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Who is responsible for a DAO?: exploring the legal personality of a DAO
11/02/2022
A Decentralised Autonomous Organisation (DAO), is a community-led entity which has central authority in place. A DAO is fully autonomous and transparent: this is achieved through the use of smart contracts which execute the rule and duties of the DAO. DAOs are becoming a prominent part of the Web 3.0 revolution and look to continue their surge in 2022.
While there is no doubt about the rapid adoption of DAOs by different groups, it is essential to note that DAOs pose significant legal issues. While the streamlined, transparent nature of DAOs are a key selling point, it is also a source of controversy as there is no person directly responsible for the actions taken by the DAO. Traditional companies which consist of a CEO and Board of Directors, have a set of duties they must uphold and can be held accountable for, this is not present in a DAO. This begs the question, who is liable for any breaches of law of regulations by a DAO?
What is the legal personality of a DAO?
The very first DAO was used as a form of crowdfunding, but has now developed in such a way that they can be viewed as a legal entity as well as a collective investment vehicle / fund. As we can see from the examples below, the legal makeup of a DAO is open to a lot of legal issues and considerations.
DAO’s are made up of the following legal traits:
Legal personality
A DAO can be considered as a form of partnership or association. However, a DAO is not a legal entity.
Jurisdiction
Determining the jurisdiction for a DAO is a complex task, as it does not exist in a certain place or country. DAOs are a completely digital construct, made up of code and smart contracts, meaning pinpointing a geographical location is impossible.
Registration
A DAO doesn’t require any form of registration. Additionally, tokens are not shares or securities. However, national governments have started to regulate Cryptocurrency, meaning that DAO tokens could fall under these regulations.
Limited Liability
Currently, there are no rules that limit the liabilities of DAO’s members. In some countries, a DAO can be viewed as a partnership with unlimited legal liability.
Governance
A DAO does not have a hierarchical structure and therefore, is not centrally managed. All decisions are made by a consensus agreement between the stakeholders. All approved changes to the DAO are written into the smart contract and are available for everyone to see.
How can a DAO enter into a contract?
With the exception of Wyoming and Vermont, DAOs lackformal legal recognition around the world, this means a DAO lacks a legal form with which it can enter a contract.
While it is true a DAO may initiate a governance proposal which authorises an individual to enter into a commercial arrangement on the DAO’s behalf (and fund that arrangement), the representative appointed by the DAO might not automatically enjoy the limited liability that a corporate entity does. Additionally, by doing so there is a risk that the DAO could be considered a general partnership or unincorporated association. Should this be the case, the members of the DAO may be open to personal liability for any of the DAO’s actions.
One possible solution to these liability issues would be for the DAO to authorise, through a formally approved governance vote, the creation of a traditional corporate entity for the limited purpose of entering a corporate arrangement on behalf of the DAO.
While, using such a “bridge entity” would address the liability issues, doing so is inefficient, a lot of work and makes many of the key benefits that make DAOs special redundant.
Who is liable for any legal infractions made by the DAO?
As mentioned above, should a DAO initiate a governance proposal enabling a member or members of the DAO to enter into a commercial agreement on behalf of the DAO, then this opens the stakeholders up for liability. Taking this form of action could result in the DAO being considered a partnership and therefore, all the stakeholders being accountable and liable for its actions. Using a bridge entity would mitigate these risks, but at the same time devalue the merits of using a DAO in the first place.
In October 2021, the Financial Action Task Force (FATF) issued new guidelines with the aim of trying to regulate the fast moving DeFi environment (including DAOs). The guidance states that those who maintain “control or sufficient influence” over a DeFi arrangement should be subject to regulation for AML purposes. This has the effect of putting DAO members such as key signers or private key custodians under the spotlight for regulators.
Wyoming and the DAO LLC
There is light at the end of the tunnel for the liability issues relating to DAOs. In April 2021, Wyoming Governor Mark Gordon signed Bill 38. This bill led Wyoming to recognizing DAOs as LLCs, and took effect on July 1, 2021.
This new law defines DAOs as “a limited liability company whose articles of organisation contain a statement that the company is a decentralised autonomous organisation.”
This legislation will allow DAOs to be legally incorporated, hire employees, scale, and grow. Most importantly, DAO stakeholders would be able to enjoy the same liability protections as a traditional liability company i.e. they would only be liable up to the same amount as their token value.
Wyoming gives DAOs the legitimacy they need to fully develop as an alternate structure for businesses.
In conclusion
DAOs are on course to become a blockchain hot topic for 2022, however, they are still at a very early stage in their development. The lack of legal recognition and a legal regulatory framework means there are a lot of potential legal pitfalls to be considered. One of the key areas of consideration should be the liability of the members of a DAO.
If you are interested in learning more about how your business could get involved with the Web 3.0, why not book a consultation with one of our Blockchain experts here.
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