from the efforts of others.” In the words of the SEC,

“If every member in an investment club actively helps decide what investments to make, the membership interests in the club would probably not be considered securities. If the club has even one passive member, it may be issuing securities.”

Simply, all members must be actively engaged in the management of the firm. With SwiftDao’s automated exit, inactive members sell their token holdings and are removed from the Dao. SwiftDao tokens are not securities.

Properly Designed Daos Are Not Securities

Don’t believe it? Check out dOrg, launched in June as a Dao under US law as a BBLLC. Research at the Computational Law Research and Development at MIT led to the creation of new legal structures that allow Daos to form BBLLCs (Blockchain-Based Limited Liability Companies). The US state of Vermont in July of 2018 was the first to explicitly create rules for the formation of BBLLCs. Forming a BBLLC in the USA opens up Daos to investment from the deep capital markets of the US, all while providing a clear and safe way to limit investor’s liability. Lawyers can also now more easily work with Daos, since under Vermont law the linkage between BBLLCs and traditional LLCs are very clear, meaning that the legal histories of traditional LLCs apply to BBLLCs.

Of course, shares in LLCs, whether blockchain-based or not, may still be considered securities. However, most LLCs do not issue securities since the members are all actively engaged in the management of the business. That’s where SwiftDao’s automated exit is of critical importance. Automated exit means inactive members are removed on a regular basis from the firm.

Automated Exit Reduces Fraud

But automated exit has many other advantages besides avoiding legal complexity. The entire reason for securities legislation in the first place is to prevent fraudulent managers from stealing money from investors. Solutions that sidestep securities regulation but still allow principal-agent fraud will fail. Such solutions would quickly find that the public will support new, expansive regulation to protect innocent small investors.

Automated exit solves the principal-agent problem. Any investor who wishes to passively sit by and let others do the work are quickly removed from the Dao. Thus, the members of the Dao have no one to defraud but themselves.

Automated Exit Prevents Vote Buying

Vitalik Buterin, who needs no introduction, noticed as early as December 2017:

“One of the main criticisms of coin voting mechanisms so far is that, no matter where they are tried, they tend to have very low voter participation… Low voter participation means two things. First, the vote has a harder time achieving a perception of legitimacy, because it only reflects the views of a small percentage of people. Second, an attacker with only a small percentage of all coins can sway the vote.”

Making decisions by voting struggles to produce good outcomes because most members do not vote. He further explored how this problem results in cartels in his March 2018 blog post:

“What this [coin holder voting] can easily lead to is funds that offer kickbacks to users who vote for them, leading to the exact scenario that we saw above with DPOS delegates. In the best case, the funds will simply be returned to voters, giving coin holders an interest rate that cancels out the inflation, and in the worst case, some portion of the inflation will get captured as economic rent by a cartel.”

Vote buying result in plutocratic capture of an organization at the expense of smaller investors. SwiftDao’s automated exit solves this problem primarily by removing members who don’t vote. There’s a second defense against vote buying with SwiftDaos. Minorities who disagree with the outcome of a vote can always exit, selling their tokens in the monthly auction. However, if the auction price is low, they can elect to redeem their tokens for a percentage of holdings by the SwiftDao. While this doesn’t return any non-tokenized assets to the member, as more assets become tokenized this second option will become a more potent option.

Automated Exit Forms A Community

There’s one final advantage to automated exit that must be mentioned: community. Members of traditional investment clubs, whose structure SwiftDaos are based off, frequently find that the network and friendships they form in the club are just as valuable as the payout from investments. The history of BetterInvesting is a great example; the founders very early on found that education and networking were critical aspects of their value proposition.

Why? Its because inactive members are forced to leave. Members who don’t vote and aren’t engaged are a serious barrier to communication, since they damage the culture of the organization. Removing these members reinforces the organization’s values, making communication, education, and cooperation the norm instead of the exception.

Register To Join The SwiftDao Beta

Most of you reading this post have already done so, but for those who haven’t: make sure you sign up at swiftdao.com to get early access to the first SwiftDaos. The first trial SwiftDao will be SwiftPater with the mission to invest in and reap profits from the SwiftDao standard. By joining early, you will be one of the first into the new boom SwiftDaos will create in the blockchain ecosystem. Imagine the ICO boom without the fraud or regulatory problems – that’s what the SwiftDao standard is creating.