Legal anatomy of a DAO


None of the below should be construed as legal advice as this a highly risky untried area of law. In the below we are just giving examples regarding UK law as illustrations; there are a myriad of laws that will apply due to the international nature of a DAO. Contact Diacle if you wish to find out more.

Constitutent elements of a DAO

  • Smart contracts
  • Exchange of digital currency for a DAO token
  • DAO token represents membership in the DAO and is freely exchangeable
  • Profit generated from the investment of the DAO’s funds paid back to the DAO holders
  • Members of the DAO enter into a contract essentially with the other members
  • A DAO, by default, does not have INDEPENDENT legal personality
  • As a legal structure, by default, it resembles more like an informal partnership and or a membership of an informal association

If the DAO token represents a financial interest in a structure then most likely it is a form of security, although not formalised through the incorporation of a legal entity. Securities/shares are regulated in most jurisdictions in the world and the activities relating to promotion or arrangement of a deal in securities are equally regulated. Great care is required when you tip-toe around securities laws.

Inevitably, the use of a Smart Contract is designed to remove a single point of failure i.e. the promoter of a particular DAO. As such, it may be argued that the Smart Contract not the promoters are providing a template for members to join and invest. This is a form of regulatory arbitrage but needs very careful analysis to ensure that the original promoters are not exposed. ‘Substance over form’ can be an area where the court system will trump a technical regulatory arbitrage argument.

(To be clear DAO promoters are persons who write the smart contract templates, designs the governance structure, initiate the smart contract etc.)

Areas of serious consideration for DAO promoters:

First is jurisdiction. In the DAO membership agreement it should state the jurisdiction where any disputes regarding the membership agreement will be addressed. Based on that the promoters of the DAO will need to shop around for the best jurisdiction for this type of structure. Shopping around is a process of engagement – not simply picking an offshore jurisdiction and incorporating an IBC. Best to work with regulators than shy away from them.

Second is conversion. Does the DAO remain an informal membership organisation or is it simply a pass-through vehicle into a real life incorporation? There are a number of options and the trade-off depends on the outcomes intended.

Third, is to consider financial regulation. In the UK, a DAO could be an unregulated Collective Investment Scheme (UCIS) as it involves the pooling of funds. UCIS usually applies in the UK, for example, to the pooling of capital to purchase illiquid assets such as forms of physical property and usually involves the property being managed by a scheme operator; however, the UCIS definition has a large scope. A DAO could have characteristics that bear resemblance to a UCIS, so a careful analysis is required of this area. UCIS cannot be marketed to retail clients in the UK for instance. The relevant regulated activities that are connected to a UCIS are that of advising, promoting a UCIS as well as operating or even establishing a UCIS.

DAO Crowdfunding?

There are arguments that a DAO is a form of crowdfunding. The best form of crowdfunding for this is rewards-based crowdfunding, which is an unregulated activity in most countries. Any other form of crowdfunding involves some regulation. Things have not eased up in the US on crowdfunding as you still need to register with the SEC and foreign projects certainly don’t have any exemptions.

DAO Governance

It is critical to think about the contract creation process and the governance of the DAO. Company law can provide inspiration about a suitable governance structure for commercial undertakings. Without question, the DAO will need the flexibility to change its own constitution as it learns from its mistakes (and there will be many).

So if you need to set up a DAO and need regulatory support on how best to structure it contact for a 30 minute no-obligation discussion. Of most interest please contact us if you wish to engage with regulators to have your DAO approved before launch. We will be launching DAO.LEGAL over the next week so stay tuned for more DAO legal news.

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