Step 3: Network Foundation Structures (US and non-US Teams)

We believe our research on the best practices for Web3 founders should be freely accessible for everyone. However, please note that we are not lawyers. We just want to get this information out there so you have a starting point before seeking legal council.
We believe our research on the best practices for Web3 founders should be freely accessible for everyone. However, please note that we are not lawyers. We just want to get this information out there so you have a starting point before seeking legal council.

Intro

In this article, we delve into the topic of network foundations and their significance in the blockchain ecosystem. Specifically, we will explore two different models that are commonly used in establishing foundations: the Legal DAO Wrapper model and the Council and Board model. These models serve as governance structures for network foundations, each with its own unique approach to decision-making, decentralization, and resource management. By examining these models side by side, we aim to uncover the unique benefits, drawbacks, and implications they bring to network development.

Why is a network foundation needed?

A network foundation is essential for various reasons and performs several tasks and responsibilities. These tasks may vary depending on the foundation model chosen. Let's explore the key reasons why a network foundation is needed and the associated tasks and responsibilities:

Bridging On-Chain and Off-Chain Worlds:

A network foundation serves as a bridge between the on-chain and off-chain worlds. It facilitates interactions, partnerships, and collaborations with entities in the traditional off-chain realm, such as businesses, regulatory bodies, and legal frameworks. This bridge is essential due to inherent limitations and challenges in directly interfacing decentralized blockchain networks with traditional off-chain systems and processes.

Legal Liability and Compliance:

The foundation provides a structure to address legal liability and compliance requirements. It offers a layer of legal protection and helps mitigate potential liability risks for token holders, DAO members, and founders. By establishing the foundation as a legal entity, it assumes responsibility for the network's actions and obligations, safeguarding individual participants from personal liability. The foundation becomes accountable for addressing legal disputes and regulatory compliance, ensuring a level of reassurance for network participants.

Treasury Management:

One of the key roles of the foundation is managing the network's resources and safeguarding the allocated tokens or assets. According to the two different models we will lay out in the next section this managed treasury can be the strategic reserve and/or the community pool.

What are the different models of a Network Foundation

Two different models have emerged for setting up the network's foundation: the "Legal DAO Wrapper" model and the "Council and Board" model.
Note, that it is becoming more common for networks to implement both models concurrently, meaning a part of the funds, held by the network is distributed via governance proposals while a secondary “strategic reserve”, typically with a smaller allocation is allocated by a centralized structure to ensure efficiency during the early stages while still growing the community who will participate in on-chain governance.
The two models differ in their governance mechanisms, decision-making structures, and the extent of decentralization. The Legal DAO Wrapper model prioritizes decentralized decision-making through community voting, while the Council and Board model combines centralized decision-making expertise with off-chain engagement opportunities. Both models aim to ensure efficient treasury management and community engagement, albeit through different approaches. Let's explore each model:

Legal DAO Wrapper Model

The Legal DAO Wrapper model is a governance structure where a foundation operates as a decentralized autonomous organization (DAO) established on the blockchain. It emphasizes decentralized decision-making and community participation.
The Foundation acts on behalf of the DAO through decentralized governance and voting processes by the community which it then executes when off-chain processes are involved.
  • Legal Structure: The foundation is legally established as a DAO, which is governed by smart contracts and operates on the blockchain. The DAO's rules and processes are encoded in the smart contracts and/or in the DAO’s constitution, that ensure transparency and decentralization. The entity usually consists of several directors.
  • Treasury Management: The foundation manages the network's treasury, which includes the funds and assets belonging to the network. These funds are held in a transparent and auditable manner within the blockchain such as the “treasury pool” which can be allocated by the foundation according to the decisions made via governance.
  • Decision Mechanism:
    • Governance Proposals: Community members can submit proposals for funding projects, initiatives, or improvements to the network. These proposals outline the objectives, budget, and expected outcomes. The community members then vote on these proposals.
    • Voting Mechanism: Voting can be conducted through on-chain mechanisms, such as token-weighted voting, where the voting power is proportional to the number of tokens held by each community member.
    • Decision-Making: Once voting is complete, the proposals with the highest community support are approved, and the funds allocated accordingly.
    • Funds Allocation: The foundation's role is to execute the approved proposals and distribute the funds as specified by the community that can’t be allocated via on-chain.

Council and Board Model:

The Council and Board model involves a foundation structured as a traditional legal non-profit entity with a council or board responsible for decision-making. It combines centralized decision-making expertise with external engagement opportunities.The foundation operates with a council and a board that make decisions on how the network's treasury is spent and ensures the responsible utilization of these resources in alignment with the network's goals and community interests. It establishes guidelines, criteria, and processes for funding proposals, resource allocation, and budget management. Here's an outline of this model:
  • Legal Structure: The foundation is established as a traditional legal entity, typically as a nonprofit organization. It typically consists of a council or board of directors responsible for overseeing the foundation's activities.
  • Treasury Management: Similar to the DAO wrapper model, the foundation manages the network's treasury, which comprises the funds and assets. In this model on the other hand the treasury is fully controlled and managed by the foundation's council or board who are the decision makers of the fund distribution..
  • Decision Mechanism:
    • The council or board members are entrusted with the decision-making authority regarding how the treasury is spent. They evaluate proposals and make decisions based on their expertise and fiduciary responsibility.
    • Proposal Evaluation: Community members or external parties can submit proposals for funding. The council or board reviews these proposals based on predefined criteria, such as alignment with the network's goals, feasibility, and potential impact.
    • Decision Making: The council or board members deliberate and vote on proposals internally. The voting mechanism can vary depending on the foundation's bylaws or established governance processes.
    • Fund Allocation: Once decisions are made, the foundation allocates funds to the approved proposals, ensuring that the chosen initiatives receive the necessary financial resources for implementation.
Additionally the Council and Board foundation model often fulfills the following tasks for the network:
Strategic Partnerships and Funding:
The foundation acts as a representative entity that engages with external stakeholders and explores strategic partnerships, collaborations, and funding opportunities that support the network's growth, development, and adoption. The foundation's credibility and legal standing enhance its ability to attract resources and establish meaningful relationships with external entities.
Public Relations and Advocacy:
The foundation takes on the responsibility of promoting the network, raising awareness, and advocating for its benefits and use cases. It engages in public relations activities, community building, and educational initiatives to drive adoption, attract users, and encourage participation in the network ecosystem. The foundation often organizes meetups, events, and communication channels to gather feedback, address concerns, and foster collaboration among developers, users, and participants.
Liquidity Acquisition and Token Sales:
The foundation plays a crucial role in enhancing the liquidity of the network's token, attracting investment, and expanding its market presence. It can raise venture capital through token sale agreements, securing additional funds for the network's development. Additionally, the foundation can facilitate token listings on centralized exchanges, enabling broader accessibility and trading opportunities for token holders. Compliance with anti-money laundering (AML) and know your customer (KYC) requirements is essential in the process.
It's important to note that token listings on centralized exchanges typically occur at a later stage, once the network and its token have gained sufficient recognition and market demand. The foundation plays a crucial role in coordinating the necessary processes and compliance measures to ensure smooth and compliant token listings.

How does a “centralized” council and board members foundation model fit into the decentralized network?

The foundation is a piece in the puzzle of the structure of a decentralized network, despite being a centralized entity. Its nature is that of a trust, distinct from a typical shareholding company, as it doesn't have owners. “Non-profit” status means that the revenue distribution among Foundation members is not allowed. Therefore all liquidity which the Foundation might receive should be used to spend just for the ecosystem’s development and support. There are no revenue sharing activities. Instead, it operates based on a mandate that outlines its purpose, objectives, and guiding principles. This mandate serves as a guiding document that defines the foundation's mission, goals, and areas of focus, providing clarity on its role within the blockchain network and its responsibilities towards stakeholders.
The legitimacy of the foundation's centralized role within the decentralized structure depends on how the network's tokens were distributed through a decentralized process. During the decentralized token distribution, there was a consensus that a portion of the tokens, commonly “the strategic reserve”, should be allocated and managed by the foundation. It's important to note that the foundation had no involvement in the token's launch, its distribution, or any decision-making regarding the token distribution. Its sole purpose is to act as a trust that holds the tokens, with a mandate to serve the network.
Additionally the token allocation comes into play: The amount of tokens that is allocated to the “centralized” foundation model should be well-balanced in relation to other token pools and not hold a majority of the tokens. Common allocations are around 10-20% max. of the genesis allocation to ensure the foundation doesn’t hold too many tokens and can be regarded to be controlling the network therefore.
Note:
Oftentimes the foundation is approached by the regulators as it is usually seen as the primary point of contact and the entity that is “overseeing” the network which doesn’t mean that the foundation is viewed as decentralized per se but because it is most approachable and therefore the foundation is often the entity that will take part in and that will supplying resources for building a defense strategy in response to the regulators requests.

Treasury Allocation: How the Foundation receives the funds

Funds are usually allocated to the foundation during the network's genesis phase. Within the Cosmos ecosystem, this refers to the initial launch and configuration of the network's parameters, including the allocation of funds to the foundation's treasury. The specific allocation to the foundation at genesis depends on the chosen model, whether it is a Legal DAO Wrapper or a Council and Board model.

Treasury Allocation to Foundation as a Legal DAO Wrapper Model:

In the Legal DAO Wrapper model, a portion of the network's native tokens is allocated to the foundation's treasury pool or strategic reserve pool, governed by smart contracts encoded in the blockchain. These tokens serve as financial resources for the foundation to manage and execute according to the DAO's governance processes.

Treasury Allocation to Foundation as a Council and Board Model:

In the Council and Board model, the treasury allocation to the foundation is also determined during the genesis phase. This allocation involves assigning a certain amount or percentage of the network's native tokens to the foundation usually held in a multisig wallet which is controlled by the foundation council and/or the board members.

When is a foundation set up

To ensure a seamless and efficient process for receiving, managing, and distributing funds, the foundation (in both the Legal DAO Wrapper and Council and Board models) should be set up well in advance before the network's genesis. The foundation's establishment requires sufficient time for legal entity formation, governance preparation, and allocation planning. Setting up the foundation pre-genesis allows for a smooth transition into the network's operational phase, ensuring transparency, accountability, and effective management of the network's resources from the outset. The specific duration of the setup process may vary depending on project complexity and regulatory requirements, but allocating an adequate time frame for foundation establishment is crucial.

Conclusion - Upsides and Downsides

Legal DAO Wrapper Model:

Upsides:
  • Strong emphasis on decentralization and community-driven decision-making.
  • Transparency and audibility due to the use of smart contracts and on-chain governance mechanisms.
  • Direct community participation through on-chain voting and proposal submission.
  • Potential for greater inclusivity and representation of diverse stakeholders.
  • Alignment with the principles of decentralization valued by many blockchain enthusiasts and communities.
Downsides:
  • Decision-making process may be slower due to the need for community voting and consensus.
  • Higher complexity in implementing and maintaining smart contracts for governance.
  • Potential challenges in coordinating and aligning the interests of a large and diverse community.
  • Governance processes and decision-making may require technical knowledge, potentially excluding non-technical participants.
  • Limited scalability in handling large-scale governance and decision-making processes.

Council and Board Model:

Upsides:
  • Streamlined decision-making process with a smaller group of individuals responsible for key decisions.
  • Expertise and efficiency in decision-making due to the involvement of experienced council or board members.
  • Flexibility in off-chain engagement and partnerships with external entities.
  • Potential for quicker response times and agility in decision-making.
  • Easier coordination and communication within a smaller group.
Downsides:
  • Lesser degree of decentralization compared to the Legal DAO Wrapper model.
  • Potential for concentration of power and influence in the hands of council or board members.
  • Limited direct community participation and influence in decision-making.
  • Need for robust governance mechanisms to ensure accountability and transparency.
  • Risk of decisions being influenced by individual biases or external interests.
In conclusion, the Legal DAO Wrapper model and the Council and Board model offer distinct approaches to network foundation governance, each with its own set of upsides and downsides. The Legal DAO Wrapper model places a strong emphasis on decentralization, community participation, and transparency through on-chain governance mechanisms. This model empowers the community, fosters inclusivity, and aligns with the principles of decentralization valued by many in the blockchain space. However, it may face challenges in terms of decision-making efficiency and scalability.
On the other hand, the Council and Board model offers streamlined decision-making, expertise, and off-chain engagement opportunities. This model can facilitate quick and efficient decision-making, leverage specialized knowledge, and enable strategic partnerships. However, it may involve a lesser degree of decentralization and limited direct community participation, raising concerns about concentration of power and potential exclusion of community voices.

Jurisdictions

The most common foundation setups and jurisdictions for blockchain network foundations can vary depending on factors such as the project's goals, legal considerations, and the preferences of the founders. However, there are several jurisdictions that are frequently chosen for setting up foundation structures in the blockchain space. Two common but at the same time quite different foundations are the Swiss Foundation, and the Cayman Island Foundation. Below you find an outline of each according to set-up time, cost, ownership and management and for which projects and/or jurisdiction they are a better fit. Let's get into the details of these two commonly chosen jurisdictions for blockchain network foundations:

Examples

Swiss Foundation (European teams)
Cayman Foundation (US & global teams)