DAO Legal Discussion
Guidance to setting up a DAO without running into any legal issues
The information provided here does not constitute legal advice. All information and content are for general informational purposes only. You should consult your own lawyer to obtain advice with respect to any particular legal matter in the relevant jurisdiction. Only your individual lawyer can make sure that the information contained here and your interpretation of it, is applicable or appropriate to your particular situation. Please note that all existing ideas around DAO issues are not yet court-verified and could potentially fail. However, there is value in starting a discussion of how to make DAOs become legally viable solutions and add value to society.
- If your DAO is not truly decentralised and does not have a legal form (or "wrapper") around it, it should be considered "at risk", meaning its members are bearing significant liability.
- Simply using a smart contract that creates a multisig structure and/or spinning up a Discord channel for people to direct those funds and calling it a "DAO" doesn't change that. Members are legally responsible for what happens with funds and actions. "DAOs" which are actually just a shared account do not provide any legal protections and should simply be considered an account of whatever group or organisation controls it.
- To provide actual functionality and legal protection for a DAO, it should be truly decentralised (no single entity or person has control) or have a legal entity/"wrapper" associated with it (like a US LLC or Swiss Association) and perform any necessary KYC relevant to its actions.
- DAOs need to consider taxes and employment law like any other legally recognised organisation.
The Decentralised Autonomous Organisation (DAO) is a fantastic blockchain technology application in the context of social coordination. Implemented and applied well, the DAO can provide an attractive alternative to traditional collaboration frameworks (legal entities, 1 to 1 agreements) in certain contexts. As DAOs haven’t been addressed much by lawmakers yet, there is uncertainty concerning their legal treatment in most jurisdictions. This post is discussing a few non-binding thoughts on applying DAOs with some ideas on how to potentially solve legal challenges.
While it is understood that this post is non-binding, there is one particular piece of advice that one can give whole-heartedly. Please do not set up a DAO with the target to circumvent any law or regulation, as this attitude will likely put you on a path of conflict and failure. Instead, initiate a DAO with the best of your intentions to provide a solution to challenges of your ecosystem while keeping an eye on mitigating any negative externalities.
What is a DAO?
A DAO is a number of people coming together to complete a mission together in an organised manner by using a set of smart contracts that provide governance functionality (voting, multi-signature execution, interface). The smart contracts themselves do not constitute a DAO yet. It is rather the collective actions of the participants through the smart contracts that inhale life into the DAO. There isn’t a specific number of participants defined that constitute the decentralisation of a DAO, but it should be many. Also there shouldn’t be any single party controlling the DAO. Otherwise, it isn’t autonomous. DAOs are essentially a cooperative of people sharing a pool of assets. A DAO isn’t a recognised legal entity type in any jurisdiction yet. Its implementation results in legal uncertainty, as it is subject to different interpretations by judges, courts, and regulators.
Everyone is responsible for their own actions. This is one of the key underlying assumptions of every legal framework. There is an exception. Legal entities allow shifting certain responsibilities from the individual to a legal construct: a company, a foundation, an association and so on. However certain responsibilities always remain with the individuals. For example, individuals remain subject to criminal law. As DAOs are not legal entities by themselves, most jurisdictions assume that individuals remain responsible for their actions with the DAOs and treat it as a general partnership.If DAOs are truly decentralised then no individual person can be identified to have taken any specific action. If DAOs are not well decentralised, introducing a legal wrapper (for example a Swiss Association ("Verein")) for the DAO might make sense to protect the DAO participants from certain liabilities. If a DAO is not specifically organised with a legal wrapper around it, the following uncertainties arise:
- DAOs are currently not recognised legal actors in any jurisdiction, and thus become subject to unexpected interpretations by various stakeholders.
- By lack of legal recognition, DAOs can be considered a mental concept shared among its participants only. Thus, DAOs generally are typically unable to interact with third parties or governmental actors in their own capacity. This means they can't execute contracts.
- DAOs are at risk of being considered general partnerships. EACH DAO partner would then be held jointly and severally responsible for all liabilities of the DAO’s actions, and all personal assets of each partner may be subject to seizure to meet the liabilities of the DAO (unlimited liability of each DAO participant).
Safety for the DAO
There are several things you can do to reduce risk of running into any issues when setting up a DAO and limiting liability.
Technical Development of the DAO
As the developer of DAO smart contract system, your liability is expected to remain limited or be none as long as you don’t retain any control over the smart contracts. This is similar to how software developers of banking systems are not actually responsible for their ultimate use. Nevertheless, expect that regulators knock on your door for a discussion about your creations if they can’t find any other “responsible person” to talk to. There might be good reasons why Satoshi preferred to remain anonymous.
Setting up the DAO
When you set up a DAO, introduce many participants who can only exercise control through collective action. Have the DAO operate in areas considered legal and avoid regulated business activities (acting as a bank, exchange, investment vehicle, financial intermediary, gambling, or any illicit activities). Establish a vision statement and a DAO Constitution that help align the participants on the good cause and fosters an ongoing discussion about how to avoid negative externalities of the DAO to the general public.
Funding the DAO
Before funding a DAO, try to identify the participants of the DAO, to obtain a view of their good standing. Check the past and proposed activities of the DAO for any activities that could reflect poorly on yourself or the organisation you might be representing. Before you transfer the funds, obtain proper documentation on the purpose of the transfer. Try to obtain an invoice (e.g. from the legal wrapper of the DAO) that describes the purpose of the contribution to the DAO. If you cannot obtain an invoice, do your own write-up including a justification for the contribution, e.g. by extracting information in the form of PDFs from the forum posts that led up to your contribution. Check what documentation is required in your jurisdiction as a legal proof e.g. for any tax audit. Do not retain any rights in funds after you transfer them to the DAO. Do not seek to retain any control over the DAO, as control introduces responsibility.
Operating the DAO
Decisions should be taken by the broader collective of the DAO. If any decisions can be accrued to any single individuals, these people are responsible for their decisions and derived actions. Responsibility is desired as long as the decision, the derived actions, and outcomes don’t cause any issues. Don’t try to control the DAO. If anyone controls the DAO, it isn’t a DAO anymore. It is just someone operating through a set of smart contracts. Promote a healthy discourse on the actions of the DAO. Make improvement proposals to address any negative externalities and issues emerging over the lifetime of the DAO. Engage in a dialogue with all stakeholders including politicians, lawmakers, and regulators.
Using the DAO Tools for Other Purposes
Of course, you can also deploy and use the DAO smart contract toolset without forming a true DAO and use the tools more or less like a regular multisig, e.g. to simplify operations of your organisation. In that case, make sure to put in place all the compliance measures that are standard to operating in a traditional business environment.
Legal Wrapping of a DAO
A “Legal wrapper” in whatever jurisdiction it’s set up, can provide the required legal basis to interface with the authorities. Moreover, the legal entity put in place helps shielding liabilities from the participants of the DAO. The draw back is that the legal wrapper requires compliance with the laws of the applicable jurisdictions which can restrict the DAO to meet its full purpose and results in an administrative overhead.
Switzerland as an Attractive Jurisdiction for Legal Wrapping
Switzerland has earned itself the reputation of providing a crypto-friendly jurisdiction. The collaboration with authorities is excellent, allowing legit crypto projects to realise their visions on a path in compliance with regulations. Local advisors have accumulated extensive crypto expertise and support a quick and efficient setup. The Swiss Association ("Verein") has become a popular model for legal wapping of DAOs that are not meant to be a profit-seeking organisation.
The Swiss Association is governed by the articles 60 et seq. of the Swiss Civil Code. An association does not require approval from any authorities in order to setup in Switzerland and thus does not require registration in the corporate registry if it does not pursue a business purpose (target to generate recurring income). However under certain circumstances, it must fill a tax declarations. The statutes of the association can establish that members have no individual responsibility and liability. The creation of an association does not entail any 3rd party cost. Here you can find basic information on the Association setup requirements.
We advise to consult your lawyer to choose the right structure that will meet the goals of your organisation which is different from project to project. Matthias Kuert of CMS, Thomas Linder of MME, and Raphael Baumann of PST are crypto-experienced legal experts for structuring and setting up legal entities in Switzerland. MME and Silvan Amberg of SwissTaxExpert can help with any tax topic arising. Roger Rohner and Mario Erni of Retax will also be at your disposition for Swiss VAT and Swiss personal tax topics. Accounting can be taken care of by the accounting firm Cleverkin that fully specialises in servicing crypto projects. Financial audit services, if necessary, are provided by Copartner and Wadsack.
An alternative to Switzerland for legal wrapping can be found in Vermont, i.e. the hybrid entity model called “Blockchain based LLC” here, including the Operating agreement as a template of BBLLC here.
Wyoming’s state senate passed a bill called the Decentralised Autonomous Organisations Supplement (DAO Supplement), with the target to clarify the legal status of the decentralised autonomous organisation (DAO). You can proceed with registration here.