DAO and Law: Lawyers on the Experience of Decentralization. Part 1

DAO Politics — a ForkLog podcast series, in which we, together with invited experts, examine howdecentralized autonomous organizations are structured, and discuss their conceptual and technological foundations. In this episode we begin a broad discussion of the legal aspects of DAOs with lawyers Baseley&Partners Eliza-Tatyana Vasilyeva and Bogdan Popovchenko.

1. Many DAO founders believe that their organizations are not subject to legal regulation. And they’re wrong. Evangelists, founders and participants of DAOs are often convinced that they are engaged in so technologically unique activity that it falls outside regulatory oversight. However in practice anonymity and decentralization of DAOs are limited, and ignoring legal formalities carries risks.

In particular, there is a possibility to classify a DAO as a general partnership. The key disadvantages of such an approach include:

\n
• Personal assets of the partners are unprotected;

\n\n\n

• Liability of partners for the actions of one another;

\n\n\n

• Lack of a separate commercial entity from the partners;

\n\n\n

• Dissolution upon the death or withdrawal of a partner.

\n

\n\n\n

2. DAOs can be registered as LLCs, trusts and private funds. For example, under Wyoming law Wyoming is applied the same requirements as for limited liability companies, except for those relating to the company name and management. This is because, unlike a ‘traditional’ LLC, Wyoming DAOs can be run by both the members of the organization and by algorithms (smart contracts).

\n\n\n

Alternative LLC option is to structure the DAO as a private fund or a trust. This is because the structures of DAOs, private funds and trusts share a number of similarities, and autonomy is a key criterion necessary for their existence.

\n\n\n

The most common jurisdictions used for creating private funds for blockchain business are Switzerland and the Cayman Islands.

\n\n\n

Among Switzerland’s key advantages are flexible legal regulation applicable to private funds, which allows structuring DAO activities, as well as high reputation and relatively low tax burden on the entity’s activities.

\n\n\n

In the case of the Cayman Islands it’s worth noting the regulation that allows creating legal entities that can operate as a private fund or a common-law trust, while preserving their legal personality, limited liability and tax neutrality.

\n\n\n

3. Many DAOs imitate in their activities structures that existed long before blockchain: trusts, private funds. Many, but not all. Some DAOs implement new economic models and apply within the system various technologies, such as tokenization of reputation and verification of events. In the Baseley&Partners project we try to build exactly such a DAO: bringing together lawyers who contribute content, create chatbots inside the platform. There are gradations as to who can verify what, which bots to validate, what income to receive from monetizing intellectual property owned by the organization.

\n\n\n

4. Licensing of DAOs in the EU helps save costs and expand geographic reach. Organizations that hold so-called Investment Promises (i.e., attract investments) require a licensing procedure. In the EU there is a passporting regime that allows crypto projects that have obtained the right to operate in one EU country to conduct activities across the entire union, subject to national law. Licenses in Estonia, Bulgaria, Latvia, Lithuania are fairly accessible. Therefore we like crypto regulation in the EU. It is less developed than in Switzerland, but it allows enormous geographic reach and a clear legal infrastructure. In the US, it’s a different situation: each state has its own regulator, and one must comply with different laws.

\n\n\n

5. In some states, DAOs are regulated at the local level, however problems may arise in interaction with the Federal Reserve System. In the US, legal regulation of decentralized autonomous organizations exists in Wyoming, Vermont, Delaware, Utah. One state recognition of a DAO as a legal entity is not enough to ensure legal protection. If I create such a structure in Utah or on the Marshall Islands, I grab all the tokens and disappear with them, the jurisdiction of my location would apply, not Utah or the Marshall Islands.

\n\n\n

In Wyoming, progressive regulation was enacted that allowed DAOs to operate anonymously. Everything was fine until the moment of encounter between local and federal regulators. The crypto exchange Kraken registered in Wyoming, gained the ability to create a depository, but could not open a master account due to regulatory constraints of the Federal Reserve. Therefore, state legislation should be evaluated not only by forwardness but also by existing practice of interaction with the federal center.

\n\n\n

\n\n\n

6. When choosing jurisdiction it is important to take into account the views of the participants in your organization. For our DAO we considered different forms of territorial anchoring: a Wyoming-registered DAO, a Public Benefit Corporation, a private fund in Europe, offshore entities in the Marshall Islands. If we had a centralized structure, we would have chosen based on the location of the decision-makers. However our governance tokens are distributed to the whole community, whose representatives live in different countries.

\n\n\n

For us, the reputation of the chosen structure in the eyes of the community matters. The monetization question is important: how the DAO will interact with the outside world. We have a conservative European and American audience that responds better to European private funds or American trusts than Wyoming or the Marshall Islands.

\n\n\n

It is important not to choose the jurisdiction of DAO registration, but the regulation based on the location of participants. The Marshall Islands law in this respect is better than Wyoming’s because it provides the reduction of fiduciary liability of participants and recognition of the DAO form. The question remains which projects will operate under this legislation. Lawyers and lawmakers should focus not so much on creating new decentralized tools, but on integrating decentralization into existing legal frameworks.

\n\n\n

7. Mass adoption, tax regulation and delineation of responsibility of participants will improve the legal framework for decentralized autonomous organizations. What DAO enthusiasts expect first and foremost:

\n\n\n

\n
• global adoption of smart contracts — to replace paper forms and facilitate interactions via smart units and metaverses;

\n\n\n

• introduction of a single-tier tax — taxed only when income reaches the final participant at his place of residence, without taxation at the DAO level;

\n\n\n

• a legally transparent approach to delegates. Currently there is a problem that in the absence of proof of founder, the developers — people who have not remained anonymous — may bear liability.

\n

\n\n\n

Changing all legislation quickly is not possible; it’s a long process. To ensure fewer disasters among early adopters, safe harbours are needed. A Sandbox can operate as such a harbour: everyone who fits the criteria is guaranteed a certain approach while the tool is tested.

\n\n\n

For now, the situation is: the community does something, regulators attack them, and courts decide who survives. It is a harsh path with heavy losses. Collaboration and engagement with regulators is another path, but here DAO enthusiasts must first learn to lobby their interests.