DAO is a new form of human organization suitable for Web3. After experiencing a flourishing development in the early stage, most of the DAO friends who were doing it for love are no longer enthusiastic. Most of the "organizations" set up in the name of DAO have come to nothing after the initial boom and quietly returned to the fold of WeChat.
However, the DAOs that are actually doing things will encounter some practical problems, such as how to accept VC investment, how to sign agreements with Web2 service providers, how to list tokens on exchanges, and how to pay members. The root of these problems lies in whether the DAO is registered as a legal entity. The registration of the DAO legal entity is part of the DAO legal wrapper. Without the legal wrapper, the interaction between the DAO and the external Web2 world will become extremely complicated. In addition, a DAO without a legal wrapper will also bring some direct risks to DAO members.
1. What is DAO and what is the legal wrapper of DAO
DAO is the abbreviation of Decentralized Autonomous Organization. In essence, DAO is a decentralized organization based on blockchain distributed ledger technology and maintained by a series of smart contracts. It revolves around a common goal, and community members jointly create, obtain and distribute value, and the value scale is often a custom token.
The DAO's Legal Wrapper is a set of legal frameworks or legal entities specifically for DAOs, which provides DAOs with a recognized legal status in relevant jurisdictions. Its essence is to "wrap" the DAO in a legal framework, thereby bridging the gap between the DAO and the real world, enabling the DAO to link with the traditional legal system, ensuring compliance with relevant laws and regulations, and protecting the rights and interests of DAO members, while being able to participate in broader real-world activities.
The legal wrapper of the DAO does not absorb or replace the DAO running on the chain. The DAO continues to run on the chain, but only transfers some of its functions and responsibilities to the legal entity of the DAO, which can obtain legal protection in relevant jurisdictions, manage tax and regulatory obligations, enter into contracts, own assets, make legal payments, and participate in real-world interactions. The DAO and multi-signature wallet retain direct control over smart contracts, vaults, and any on-chain assets, and only provide funds to its legally wrapped entity when needed.
2. Does DAO need legal packaging?
The legal environment for DAOs is complex and ever-changing, and regulators around the world are struggling to figure out how to classify and regulate DAOs. DAO activities may fall under a variety of laws and regulations, including tax laws, securities laws, anti-money laundering regulations, VASP regulations, data protection laws, and intellectual property laws. Compliance with these laws and regulations is critical to the growth of DAOs.
We have seen some pure on-chain DAOs running well, so why do DAOs need legal packaging? Consider this: if the DAO is going to work with other DAOs or companies, or intends to issue tokens to the community, or issue governance tokens to DAO core members, or manage the treasury, then this answer is obviously necessary.
Unregistered DAOs will certainly encounter difficulties in interacting with investors, service providers, virtual asset exchanges, and other entities. But more importantly, founders and members of unregistered DAOs also face legal risks, especially:
A. Risk of legal liability. An unregistered DAO can be considered a general partnership. Once a DAO is identified as a general partnership, each member of the DAO will be legally responsible for all assets and liabilities of the DAO. A registered DAO can be a separate legal entity, which can meet the compliance requirements of the place of registration and other jurisdictions, and more importantly, provide DAO members with limited liability similar to a corporate organization.
B. Tax risks. DAO members may face fines or other penalties if they fail to pay income tax. A registered DAO can make a series of mature tax declarations based on its organizational form and meet the tax compliance requirements of relevant jurisdictions.
C. Financial compliance risks. Absorbing funds or engaging in economic activities in the anonymous blockchain world without relevant KYC/AML/CTF verification procedures to check the source of funds may lead to administrative and criminal investigations involving securities compliance, AML/CTF compliance, and financial crimes.
One of the most recent cases of legal action against DAOs is CFTC v. Ooki DAO. The U.S. Commodity Futures Trading Commission (CFTC) found that DAO, as an unincorporated association, was responsible for illegal asset trading and other violations. In addition, the CFTC stated that "each voting participant in the DAO can and should be held personally liable for any illegal activities conducted by the DAO". If Ooki DAO had established a legal entity, the above legal responsibilities would be borne by this entity and the members of the DAO would also be protected. On the contrary, without proper legal packaging, each member of the DAO would be exposed to potential risk liabilities.
3. What is the most common organizational form of DAO?
DAO legal entities can be registered as different organizational forms: Foundations, Associations, Non-Profit LLC or For-Profit LLC. The actual choice of organizational form and jurisdiction depends on the type of DAO (community/protocol, service, investment), business model, token functionality and other factors.
For protocol/community type DAOs, the most common and most common path is to register the DAO as a foundation. The foundation has no owner (a Self-Owning Entity), and its members are not equivalent to company shareholders. Members contribute funds to the development of the project according to the foundation's statutory goals (Statutory Goals).
Members of the DAO Foundation have the right to vote on governance proposals and elect trusted people to serve as guardians or overseers, a special role that ensures that governance procedures and resolutions are organized and implemented. The decision-making mechanism and implementation of resolutions are handled by the DAO Council, a governance mechanism elected by DAO members, which has a fiduciary obligation to manage the contributions made by DAO members for the benefit of the Foundation (the DAO Treasury).
The foundation charter stipulates some key matters of the DAO, including the foundation's goals, the use of DAO funds, how members are recruited, and the DAO's governance rules, such as voting procedures.
4. Which jurisdictions are suitable for registration of DAOs?
The most popular jurisdictions for registering DAOs in 2023 include: the Marshall Islands, the US (Wyoming), Switzerland, the Cayman Islands, Liechtenstein, Singapore, Panama, the British Virgin Islands, Gibraltar, and the Bahamas.
When deciding in which jurisdiction to establish a DAO, it all depends on the DAO’s business model, legal needs, and preferences. There are usually three main criteria for judgment:
A. Does the DAO want to generate revenue and distribute it to its members? If so, then you can consider organizational forms and jurisdictions that are suitable for for-profit DAOs. For-profit DAOs often consider organizational forms such as Liechtenstein Foundations, Wyoming DAO LLCs, Marshall Islands DAO LLCs, or Panama Foundations. If it is a non-profit DAO, then it is often considered Swiss Foundations/Associations, Cayman Islands Foundations, or Marshall Islands DAO LLCs.
B. The degree of decentralization of the DAO. Some organizational forms provide greater flexibility for decentralized governance structures, while others are very rigid in terms of governance structures and voting procedures. DAOs with relatively low levels of decentralization include the Swiss Foundation, Liechtenstein Foundation, and Singapore Foundation. DAOs with high levels of decentralization include Wyoming DAO LLC, Cayman Islands Foundation, and Marshall Islands DAO LLC.
C. Will the DAO sell tokens in the future? If so, some jurisdictions may require a license. For example, a DAO registered in the Cayman Islands, Singapore, the US (Wyoming) and the Bahamas may need a VASP license, while a DAO registered in Panama or the Marshall Islands may not need any license.
D. KYC for DAO members. Some countries, including Switzerland, Liechtenstein, Singapore and the Cayman Islands, have high KYC requirements. Other countries, such as Panama, the British Virgin Islands and the Marshall Islands, have fewer or no KYC requirements.
These are the minimum criteria that should be considered when considering registering a DAO. Legal nodes provides the following table of relevant jurisdictions and an overview of their suitable organizational forms for DAOs, including whether local management of the DAO is required, KYC procedures, ease of registration, and for-profit/non-profit nature.
5. Choosing the right legal structure for a DAO?
Before considering the above complex organizational forms and jurisdictions, the initial core team of the DAO first needs to clarify the following prerequisites internally:
A. Finalized white paper. The white paper should describe how the DAO operates, its business model, treasury and financing, procedures for onboarding new members, and governance procedures such as voting and decision-making;
B. Detailed description of the purpose of the token. Whether it is a utility, protocol, payment, governance, dividend or other type of token, it is necessary to describe in detail how the token is used and the purpose of its use;
C. Tokenomics. In particular, it is necessary to clarify the token allocation of all parties involved in the DAO, such as the initiator, core team, investors, treasury, etc. It is also necessary to record the form in which the tokens are allocated: such as private/public sales, airdrops, incentives, exchange launch platforms, SAFT or other methods, the subsequent lock-up period of the tokens, the unlocking method, etc.
It is also important to understand where the DAO’s core team base is, the composition of the DAO’s council members, and where the potential investor base is. This information helps determine whether additional special purpose companies are needed in the DAO’s organizational form to issue tokens and other subsequent operations.
Without finalizing the above, it will be difficult for DAO teams and legal experts to determine which jurisdiction is most appropriate and what organizational form is most appropriate to register the DAO.
VI. Conclusion
In any case, DAO marks a new chapter in human history. Although we don’t know to what extent DAO will affect the existing forms of human organization, it turns out that DAO’s governance model is relatively successful in Web3. Although DAO’s road is bumpy, its future is bright.
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This article is for learning and reference only. I hope it will be helpful to you. It does not constitute any legal or investment advice. I am not your lawyer. Please contact us at WeChat: taxman001 to learn and improve together.
REFERENCE:
[1] The Best Entities and Countries for DAO Registration in 2023
https://legalnodes.com/article/choose-a-crypto-friendly-country-for-dao
[2] DAO Strategy and Legal Wrappers
https://www.paradigm.xyz/2022/06/dao-strategy-and-legal-wrappers#ownerless-foundations
[3] The DAO Legal Wrappers and why you need them
https://neoslegal.co/dao-legal-wrappers/
[4] Costs and Benefits: Thinking Through Legal Structures forDAOs
https://primedao.mirror.xyz/Ddzudtmg1wCd6H_EVg63V0QYwSUfkgLtGsJfV3_rvR0
[5] The ultimate legal structuring guide for Web3 founders of DApps (DeFi, GameFi, SocialFi, and others)
https://ain.capital/2022/07/16/the-ultimate-legal-structuring-guide-for-web3-founders-of-dapps/
[6]Legal Wrappers and DAOs
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4123737