The Legal Standing of DAOs and the Lack of Regulation

A decentralized autonomous organization (DAO) is one of the most innovative concepts to have been successfully implemented through blockchain technology.

A blockchain is a digital ledger of transactions that are duplicated and distributed across the entire network of computer systems, or the internet.

A DAO is formed by combining blockchain technology with smart contracts, which are computer codes containing a set of rules, which the parties are in agreement to. If and when the pre-defined contingencies are met, the agreement is automatically enforced, which facilitates, verifies, and enforces the negotiation or performance of the agreement or transactions. The agreement is said to be completed either in full or further instructions are sent to a third party for the performance of some specific transaction. DAOs operate on the rules laid down in the smart contract. These rules are determined by the members of the DAO, autonomously through voting. Thus, DAOs have a decentralized governance structure without any hierarchy in place inside the organization.

A detailed description of DAOs can be found on our blog post titled ‘History of the DAO’ here.

The Current Legal Status of DAOs

Traditional legal entities like general partnerships, public limited companies, firms, etc have a legal existence due to a legislative framework that defines the regulations necessary for registration and incorporation of the entity. Incorporation awards the entity with a legal personality due to which the entity is able to perform various functions, including,

  • own assets in its name;
  • have perpetual existence; and
  • sue or be sued under the jurisdiction of a court in its own name.

Thus, incorporation gives the entity certain privileges, in exchange for which, the persons operating the entity are bound to comply with the financial and operational requirements imposed by the legislation.

Currently, Wyoming is the sole state to give DAOs legal recognition by giving them an opportunity to incorporate and register under a new act. The Wyoming act applies the Wyoming Limited Liability Company Act to DAOs so they can have legal status as limited liability companies. The act lays down the requirements of DAO for registration and incorporation. It further lays down a few rules and regulations that a DAO must comply with. This creates uniformity, creating a fair and equal ground for different entities to operate.

Lack of Regulation

Apart from Wyoming, in every other country, the legal status of DAO remains uncertain. Thus, it becomes unclear who would bear the legal rights and responsibilities.

It also creates uncertainty for legal actions brought against a DAO. In case of a lawsuit filed against a DAO, the suit may be stalled as it becomes difficult to identify the person who would represent the DAO, verify whether such person is authorized to do the same, and it also becomes difficult to determine the jurisdiction of the court.

If DAO is considered to be similar to a general partnership, and not given a unique identity of its own, the members of the DAO would become subject to unlimited liability. Thus, the members would be liable for each other’s fiduciary duties as partners, which they might not have considered at the time of making the investments. The risk of personal liability would further discourage more people from investing in DAOs.

Since DAOs are completely decentralized and don’t require a physical space to operate, it has the ability to operate across the globe with limited costs. However, the lack of regulation and uniformity makes it difficult for a DAO to operate internationally as the rules and regulations in every state and country may differ.

Lack of legislative framework also makes it arduous to ascertain the rightful owners of any Intellectual Property Rights relating to the DAO. In the absence of a legal personality, it is impossible to designate ownership of such IPR. This would make it problematic to prove the true ownership in case of a challenge to it, identifying potential breaches, handling transfers, and licensing of rights to third parties.

Further, having no regulation monitoring the DAOs would mean that there is no obligation for the DAOs to comply with applicable data protection laws. As a result, giving the DAOs complete autonomy over the type of data collected, the manner in which the data is stored, the quantity and quality of data to be collected, and security measures adopted for the protection of the personal data.

Having a legal identity is important also when it comes to harm caused by a DAO. The principles of justice are the same across the world, ie, a wrong must be corrected. Thus lack of legal identity causes hindrances in the administration of justice and due to the novel structure of DAO, the person responsible for the wrongful action of the DAO that caused the harm cannot be determined.

MiCA

The Markets in Crypto Assets (MiCA) is part of the EU’s Digital Finance Strategy which aims to regulate the digital currency market in the EU. MiCA aims to create an innovation-friendly framework with the purpose to bring within its purview all crypto assets not covered by the EU Financial Service Legislation. The four broad objectives of MiCA are:

  1. to provide legal certainty for crypto assets not under the domain of any existing EU Financial Service Legislation for which there is a need;
  2. to establish uniform rules for crypto assets service providers and issuers across all member states;
  3. to replace existing national frameworks applicable to crypto assets not covered by existing EU Financial Service Legislation; and
  4. to establish specific rules for Stablecoins.

Stablecoins have been one of the main focal points of the regulation. Stablecoins were created to overcome the high volatility of digital currencies. The value of the stablecoin is pegged to another asset such as fiat money, gold, or other crypto assets.

The regulation further focuses on regulating crypto assets service providers. It stipulates that only persons with a registered office and authorization from relevant national competent authorities as crypto-assets service providers would be permitted to provide services with respect to crypto assets. It also puts an obligation on the service providers to act honestly, fairly, and professionally, keeping the best interests of their present and potential clients in consideration, which includes making their pricing policies publicly available in addition to having efficient safeguards in place.

FATF

Cryptoassets possess the ability to smoothly transfer value from one corner of the world to the other and thus have the potential to significantly change the face of the finance industry. The speed, global reach, and anonymity of virtual assets, which are its advantages could also attract the attention of white-collar criminals. Without a uniform regulation in place, virtual assets have the risk of becoming a virtual oasis for fraudulent financial transactions as well as terrorism financing.

The Financial Action Task Force (FATF) monitors the development is the crypto industry and has observed that there are countries that have started adopting regulations for crypto assets while many others have not. This creates a gap in the global framework concerning crypto assets and thus, creates loopholes for the possibility of criminal activities. The only solution to this global problem is creating uniform rules and regulations to monitor the crypto sphere.

FATF has issued binding standards to regulate the crypto assets and prevent their misuse for money laundering and terrorism financing. When implemented globally, they would ensure the growth and advancement of the crypto industry and businesses and develop a regulated environment that encourages innovation while also preventing criminal activities.

The Need of the Hour

While a DAO may have extensive internal rules governing the conduct between the members internally and the relationship between the members and the DAO, these rules are nugatory when it comes to interacting with external jurisdiction’s legal systems. Further, DAO tokens, which represent the initial contributions made by each member, are considered to be one of the major factors determining the rights of the members with respect to the DAO. Although, since the DAO is not considered to be a legal entity, the tokens cannot be given the same standing as that of shares in a public company and are not legally considered to be determinants of ownership rights.

Therefore, although the DAO is capable of functioning smoothly internally, without a legislative framework, it is impossible for the world to adopt and work with DAOs. Legislations are necessary

  • to give legal status to DAO,
  • to determine the representatives of the DAO,
  • to lay down the rules and regulations that the organization must adhere to,
  • to lay down the minimum requirements for forming a DAO,
  • to determine how the DAO would operate on a global scale.

Conclusion

Financial innovation has radically changed the financial landscape. The global systems of justice should be compatible with the global system of business. DAOs are the future of the business world. They have the capacity to fundamentally change how businesses are formed and operated. There is no denying that the world is moving towards a more decentralized and free system of governance.

It is inevitable that the world will soon move towards decentralization. DAOs are the beginning of this era of decentralization. They have the potential to grow and take over the business industry as we know it now. However, the lack of a legislative framework is tampering with the growth of DAOs internationally.

The law is always changing and must evolve with the new changes happening in the world. DAOs are a revolutionary change. Operating without human intervention, they possess the capability of achieving more than can be imagined. Thus, the law must catch up with the developing technology, and countries all over the world must follow the precedent set by Wyoming with their new law.

WACEO is a non-profit organization with a mission to help blockchain organizations be compliant with the dynamic regulatory atmosphere. It not only helps DAOs with governance policies but also helps them with business-related services, including (but not limited to) legal work, accounting services, legal and regulatory audits, tax services, and even dispute resolution. WACEO is a one-stop shop for all services required by DAOs. Apart from providing basic services, it also helps DAOs incorporate and ensures compliance with the prevailing regulations.

For more information on WACEO and our work, visit our website. To keep yourself updated on the latest developments in blockchain organizations, subscribe to our newsletter.

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Providing the Road to Regulatory Clarity in the Blockchain Industry.