Since 2016, when «The DAO» made its appearance in the United States of America (the USA), the topic of Decentralized Autonomous Organizations (the DAOs) has been widely debated in the global financial and legal scholarship and practice, due to their exponential rise. In May 2021, the estimated assets under management relating to DAOs, were inferior to 1 billion dollars,1 whereas in April 2023, that sum exceeded the amount 25 billion dollars. By 2030, the economic footprint of DAOs is estimated to skyrocket to 1 trillion dollars.2
Albeit sporadic attempts to delineating this emerging phenomenon have only recently been initiated in Europe, so far mainly focused on academia, in the USA, the first approaches to understanding and regulating DAOs have already been set into motion as early as of 2018. Nonetheless, the overwhelming majority of DAOs constitute de facto economic players acting for the better part of half a decade under no legal regime.
In view of the above, the concept and function of DAOs presents significant challenges to the existing framework of banking and financial law, as it illustrates the inherent complexities and regulatory gaps with respect to what are known as ‘atypical’ assets. Several legal inquiries may be posed with respect to these newly emerged Organizations, pertaining to their legal status (e.g., should they qualify as legal subjects or objects, do existing legal constructs suffice for the purpose of DAOs or should they be incorporated under new ones?).
The author postulates that DAOs serve as ideal incubators for the exchange and further development of ‘atypical’ financial products emerging from the advancement of blockchain technology and therefore must be better promptly regulated in a uniform manner. To underpin such argument, the present study aims to: (a) scrutinize the legal notion of DAOs, by critically analyzing their statutory nature, as well as the legal constructs advanced under diverse jurisdictions for the regulation thereof (Part A); and (b) highlight the importance for establishing a more comprehensive regulatory framework for DAOs on a global level (Part B).
To date, no universally accepted legal definition for DAOs exists.3 Nevertheless, it appears that core qualities thereof are unanimously agreed upon; hence, DAOs could be described as «collectively owned, governed by blockchain and working towards a shared mission».4,5 Another definition, refers to DAOs as: «smart contracts (i.e. blockchain-based software), deployed on a public permissionless blockchain, which implements specific decision-making or governance rules enabling a multiplicity of actors to coordinate themselves in a decentralized fashion. These governance rules shall be technically, although not necessarily operationally, decentralized”.6
The following two (2) elements distinguish DAOs from traditional corporations: (a) the distribution of decentralized decision-making power to their members through a mechanism of governance tokens, (b) the cross-border DAO operation on the blockchain, and specifically via smart contracts, the content of which must be decided in advance and, as a rule, cannot be tampered with retrospectively, allowing the automatic execution of the decision taken.
In conjunction with the above, DAOs also pursue specific objectives, determined upon configuration of the pertinent smart contract. The scope of said objectives remains subject to the applicable law. For instance, several jurisdictions (e.g., Switzerland, the British Virgin Islands, Singapore etc.), do not recognize for-profit DAOs, however this is not the case for most of the existing DAO frameworks.
Despite the plurality of DAO types, all of them are premised in the establishment of a decentralized governance model, where decisions are taken by the community through an electronic voting system and a predefined set of rules. For a DAO to be created, firstly a community has to be formed and its common purpose has to be delineated.7 Hereafter, the principles and operating rules governing the DAO must be agreed upon and subsequently encoded in a smart contract. Once coded, these immutable procedures become public and can be consulted by accessing the DAO code. Decision-making within a DAO can be exercised through various voting systems, by members holding governance tokens.
At present, there is no official DAO taxonomy, hence all the existing attempts at classification are indicative.8 The more linear classification approach is solely based on the DAO’s underlying purpose.9 Indicative categories resulting from this delineation include: (a) Protocol DAOs, managing decentralized protocol platforms, while offering DeFi services (e.g, MakerDAO, Uniswap and Yearn Finance). (b) Investment DAOs, enabling capital aggregation and joint investment decisions, without the interference of traditional intermediaries like banks (e.g., Olympus Pro, Krause House and CityDAO), (c) Philanthropic DAOs, promoting social responsibility (e.g., The Big Green DAO, EduDAO, MolochDAO). Another more sophisticated taxonomy approach relies on the identification of the DAO’s primary objective, as well as the means to achieve that said objective.
In the USA, at the time of writing this paper, four (4) states have so far adopted a specific legislative regime for DAOs (Wyoming, Vermont, Tennessee, and Utah); all of them promulgate the qualification of a DAO as a domestic Limited Liability Company (the LLC) and the establishment of an ad hoc special regulatory framework therefor. Contrarily, other states, such as Delaware, promote the incorporation of DAOs under the already existing LLC regime.
In April 2021, Wyoming became the first USA state to adopt a dedicated DAO law (the Supplement). The Supplement’s primary objective pertains to the granting of legal personality to DAOs through their incorporation as domestic LLCs. To that end, the Supplement is complemented by the mutatis mutandis application of the Wyoming LLC Act, whereas in case of conflict of laws, the Supplement prevails.
The Supplement allows existing LLCs to be converted into DAOs by following the therein applicable formalities,12 while the DAO members are not subject to fiduciary obligations, but only to the contractual covenant of good faith and fair dealing obligation when representing the DAO.13 Furthermore, the Supplement provides for the possibility of updates, modifications and/or improvements to the underlying smart contracts of DAOs. On a final note, the Supplement prohibits the incorporation of foreign DAOs into the Wyoming legal order.14
The Supplement was amended less than a year after its adoption. Pursuant to said amendment, the, incompatible with the DAOs’ operation, distinction between DAOs managed by members or algorithms, was eventually abolished.
In 2018, the State of Vermont introduced the Blockchain-Based Limited Liability Company (the BBLLC) legal framework, comprising six (6) provisions applying to entities registered as LLCs «using blockchain-based technology for a significant part of their business activities». As with the Supplement, the Vermont LLC Act applies supplementally to the BBLLC statute.
Notably, under provision 4173 of the BBLLC statute, extensive disclosures must be provided for under the BBLLC’s operating framework, ranging from a description of the entity’s mission to a detailed analysis of its way of functioning (i.e., level of centralization, type of blockchain in which it operates, voting procedures, member onboarding, etc.).
In 2019, under the BBLLC statute, dOrg became the “first legally established Decentralized Autonomous Organization (DAO) under United States law”.17
The State of Delaware is known as the most beneficial jurisdiction for LLC incorporation in the USA, due to its flexible LLC regime, reduced bureaucracy, established jurisprudence, and high-quality legal expertise. This advantageous regulatory ‘package’ is also applicable in the case of DAOs, which may be directly incorporated as domestic LLCs, thus availing of high levels of entity anonymity and retention of the funds collected from the sale of DAO tokens on behalf of the entity.18 The Delaware LLC regime stipulates that “...the debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, shall be solely the debts, obligations and liabilities of the limited liability company, and no member or manager of a limited liability company shall be obligated personally for any such debt, obligation or liability of the limited liability company solely by reason of being a member or acting as a manager of the limited liability company...”.19
Albeit Switzerland has not adopted a dedicated DAO law, the therein possibility of DAO incorporation by way of various ‘legal vehicles’ such as (a) the Company found in the Private International Law Act (the PILA),20 or as (b) collective investment schemes under the Swiss Federal Act on Collective Investment Schemes (the CISA), has been widely advanced.
Article 150 par. 1 of the PILA, defines a Company as: “any organized association of persons and any organized unit of assets”. For the qualification of a DAO as an organized association of persons, the criterion of ‘organization’ must be met, in practice depending solely on the demonstration of a sufficiently organized internal structure.21 The criteria for the qualification as an organized unit of assets are more demanding i.e., (a) the management of assets by an administrator, (b) the independence of the assets from the personal assets of the administrator and (c) the dedication of the assets at a common goal.22
DAOs could also qualify as collective investment schemes, regulated by the Swiss Financial Market Supervisory Authority (the FINMA), subject to the cumulative fulfillment of the following four (4) conditions: (a) a financial contribution; (b) in a collective investment; (c) serving supra-individual benefits; and (d) operating under third - party administration. It is postulated by the Swiss Federal Council that the first three (3) conditions are undoubtedly met by DAOs; nonetheless: “the existence of purely administrative functions or predefined directives concerning the capital management is not deemed as sufficient for the purposes of third – party administration” and should therefore be examined on a case-by-case basis.23
In late 2022, the United Kingdom Law Commission (the UKLC) launched a coordinated attempt to regulate DAOs.24 Pending the adoption of such legislation, it has been suggested25 that DAOs could be viewed as general partnerships, subject to the cumulative fulfillment of three (3) criteria, in particular: (a) the conclusion of a valid agreement between the DAO members; (b) in pursuit of a common business objective;26 and (c) aiming to achieve profit. When the above criteria are not met, the unincorporated association seems to be the suggested legal regime.27
Despite the UKLC’s initial thoughts of DAO integration within an already existent ‘legal vehicle’, as per the above, it is ultimately postulated that such an approach would fail to factor in the unique and innovative DAO traits (i.e., the absence of central administration, the operation on the blockchain), and would entail the unlimited liability of the DAO members.28 Further legal frameworks envisaged by the UKLC include the trust structure and the joint ownership of assets, which could only be viewed as a component of the overall DAO structure.29
Herein, the regulatory shortcomings identified upon review of the above legislative initiatives for DAOs are presented, underlining the need for their uniform regulation.
Firstly, the lack of a unanimous DAO definition, impedes the adoption of a comprehensive and globally coordinated regulatory regime.
In a similar vein, the meagre understanding of the immutability of smart contracts and the modus operandi of DAOs results in a weak incorporation of their technical modalities within legislation. For instance, the binary distinction and mutual exclusivity of member-managed DAOs and algorithmically (or smart contract) managed DAOs, preserved in various ad hoc DAO laws, fails to adhere to the technical reality, as the deployment of the smart contract enables the DAO’s existence, which is subsequently governed by its members.30
In addition, the practical utility of regulating DAOs under ad hoc regimes rather than the existing frameworks for traditional LLCs has been extensively criticized, due to the burdensome administrative procedures and regulatory obligations (e.g., the extensive ongoing disclosure formalities) provided under the various ad hoc DAO jurisdictions.
The prohibition on the recognition of foreign DAOs, mainly encountered in the USA regimes, seems to fail to address the cross-border operation of DAOs, while it raises significant regulatory concerns as regards the business relationships developed between local and foreign DAOs (e.g., under which law will a dispute between said DAOs be assessed?).
On a final note, the innovations brought about by DAOs pose new regulatory challenges, namely the protection of the third parties or their own members in case of insolvency, as well as their exposure on the risk of cyber-attacks,31 issues that are not addressed in the context of the ad hoc DAO regimes.
In the present section, the author overviews the bZeroX LLC (then transformed into bZx and then to Ooki DAO) cases, in an attempt to illustrate the legal uncertainty incurred, in case of absence of a comprehensive legal framework for DAOs, which call for an ad hoc legal characterization, upon adjudication of the dispute in question.
In the administrative case CFTC v. bZeroX LLC, the Commodity and Futures Trading Commission (the CFTC), imposed an administrative penalty of $250,000 on bZeroX LLC (before its transformation to bZx and then Ooki DAO), as well as its founders (the Respondents), for illegally operating as an exchange platform in a decentralized environment and for engaging in financial activities, without maintaining the necessary registrations and without following the prescribed compliance procedures.
According to the CFTC, the Respondents engaged in unlawful off-exchange leveraged and margined retail commodity transactions, activities that could only be performed by registered futures commission merchants (the FCMs) and subject to a customer identification program (the CIP). On its website, bZeroX LLC claimed that it offered a superior margin trading experience because “there is no need for any verification, KYC or AML”, while “bZeroX did not maintain a CIP and explicitly advertised the lack of KYC or AML compliance as a positive feature of the bZx Protocol».33
The two (2) Respondents were held liable for the infringements mentioned above, which continued to occur even after the conversion of the LLC to a DAO. Ooki DAO was deemed as an unincorporated for-profit association, defined as “a voluntary group of persons, without a charter, formed by mutual consent for the purpose of promoting a common objective”34 and as such, each of its members were found to be “jointly liable with other members for the association’s debts and can have his or her personal assets reached by creditors of the association”.35 The administrative proceeding was settled on September 22, 2022, with the Respondents’ acceptance of the Order issued by the CFTC.
The civil case Sarcuni et al. v. bZx DAO et al.36 pertains to the class action filed against bZx DAO, its successor Ooki DAO, their founders and several other LLCs (the Defendants), before the Southern District Court of California (the Court) by sixteen (16) plaintiffs, all former members of bZx DAO (the Plaintiffs). The bZx DAO provided decentralized finance (the DeFi) services (i.e., tokenised margin trading and lending). Despite all assurances by its founders about the security and regulatory compliance of the respective bZx DAO protocol (which had been hacked several times in the past), a phishing attack resulted in a theft of a total amount of fifty-five (55) million dollars’ worth of bZx DAO cryptocurrency and a loss equal to 1.7 million dollars by the Plaintiffs.
In its March 27, 2023 ruling,37 the Court addressed two (2) key questions while examining the relevant complaint: (a) “does bZx DAO qualify as a general partnership (the GP)?”; and (b) “should the Defendants be deemed as partners in a GP?”.
With respect to the first question, as per the Court’s articulation “...the association of two or more persons to carry on as coowners a business for profit forms a partnership, whether or not the persons intend to form a partnership”.38 In accordance with the Court’s reasoning, a GP can still exist when the individual partners control partially the GP, which was found to be the case for the BZRX tokenholders. In addition, the sharing of profits between partners, as was the case for bZx DAO, is deemed as prima facie evidence of the existence of a GP. The Court therefore concluded that the bZx DAO qualifies as a GP.39
Regarding the second question, the Court advanced that the two (2) co-founders and managers of the bZx DAO, are deemed as general partners,40 due to the fact that they held BZRX governance tokens conferring them decision-making powers.41 For several of the remaining Defendants, their qualification as general partners was accepted, while for others it was dismissed.42 On a final note, the Court rejected the allegation that the Plaintiffs, who also held BZRX tokens, should be equally deemed as general partners of bZx DAO.43
In view of this decision, the possibility of another Court extending responsibility to all DAO members holding governance tokens for damages caused by other members cannot be excluded. Nonetheless, such a ruling would require the -practically very difficult, if not impossible- identification of each of the BZRX token holders, followed by the individual affirmation of the Court’s personal jurisdiction for each of them.
Notwithstanding the regulatory conundrum of DAOs, primarily caused by the vagueness pertaining to their legal status,44 it is undoubted that they propose a novel legal entity structure in imperative need of a dedicated legal frame. It is reasonable to argue that despite the noteworthy and unprecedently prompt attempts for DAO regulation at a state level, the solution of a harmonized regulation is considered as the most adequate way-forward, given the cross-border nature of DAOs. That said solution necessarily requires initiatives deriving from higher normative levels (e.g., the Federal Government in the USA, the European Union in Europe), ultimately resulting at a delineation proposed by the competent intergovernmental organizations (i.e., the UNIDROIT and UNCITRAL).45
The author considers the passage from a federal and statewide level as an indispensable precursor to the eventual development of a supra-national roadmap for DAOs. As regards the European Union (the EU), the recently enacted Digital Finance Package (the DFP),46 seems inadequate for addressing complexity of DAOs,47 as the therein existing definitions appear particularly narrow for their inclusion.48 This is why, it is hereby argued that DAOs should be treated at an ad hoc legal basis. To date, no major case involving DAOs has occurred within the EU legal order; Nonetheless, legislative proactivity is encouraged so that a suitable and coordinated regulatory response is given promptly to the admittedly complex puzzle of DAOs. n
