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Reforming the law

Decentralised autonomous organisations (DAOs) A scoping paper

July 2024

© Crown copyright 2024

This publication is licensed under the terms of the Open Government Licence v3.0 except where otherwise stated. To view this licence, visit nationalarchives.gov.uk/doc/open-government-licence/version/3.

Where we have identified any third party copyright information you will need to obtain permission from the copyright holders concerned.

This publication is available at https://lawcom.gov.uk/project/decentralised-autonomous-organisations-daos/.

The Law Commission

The Law Commission was set up by the Law Commissions Act 1965 for the purpose of promoting the reform of the law.

The Law Commissioners are:

The Right Honourable Lord Justice Fraser, Chair

Professor Nick Hopkins

Professor Sarah Green

Professor Penney Lewis

Professor Alison Young

The joint Chief Executives of the Law Commission are Joanna Otterburn and Stephanie Hack.

The Law Commission is located at 1st Floor, Tower, 52 Queen Anne's Gate, London SW1H 9AG.

Table of contents

GLOSSARY

TABLE OF ABBREVIATIONS

LAW COMMISSION DOCUMENTS FREQUENTLY REFERRED TO

• CHAPTER 1:    INTRODUCTION

Background to this project

The aims of this paper

Initiatives on cryptoassets

Structure of this paper

Acknowledgments and thanks

The team working on this project

• CHAPTER 2:    A BEGINNERS’ GUIDE TO DAOS

A high-level introduction to the concept of a “DAO”

Explaining the features of DAOs

What is a DAO, legally speaking?

Jurisdiction and extra-territoriality

A spectrum of DAOs: pure DAOs, hybrid arrangements and digital legal entities

Next steps

• CHAPTER 3:    PURE DAOS: LEGAL CHARACTERISATION AND

LIABILITY OF PARTICIPANTS

A simple example of a pure DAO

Issues associated with pure DAOs

Characterising a pure DAO under the law of England and Wales

DAOs as general partnerships?

DAOs as unincorporated associations?

Other possible characterisations of a pure DAO

Fiduciary duties for software developers?

• CHAPTER 4:    HYBRID ARRANGEMENTS

Why do DAOs use legal entities?

The issue of DAO-entity fit

Distinguishing digital legal entities

Domestic options

Options in other jurisdictions

• CHAPTER 5:    ENGLAND AND WALES AS A JURISDICTION: POTENTIAL

AREAS OF FURTHER WORK

England and Wales as a jurisdiction

DAO-specific entities

Purpose trusts and foundations

Limited liability associations

Facilitating the growth of digital legal entities

• CHAPTER 6:    FINANCIAL REGULATION AND TAX

DAOs and financial regulation

DAOs and tax

• CHAPTER 7:    NEXT STEPS

• APPENDIX 1:    TERMS OF REFERENCE

• APPENDIX 2:    ACKNOWLEDGEMENTS

• APPENDIX 3:    DAOS AND PRIVATE INTERNATIONAL LAW

• APPENDIX 4:    DAOS AS GENERAL PARTNERSHIPS OR

UNINCORPORATED ASSOCIATIONS

• APPENDIX 5:    DAOS AND CONTRACT FORMATION

• APPENDIX 6:    FURTHER READING

Glossary

We recognise that many of the entries in the glossary describe complex or technical terms or concepts which are not easy to summarise in short definitions and that the meaning or interpretation of some of the terms remain disputed by market participants, academics, and other commentators.

As such, the glossary provides a high level, accessible explanation of some of the key terms used in this paper for readers who may be unfamiliar with DAOs and the technologies they use. The definitions are intended as guidance to help readers understand these terms in the context of our discussion and we therefore would not suggest that readers begin by reading the glossary out of context.

Table of abbreviations

See https://coala.global/wp-content/uploads/2022/03/DAO-Model-Law.pdf.

Law Commission documents frequently referred to

All websites last visited on 9 July 2024.

• Chapter 1:    Introduction

• 1.1    The term decentralised autonomous organisation (“DAO”) describes, in very broad terms, a new type of online organisation using rules set out in computer code. A DAO will generally bring together a community of (human) participants with a shared goal -whether profit-making, social or charitable.

• 1.2    At least originally, DAOs were conceived of as an alternative to traditional business structures. ¹They were said to offer a more equitable and transparent model, relying more on technology than on humans and institutional intermediaries, thereby removing or limiting human discretion and centralised control. They were intended to offer participants the opportunity to determine the direction of the organisation’s activities by voting on governance and operational matters using this model.

• 1.3    Today, structures that demonstrate some or all of the features described here come in a wide range of forms. Their legal and/or organisational structure, size, rules and goals may vary very significantly between different DAOs. In particular, the term DAO does not necessarily refer to any particular type of organisation (legally speaking) and therefore cannot on its own imply any particular legal treatment or consequences. DAOs could not be said to be, for example, the online equivalent of a limited company, to which a discrete set of legal rules applies. Instead, the legal, regulatory and tax treatment of a particular DAO will depend on how its own arrangements are structured. There is debate and disagreement in the market about the terminology and what can properly be regarded as constituting a “DAO”.

• 1.4    And yet, many thousands of so-called DAOs exist today. Huge amounts of value flow through, ²are created, extinguished, used and sometimes lost by such structures. This raises questions about the legal status and liabilities of the participants in what might be called a DAO. The Law Commission was asked to investigate these questions, and to consider whether any further work could or should be undertaken to put these arrangements on their own legal footing, or to give more certainty to market participants.

• 1.5    In this paper, we give an introduction to the broad concept of a “DAO” and explain some of the practical and legal questions they raise. We identify a spectrum along which different types of “DAOs” will fall depending on how formalised their structures are. That spectrum includes (in our own terminology):

• (1)    “pure” DAOs: arrangements implemented online through computer code with very limited real world activity, no formal legal structuring and rejecting

(deliberately or otherwise) dependence on law and legal institutions for their existence (although they may well still attract legal and regulatory consequences);

• (2)    hybrid arrangements: arrangements combining code-based coordination with deliberate use of one or more forms of legal entity; and

• (3)    digital legal entities: arrangements where an incorporated legal entity adopts digitalisation through the use of technology at the heart of its operations or governance.

• 1.6   Different issues and considerations arise depending on where on that spectrum a

particular arrangement sits. We identify opportunities and challenges that government or other policy-makers may want, or need, to investigate further, to ensure an appropriate reaction to DAOs. We do not make any formal recommendations for law reform.

BACKGROUND TO THIS PROJECT

• 1.7    Since 2020, we have been working on a range of projects aimed at improving certainty around the legal status of certain emerging technologies, including smart (legal) contracts and digital assets such as crypto-tokens. The case for a project on DAOs emerged from our work on digital assets in particular. Many decentralised finance (“DeFi”) and crypto-token market participants describe their organisational structures as DAOs, and/or have exposure to, or interact with, DAOs or other digital or decentralised organisations.

• 1.8    In September 2022, we were asked by the Department for Business and Trade (formerly the Department for Business, Energy and Industrial Strategy) to undertake a scoping project on DAOs. The Department for Business and Trade is the sponsoring department, given its responsibility for company law and the corporate forms within that legal framework. HM Treasury also has an interest as the broader approach to crypto-tokens from both a private law and regulatory perspective is within its remit.

• 1.9    The DAOs project complements our existing work on emerging technologies and making the law of England and Wales a clear and reliable choice in an increasingly online and decentralised world.

• 1.10    In summary, we were asked to:

• (1)   explain what a DAO is, and how a DAO might be categorised in law; and

• (2)   identify the main options for legal reforms or innovations that might be required

to existing company law and other legislation in England and Wales to clarify the status of DAOs and facilitate their uptake.

• 1.11    DAOs have become closely associated with discussions about DeFi. However, this is only one kind of activity that a DAO can engage in. In this project we consider DAOs more generally and will not be looking in detail at regulation of DeFi or cryptoassets.

• 1.12    We have not been asked at this stage to develop recommendations for reform.

• 1.13    Our terms of reference are set out in full in Appendix 1.

Call for evidence

• 1.14    In November 2022 we published a call for evidence which asked for information on how DAOs are structured and operate, how the law might best accommodate different types of DAO structures and how DAOs might integrate into existing legal frameworks. We also asked where the law of England and Wales might be inhibiting the establishment and operation of DAOs, compared to other jurisdictions.

• 1.15    We received 27 responses, principally from lawyers, technologists and academics. Those responses, together with subsequent discussions with stakeholders, have informed the content of this paper. A full list of respondents and people we have met to discuss this project is set out at Appendix 2.

Territorial extent

• 1.16    As the Law Commission for England and Wales, we have jurisdiction to consider only the law of England and Wales, and not of Scotland and Northern Ireland. However, some legislation of potential relevance to this project extends to the whole of the UK (for example, much of the Companies Act 2006³), and some relevant policy areas are within the legislative competence of Westminster. ⁴On the other hand, there may be some differences of law and practice in devolved jurisdictions.

• 1.17    As set out above, the purpose of our current work is to produce a scoping study rather than formal recommendations for reform, meaning that questions of legislative territorial extent and competence do not arise at this stage. Notwithstanding this position, we are keen to ensure that our work is alive to any relevant issues pertaining to Scotland or Northern Ireland, but have not had any drawn to our attention in the course of this project. In the event of any future work culminating in law reform, due consideration would need to be given to its territorial application, in consultation with the appropriate parties.

International aspects of DAOs

• 1.18    The decentralised and global nature of some DAOs can make it difficult to associate a DAO with any particular jurisdiction. This poses challenges for private, public and criminal law. While we consider DAOs from the perspective of the law of England and Wales, it may be that the cross-border nature of a particular DAO means that the laws of this jurisdiction do not apply. We touch on some issues of private international law and extra-territoriality in this paper. We are also looking separately at questions of private international law as it applies to digital assets, some of which may be relevant to DAOs.⁵

THE AIMS OF THIS PAPER

• 1.19    In this paper, we aim to give a clear introduction to what DAOs are, and to situate them within the legal framework of England and Wales (to the extent possible), identifying how the current law might respond to, or facilitate, DAOs. We also identify areas where further work might be useful to accommodate these new types of arrangement, if this were thought desirable, and to ensure that their activities are within the reach of the regulatory regime where appropriate.

• 1.20    The Law Commission is a law reform body; our role is to review areas of the law and make recommendations for change, with the aim of ensuring that the law is as simple, accessible, fair, modern and cost-effective as possible. Our work is addressed primarily to the Government and focuses on the aspects of DAOs that are significant for policy and legal purposes. As such, we do not aim to provide overly detailed or technically precise descriptions of the technical features of DAOs, but rather explain the technological features to the extent necessary in that context. It is designed to be an introduction to the topic, rather than a comprehensive review of everything going on in the market, with all the intricacies of practice.

• 1.21    We emphasise that how a DAO, or its participants, will be regarded in law or, for example, for tax purposes, will depend entirely on the exact arrangements in any particular DAO. We do not seek to advise participants in DAOs how they should structure their affairs. These questions are properly for legal and other professional advisors based on the requirements of the particular arrangement. There are also other public resources available that seek to give guidance to DAOs directly. For example, in January 2023 the World Economic Forum published a paper about DAOs aimed at helping DAOs to “develop effective operational, governance and legal strategies”.⁶

• 1.22    We hope that our work will also be of interest to market participants and advisors. We set out our understanding of the features that might lead to something being called a DAO, and the ways in which such organisations arrange themselves. We identify some of the implications of different structures, and identify situations in which stakeholders involved with such arrangements may be exposed to risk, to raise awareness and encourage participants to consider their exposure.

• 1.23    Although a few other jurisdictions have introduced legislation purporting to create bespoke “DAO” organisations, we do not, at least at this relatively early stage in the development of DAOs, recommend the development of a bespoke legal framework for DAOs in England and Wales. This is largely because there is no consensus on what a DAO is, how it should be structured, or what a DAO-specific entity could or should

See the project page for updates on this work: Private international law Digital assets and ETDs in private international law: which court, which law? https://lawcom.gov.uk/project/digital-assets-and-etds-in-private-internaionaklOw-whjchcour-whjchHlaw/.

World Economic Forum, “Decentralised Autonomous Organization Toolkit Insight Report” (January 2023), p look like. That said, the law of England and Wales already provides a range of options for structuring, which could accommodate increased use of code for governance and other activities (potentially with some targeted law reform, which we discuss in Chapter 5). This jurisdiction also offers the flexibility of common law, reliable courts, and excellent quality legal and other professional advisors. These come with what some might consider to be constraints: tax liabilities; a tendency towards transparency (for example in terms of beneficial ownership of entities); regulation to protect employees, consumers, and investors, and the integrity of the financial system through measures such as anti-money laundering and KYC (“Know Your Customer”) requirements. These are fundamental to our legal, political, economic and social landscape.

• 1.24    Our work focuses on principles of private law and, in particular, the law relating to organisations and business associations. We do not cover in any detail issues relating to, for example, financial regulation (including anti-money laundering) or tax. Nevertheless, we recognise that these are highly relevant to the structuring and operation of organisational arrangements, and summarise the key points as they apply to DAOs, and areas for further work, in Chapter 6.

INITIATIVES ON CRYPTOASSETS

• 1.25    We are aware of a number of initiatives and projects which have considered cryptoassets under the law of England and Wales. These do not consider DAOs specifically, but are relevant to certain aspects of DAOs including taxation and regulation of DeFi and other crypto activities. They include:

• (1)    HM Treasury proposals for future cryptoasset regulation, published in October 2023;⁵

• (2)    HM Revenue and Customs consultation on the taxation of Decentralised Finance involving the lending and staking of cryptoassets, which closed in June 2023;⁶

• (3)    the HM Revenue and Customs Cryptoassets Manual, which covers the taxation of decentralised finance and was last updated on 21 August 2023;⁷

• (4)    Financial Conduct Authority guidance on cryptoassets in relation to the regulatory perimeter (that is, the boundary that separates regulated and unregulated financial services activities), published in July 2019; ⁸and

• (5)    Financial Conduct Authority guidance on cryptoasset financial promotions, published in November 2023.⁹

STRUCTURE OF THIS PAPER

• 1.26    This paper is separated into six further chapters as follows.

• (1)    In Chapter 2 we provide a “beginners’ guide” to DAOs which explains their philosophical development and the underlying technology, and also introduces some of the issues we discuss in more detail later in the paper.

• (2)    In Chapter 3 we consider “pure DAOs” in terms of their possible legal characterisation including how liability might be attributed to a pure DAO or its participants.

• (3)    In Chapter 4 we explain hybrid arrangements and look at the different legal entities that might be used as part of a hybrid DAO’s structure.

• (4)    In Chapter 5 we consider the overall attractiveness of England and Wales as a jurisdiction in which to set up DAOs and digital legal entities, identifying areas of further work that could increase the range and flexibility of legal entities available in this jurisdiction.

• (5)    In Chapter 6 we look briefly at different areas of regulation that may affect DAOs including money laundering and financial services regulation, and at taxation, and identify areas for work on related matters.

• (6)    Chapter 7 contains a list of next steps relating to the further work we identify at various points in the paper.

• 1.27    The document also contains six appendices.

• (1)    Appendix 1 sets out our terms of reference.

• (2)    Appendix 2 contains a list of stakeholders on this project.

• (3)    Appendix 3 discusses issues of private international law as they may arise in the context of DAOs.

• (4)    In Appendix 4 we look at how DAOs might satisfy the features for general partnerships or unincorporated associations.

• (5)    In Appendix 5 we consider how the rules of contract formation might be satisfied in the context of DAOs.

• (6)    Appendix 6 contains a reading list for those interested in reading more about the topic of DAOs.

ACKNOWLEDGMENTS AND THANKS

• 1.28    During the course of this project, we have met or corresponded with the individuals and organisations listed in Appendix 2. We are very grateful to those who gave us their time either in meetings on in responding to our call for evidence or both, allowing us to draw on their experience and expertise.

• 1.29    At the early stages of this project we also received valuable feedback and direction from an Advisory Panel of experts whose names are listed in Appendix 2. The contents of this paper have not been reviewed by the Advisory Panel are not intended to represent, and may not be reflective of, the views of its members.

THE TEAM WORKING ON THIS PROJECT

• 1.30    The following members of the Commercial and Common Law team have contributed to this project: Laura Burgoyne (team manager); Teresa Trepak (team lawyer); Peter Hunn (team lawyer); Matthew Kimber (team lawyer); Thomas Wingfield (research assistant); Nathan Twibill (research assistant); and Amelia-Rose Edwards (research assistant).

• Chapter 2:    A beginners’ guide to DAOs

• 2.1    In this chapter we provide an introduction to DAOs and to the issues to which they give rise. As well as an introduction or “beginner’s guide” to DAOs, this chapter also introduces some of the issues we discuss in more detail later in the paper.

• 2.2    Decentralised autonomous organisations or “DAOs” are often described as a new kind of internet-based collaborative organisation that coordinate people and resources using rules expressed in computer code. They are part of what might be called the “crypto ecosystem”.

• 2.3   So-called DAOs control billions of dollars of assets.¹⁰ They have already been the

subject of litigation,¹¹ and potentially expose participants to significant liabilities. And yet, beyond the very high-level description above, they are difficult to describe, practically or legally, largely because the term “DAO” does not connote any one type of arrangement. Commentators disagree over what characteristics an arrangement must have in order properly to be called a DAO, and many arrangements using the term look very different to the DAO ideology as originally conceived.

• 2.4    We begin this chapter by explaining where the concept of a DAO came from in the first place. We then summarise the features that one might expect to find, to some extent, in organisations that use the term “DAO”, such as the types of participants, key governance mechanisms and economic arrangements. We include a high-level introduction to the relevant technology - particularly distributed ledger technology and smart contracts - and explain how that technology is used in DAOs.

• 2.5    We then discuss some of the challenges that DAOs may face: legal characterisation; liability of participants; ability to enter contracts and hold property; assessment for tax purposes and applicability of financial regulations; and jurisdictional/territorial issues. We note that the challenges relating to a particular DAO, and the extent of those challenges, often depend on whether or not the DAO has chosen to use a recognised legal entity (such as a limited company) as part of its structure. We introduce three categories of DAO-type arrangement and explain if and how they use legal entities: pure DAOs, hybrid arrangements and digital legal entities. We consider briefly the legal entities that DAOs might adopt, while noting that such adoption might in many cases mean compromising on certain features that some people may consider central to the DAO ideology.

A HIGH-LEVEL INTRODUCTION TO THE CONCEPT OF A “DAO”

A mechanism for collaboration

• 2.6    DAOs are, fundamentally, a way of facilitating the coming together of individuals to realise certain shared goals (commercial or otherwise) and, in many cases, to be rewarded for their efforts. Of course, this is not a new concept; people have worked together for centuries, using structures of varying formality to manage their relationships.

• 2.7   Conducting business or other activities can give rise to significant liabilities and

financial risk. In some circumstances, the individual participants are personally liable for those risks and face personal bankruptcy if something goes wrong. For this reason, the vast majority of enterprises have sought some form of limited liability through incorporation since it became a viable option in the 19th century. The limited company rose to prominence more than a century ago.¹²

• 2.8    Limited liability has been described as a “privilege”,¹³ to be exercised subject to creditor safeguards. For participants, the privilege is that any downside loss is limited to the amount of capital they have invested in the organisation. In return, creditors are provided with transparency. Therefore, in most if not all jurisdictions, to obtain limited liability status, a company or other incorporated organisation such as a limited liability partnership (LLP) must be registered with the state. It must disclose the names of its officers and, in the case of companies, “people with significant control”,¹⁴ and must usually file annual accounts.

• 2.9    There are also a range of structuring options for “not for profit” organisations, including companies limited by guarantee; co-operatives; charitable incorporated organisations; and community interest companies, which also have registration requirements.

• 2.10    In general, all have a “legal personality” separate from their participants and provide their participants with limited liability, in exchange for registration and disclosure/reporting requirements. Many are subject to sophisticated legal and regulatory regimes. In most cases, a small group of people (often a board of directors or similar) is responsible for making decisions about how the entity is run and for ensuring that it complies with its legal and other requirements.

• 2.11    DAOs, to some extent, seek a different way of facilitating collaboration, and grew out of a desire to operate outside of this highly regulated, state-controlled environment.

Background to the development of DAOs: an aspirational idea

• 2.12    The DAO idea started from the proposition that particular technological developments could be used to make organisations more transparent, democratic and equitable. The idea was that organisations could be community built, owned and operated, without centralised leadership.

• 2.13    Web3 is a vision of a new iteration of the internet, intended to be controlled (and monetised) by its users rather than by a few centralised corporations. ¹⁵The proposal for an organisation based on these ideals first came to prominence in 2013 as a decentralised autonomous corporation (“DAC”). A DAC was conceived as a new form of organisation; one that could do many of the things that a traditional company might do - raise capital, pay dividends, provide services and so on - but entirely by means of automated software programs, with little or no human involvement. These programs were to run across a distributed network of computers, often using distributed ledger technology (DLT), which we explain in more detail below. The distribution of information and control is key to the concept of “decentralisation” (the “D” in “DAO”): there should be a distribution of power within the organisation such that participants can contribute to the function and operation of the DAO rather than control being vested in a single, central authority such as an executive board.

• 2.14    The concept took inspiration from Bitcoin, where the rules for the operation of a cryptocurrency system are determined by auditable open-source software run on DLT, intended to be largely free of outside influence and centralised authority, including that of governments and banks. This “self-sufficient” existence, free from outside laws or real-world intervention is a central tenet of the “autonomous” element of the DAC and DAO philosophy (the “A” in “DAO”).¹⁶

• 2.15    “Autonomous” can also be used to refer to the perceived self-executing, automated nature of “smart contracts”: computer programs that run automatically, in whole or in part, without the need for human intervention. This feeds into the idea that outside laws are unnecessary and inappropriate: “code is law”.¹⁷ This element, together with other features of the technology underpinning the idea of a DAO, is said to make the arrangement “trustless”. This is the idea that participants do not have to trust each other, or a central authority, because the technology ensures that things are run as intended and that participants are disincentivised from interfering with it. We discuss these concepts further below.

• 2.16    The original idea was that all of the entity’s assets, funding and actions would be held or executed online and “on-chain”¹⁸ to ensure transparency at all times (rather than, for example, the “snapshots” that shareholders and other creditors get of traditional organisations such as companies, which publish annual statements). This would mean that the organisation’s assets would almost certainly be cryptoassets, whether issued by the organisation itself or by a third party, with no “real-world” assets or transactions. In contrast to the transparency intended for operational and financial information, participants may be anonymous or pseudonymous, and even the original software developers are not necessarily known to each other. Participants may simply be identified by online identifiers or addresses, as is the case for Bitcoin. Individual privacy is often seen as a central tenet in the crypto ecosystem.

• 2.17    The original DAC concept has been developed and largely superseded by two related constructs: DAOs (a generalised extension of the DAC relying less on the corporate analogy), and Decentralised Organisations (“DOs”), being more like traditional entities but making use of DLT and smart contract technology for particular aspects of their operation.¹⁹

Common philosophical goals of DAOs

• 2.18    DAOs, at least as originally conceived, would likely share some or all of the following features and philosophical goals.²⁰ Note that some of these features are aspirational and may not represent how such organisations have operated in practice.

• (1)    A group of people with common interests or goals - whether commercial or otherwise.

• (2)   Use of self-executing computer programs (smart contracts run on DLT) to

implement the rules of the organisation and control its activities, rather than human actors.

• (3)   Use of open-source software, which a community of software developers use,

contribute to and develop.

• (4)    The decentralisation of decision-making, often involving the issue of native crypto-tokens that give the holders voting and governance rights.

• (5)    Fully online, “on-chain” operations; no real-world assets.

• (6)    A treasury in the form of a fund often composed of various crypto-tokens held in smart contracts, used to support the organisation’s operations. The treasury is often managed by a multi-signature arrangement that requires multiple signatures to make a transaction, to limit opportunities for theft or misuse.

• (7)    Transparency at an operational/governance level, including decision-making and asset holding, so that participants and third parties know what is happening at any particular time.

• (8)    “Censorship resistance” - technical and social resistance to outside control (including the avoidance of existing legal forms). For some DAOs this could extend as far as an ambition to be entirely free from outside oversight such as national governments and regulators.²¹

• (9)   Owners and decision-makers being the same people rather than a separation

between, for example, shareholders and directors in a traditional company structure.

• (10)    Incentivising and rewarding participants in the community who contribute towards the DAO’s creation, development, and/or operation (often by the distribution of governance or other crypto-tokens).

• (11)    Participants being distributed, potentially around the world, not necessarily known to each other, and potentially continuously changing as members invest and divest.

• (12)    Participants being capable of pseudonymous involvement.

• 2.19    Some of these features may be (or appear to be) at odds with each other but it is important to remember that a DAO may not aspire to all of these features or will aspire to them but to varying degrees. Different DAOs may prioritise different features and so exhibit some but not others, as appropriate to fit with their personal take on the DAO philosophy.

Practical implementations of DAOs

• 2.20    Whatever the label given to, or the precise features of, any particular arrangement, much of the discussion is highly aspirational. In reality, most “DAOs” do not operate in a fully autonomous or decentralised manner. Organisations of all types rely on individuals to perform certain tasks that automated processes cannot. DAOs envisage voting by (human) participants to determine how the organisation will develop. In many cases, a central group of people - often the original software developers who set up the organisation - will have a significant degree of control over the DAO’s governance and operations (and potentially gain the greater financial profit).

Sometimes this more centralised control is increasingly dispersed over time in a move towards “increased decentralisation”.

• 2.21    Many so-called DAOs now have dealings with the off-chain environment, purportedly entering contracts and holding real-world (off-chain) assets as well as assets held on-chain. Particularly in these circumstances, it is not possible to “opt out” of national and international laws merely by setting up a novel form of organisation. Indeed, many such organisations have started to use existing legal forms, such as limited companies, to benefit from the separate legal personality and limited liability they afford. This process is sometimes known as “wrapping” the DAO. As EY have noted:

A legal wrapper inevitably leads to a degree of centralisation, but it also introduces accountability, clarifies tax and reporting obligations for DAO members and the DAO and can improve regulatory compliance.²²

• 2.22    This model has become particularly prevalent due to the outcome of litigation in the United States, where participants in a “DAO” were found to be members of an unincorporated association.²³ The court rejected arguments made on behalf of the DAO that it is a technology rather than an entity or group of persons. ²⁴The finding that it was an unincorporated association meant that it could be sued and that members were potentially liable for regulatory breach.²⁵ In addition, while DACs and DAOs may have started out as somewhat anarchic arrangements, the objectives of many users have evolved. DAOs are now of interest to a much broader category of user, attracted to different features of DAOs and, perhaps more importantly, their underlying technology, to different extents and in different ways. At one end of the spectrum could be an informal group of people organising themselves through a WhatsApp or Discord chat and motivated by the original aims of DAOs. At the other end, a sophisticated organisation or even a multi-jurisdictional conglomerate may wish to make increased use of DLT and smart contracts for their potential efficiency savings, while maintaining centralised management and decision-making. At this more extreme end, the term DAO may be inappropriate, but some of the same considerations, such as how the law accommodates the use of technology, may apply.

• 2.23    As we explain in more detail below, we identify three broad types of arrangement that could appear along this spectrum. The legal characterisation of each is likely to be very different. At one end is a “pure DAO”, that keeps as closely as possible to the original philosophical aims of DAOs, eschewing legal forms and arrangements. At the other is a “digital legal entity” - an incorporated organisation in a recognised legal form, but with a particular focus on the use of DLT and smart contracts in its governance and/or operations. In between - and representing a potentially vast range of different structures - there are hybrid arrangements. These make some deliberate use of legal forms and/or legal entities but also retain a component that reflects the original aims of DAOs, such as aligning the interests of participants through on-chain decentralised control and, where possible, automating management through smart contracts.

Common questions arising with respect to DAOs

• 2.24    DAOs - broadly seen as organisations or arrangements of participants coming together for a common purpose and using particular technologies for aspects of their governance - vary considerably in their size and structure, giving rise to a range of questions for any particular DAO, including:

• (1)    What, legally speaking, is the DAO? For example, does it use a limited company or trust structure? Or, if it has not actively adopted a recognised legal form, how can it be characterised in legal terms? For example, could it be characterised as a general partnership or is it simply an arrangement of multilateral contracts between different participants?

• (2)    Who is liable for the actions of the DAO, and how can they be held accountable?

• (3)    Which jurisdiction’s laws apply to determine the answers to these and other questions? If the DAO exists only online and has not adopted a recognised legal structure that links it to a particular jurisdiction, it may not be tied to, or associated with, any particular place.

• (4)    Which jurisdiction’s tax and regulatory rules is the entity subject to? Even if a DAO can be associated for private law purposes with a particular jurisdiction, it or its participants may have tax, regulatory or other liabilities beyond that jurisdiction.

• 2.25    The answers, and the ease of finding them, will depend on where a particular DAO sits on the “spectrum” that we identify above, as well as the peculiarities of the particular DAO. The analysis is therefore highly fact specific. In this paper, we consider factors that will affect the answers to these questions for different types of arrangement. Because of the wide variety of arrangements, there are no answers of universal application.

What do DAOs do?

• 2.26    A DAO could, at least theoretically, exist in any sphere of activity from the commercial (for example, dealing in crypto-tokens) to the charitable (for example, raising money to help victims of war) or social (for example, managing sports club finances). At one extreme, the label has been applied to a small group of artists involved in creating NFTs. At the other, it is used by a DeFi lending platform with over 100,000 token holders that has tokenised $2.5 billion in real-world assets.

• 2.27    One commentator references the following basic categorisations.²⁶

• (1)    DAO operating systems: providing the technology on which DAOs are built, a kind of off-the-shelf toolkit for builders.

• (2)    Protocol DAOs: dealing with matters of governance (like a constitution or bylaws for a project) - such as UniSwap (note that all DAOs must have some system of governance whether operated through a protocol DAO or in some other way on the blockchain).

• (3)    Investment DAOs: funds pooled by members to invest in other crypto (often DAO) projects - such as BitDAO.

• (4)    Grants DAOs: providing funds on a non-commercial basis for the development of projects or infrastructure - such as Gitcoin.

• (5)    Service DAOs: teams that provide consulting and professional services to other DAOs - including “Legal DAOs” such as Lex DAO and Thing3.

• (6)    Social DAOs: a membership club where an NFT is often the “membership card” - such as Bored Ape Yacht Club (but also including informal forums without established structure where enthusiasts meet and talk online but do not create financial or technology products or systems - these may be no more than a branded Discord channel).

• (7)    Media DAOs: connected to media firms as a method of brand extension consistent with their target market, usually crypto native firms like crypto websites and newsletters - such as Decrypt DAO.

• 2.28    DAOs are often associated with decentralised finance or “DeFi” services. DeFi is an umbrella term which refers to the provision of traditional financial services - such as lending, exchange, asset management and insurance - without the use of traditional financial intermediaries. ²⁷DeFi aims at decentralisation; instead of interacting with intermediaries, users interact with smart contracts. While in practice the level of decentralisation can vary widely across applications, ²⁸it has been suggested that protocol DAOs are found behind almost all major DeFi products. ²⁹As explained by the European Securities and Markets Authority (ESMA):

Decentralisation in DeFi refers not only to the absence of intermediaries or central authorities for implementing financial services, thanks to the use of smart contracts [...], but also to decentralised governance structures. Indeed, DeFi protocols purport to have decentralised governance structures, meaning that control and power over the protocol, such as how decisions on changes to the protocol are made, are decentralised. DeFi protocols use different mechanisms for that purpose, including novel decentralised autonomous organisations (DAOs).³⁰

Aave is one example of a DeFi platform which relies on governance via a DAO. This structure releases governance to the user community, by allowing holders of the AAVE token to “vote on matters such as adjustments of interest rate functions, addition or removal of assets, and modification of risk parameters such as margin requirements”.³¹

• 2.29    All that said, what a particular DAO does is less relevant for our purposes than what it is, legally speaking, and what that means for its rules of operation, liabilities and so on. The same is true of any legal study of a particular type of organisation: a paper looking at companies or charities as legal entities would focus on law applicable to the legal structure, rather than considering the business or other activities of any particular company or charity.

• 2.30    Nevertheless, it is of course necessary to be aware of the ramifications of particular commercial or other activities, and in this paper we do recognise this in some instances. For example, if a DAO is involved in DeFi it may be undertaking a regulated activity under UK financial services law and therefore must be authorised by the Financial Conduct Authority (FCA). This then engages the question of what the DAO is - what entity/person has to be authorised? If it is not authorised and the FCA wishes to take action for regulatory breach, who can the regulator pursue and who is liable? If the DAO purports to hold assets as part of its activities, who/what actually holds them? And, fundamentally, does UK regulatory law even apply if the DAO has no “base” in the jurisdiction and does not necessarily direct its activities at the UK in particular?

EXPLAINING THE FEATURES OF DAOS

• 2.31    Here, we give a high-level introduction to the features we have identified as common, at least to some extent, across most if not all DAOs. We explain:

• (1)    the concepts of decentralisation and autonomy (that is, why DAOs exist);

• (2)    the (very) basics of DLT and smart contracts (how DAOs operate);

• (3)    key participants in a DAO (who is involved in the use and operation of a DAO); and

• (4)    the core functions of DAOs, focused on decentralised governance/voting (what the DAO is doing).

Decentralisation and autonomy

• 2.32    The concepts of decentralisation and autonomy are at the heart of the DAO philosophy and are inextricably linked with the technology that underpins DAOs. Here, we develop our explanation of these concepts before explaining the technology and how it supports them.

Decentralisation

• 2.33    As mentioned above, decentralisation in the context of DAOs relates to the dispersal of control and decision-making power, but there is no one single way in which an organisation can be decentralised. It is also not a term that is defined in law or that has a single agreed meaning. There is, for example, no definitive test that can be applied to confirm if an organisation is decentralised.

• 2.34    As such, it is more of an ideological concept than a specific set of characteristics. However, it is possible to identify different ways in which a DAO can try to be decentralised, including the following.³²

• (1)    Technically decentralised: the organisation is not dependent upon single points of failure, such as a single computer or server.

• (2)    Politically decentralised: political power or agency is dispersed within the organisation through dispersion of information and decision-making capabilities beyond just a few decision makers.

• (3)    Economically decentralised: ownership and control are distributed to a broad group of stakeholders.

• (4)    Legally decentralised: this has been described as when the “decentralisation of a system eliminates the risks that a specific regulation may be intended to address”.³³ The result may be that regulation is not required because the problems that regulation is trying to address do not materialise in a system where knowledge, control and decision-making power are distributed rather than being concentrated in a particular person or small group.³⁴ Another conception of “legal decentralisation” could mean effectively “jurisdictional decentralisation”, that is, an organisation is so decentralised that no nation state or body of law has jurisdiction over it.

• 2.35    It has been said that these different types of decentralisation must be viewed holistically. ³⁵They are interdependent.

• 2.36    Decentralisation exists on a spectrum, with complete decentralisation likely to be more aspirational than attainable in reality. For a DAO that wishes to be decentralised, there is no checklist or set of steps that it can apply to ensure that it achieves this. There are, however, examples of approaches that some organisations have taken to incorporate decentralisation within their structure, including:

• (1)   use and deployment of smart contracts and open-source code to DLT systems

(explained below), particularly in the development and deployment of software protocols;

• (2)    open-sourcing intellectual property, that is, DAOs do not (generally) take steps to protect their intellectual property in their source code in the same way as proprietary software;

• (3)    opting for full transparency or disclosure in all off-chain activities with a view to minimising information asymmetry and the presence of confidential and nonpublic information;

• (4)    design of governance mechanisms to prevent concentration of control, for example, by incentivising high levels of participation by a large number of participants; and

• (5)    use of flexible and open participation mechanisms, which generally result in a constantly shifting, changeable and unidentified body of software developers and participants.

Autonomy

• 2.37    As with decentralisation, autonomy has no specific legal meaning. As touched on above, the term is used in two different ways in market commentary: to indicate that an organisation has freedom from outside control; and to refer to automation of processes and functions using software code. There is disagreement as to the proper (non-legal) meaning of the term. From our perspective, both possible meanings are relevant to understanding the concept in the context of DAOs and we therefore explore both below.

Censorship resistance

• 2.38    The term “autonomy” can refer to an organisation being secure from undue external interference or internal, centralised control.

• 2.39    This censorship resistance also operates on a spectrum. At one end of the spectrum are DAOs whose participants consider any form of external influence to be “censorship”, including, for example, the state, regulators, courts, financial intermediaries and internet service providers. DAOs that wish to be autonomous from the state will try to exist outside of the law. This means, for example, that they may seek to rely on the organisation’s rules to govern relations between participants rather than relying on the law of a particular jurisdiction to do so.

• 2.40    Other DAOs may be more willing to accommodate some external or centralised internal influence. This could simply be the ongoing influence of the DAO’s founders or, towards the other end of the spectrum, the use of incorporated legal entities within the DAO structure, with their associated registration and other legal requirements. Censorship resistance is, at least theoretically, enabled by the automated or “trustless” capabilities of the technology.

Automation

• 2.41    “Autonomy” can also refer to the fact that key processes within a DAO are carried out automatically; that is, the organisation relies in part on software code that is capable of running programmatically and deterministically according to pre-specified functions triggered by certain events. The outcome of a vote by decision makers, for example, could result in the code automatically executing a particular action. This is distinct from a situation in which a decision would need to be actioned by humans within an organisation or intermediaries outside that organisation.³⁶

• 2.42    This element, together with other features of the technology used by DAOs, is said to make the arrangement trustless. That is, participants do not have to trust each other, or a central authority, because the technology ensures that processes run as agreed and that participants are unable to or disincentivised from interfering.

• 2.43    A DAO would be fully automated if its key processes are carried out automatically by software code. For example, a certain event occurs that triggers the code to respond in a particular way as it has been pre-programmed to do. At the moment, more complex situations and functions will need to be dealt with by humans as there are certain tasks that code cannot carry out. Most DAOs currently in existence are likely to rely heavily on individuals within their organisational structure to perform certain tasks that automated processes cannot. Such organisations may use code for some processes but humans are likely to continue to be involved in a number of roles, such as software development (including changing the code itself), legal advice, accounting, public relations and general administrative work.

DLT and smart contracts

• 2.44    The ability of DAOs to claim to be - to whatever extent - decentralised and autonomous, comes from their use of smart contracts and DLT. Indeed, facilitation of decentralisation and autonomy was the ideological force behind the development of these technologies in the first place.³⁷

Smart contracts

• 2.45    Smart contracts are computer programs that run deterministically, largely without the need for human intervention after they have been coded and set to run. Smart contracts tend to follow a conditional logic with specific and objective inputs: “if X occurs, then execute step Y”.

• 2.46    Smart contracts are not in themselves contracts in the legal sense, although they can be used to define and perform the obligations of a legally binding contract. We call these “smart legal contracts”.³⁸ DAOs might use a combination of smart contracts and smart legal contracts.

• 2.47    Performance of a smart contract, or a smart legal contract, is “guaranteed” in the sense that human intervention is not required to facilitate performance. Participants can at least in theory be assured that things will happen as they are coded to happen. ³⁹In these cases there may be a need to change the code and potentially reverse the consequences. Smart contracts often include control mechanisms to enable their management, including their modification.

DLT

• 2.48    A distributed ledger is a digital store of information or data. It is shared (that is, “distributed”) among a network of computers (known as “nodes”). The nodes may be located anywhere in the world. DLT enables the operation and use of a distributed ledger. Blockchain is a particular type of DLT.⁴⁰

• 2.49    The distinguishing feature of DLT compared to traditional, centralised databases is that the ledger can function without maintenance or control by a central administrator or entity. This means that network participants do not have to reconcile their local databases with a ledger maintained by a central administrator or trusted third party. Instead, in DLT systems, participants approve and eventually synchronise additions to the ledger through an agreed “consensus mechanism”. The consensus mechanism is set by the software underlying the DLT system. In general, it requires some or all of the participants to determine the validity of a proposed data entry. ⁴¹In some DLT systems, the consensus mechanism involves “miners” - participants on a DLT system who solve a computationally intensive mathematical problem so that data can be added to the distributed ledger. These miners do not have to (and often will not) be involved in the substance of the DAO’s activity or governance decisions, but instead verify the technological and procedural integrity of the activity or decision. They will usually receive some reward for the effort required to provide this validation of the data entries.

• 2.50    The consensus mechanism is typically designed so that, once data is added to the ledger, it cannot (for practical purposes) be amended; it is said to be “immutable”. This immutability is intended to mean that participants can trust its validity and transact with one another with confidence, on the basis that the system will operate in accordance with the rules encoded in the system.

• 2.51    DLT systems can be permissioned or permissionless and private or public. A permissioned DLT system is generally one in which authorisation to perform a particular activity on the DLT system is required. Permissioned systems tend to be private, meaning that the DLT system is only accessible for use by a limited group of participants. In a permissionless system, no such authorisation to perform activities on the DLT system is required. Permissionless DLT systems tend to be public, meaning that the DLT system is accessible for use by the public. Mining is typically a feature of permissionless DLT systems. Permissioned DLT systems may use different consensus mechanisms which do not involve mining. There is not a binary distinction between permissioned and permissionless systems, but rather various degrees and types of permissioning to consider.

• 2.52    Computer programs such as smart contracts can be recorded on a distributed ledger and performed by the computers on the network. Smart contracts, and smart legal contracts, can be deployed on a distributed ledger so that actions or contractual obligations expressed in computer code are performed automatically by the computers on the network. This enhances the automated or deterministic functioning of smart contracts, because the decentralisation of a DLT dramatically reduces the ability to intervene in the operation of a smart contract.

DLT and smart contracts as used in DAOs

• 2.53    Smart contracts in DAOs will generally be used to set out, in code, the DAO’s governance framework, including its purpose, the roles and responsibilities of participants, and its incentive structure, as well as controlling the DAO’s treasury (discussed further below). These can be referred to as “DAO smart contracts” or “governance level smart contracts”.

• 2.54    Although not all smart contracts use DLT, those used in DAOs are likely to be deployed on DLT because of its decentralised nature.

• 2.55    Ethereum, a major blockchain system that can be used to host smart contracts, describes the arrangement for a DAO as follows:

The backbone of a DAO is its smart contract, which defines the rules of the organization and holds the group’s treasury. Once the contract is live on Ethereum, no one can change the rules except by a vote. If anyone tries to do something that’s not covered by the rules and logic in the code, it will fail. And because the treasury is defined by the smart contract too that means no one can spend the money without the group’s approval either. This means that DAOs don’t need a central authority. Instead, the group makes decisions collectively ... This is possible because smart contracts are tamper-proof once they go live on [the ledger]. You can’t just edit the code (the DAO’s rules) without people noticing because everything is public.⁴²

• 2.56    DLT is also the means by which DAOs can make financial and operational information publicly accessible.

• 2.57    Beyond the DAO smart contracts addressing governance, there may be a further “layer” of smart contracts that facilitates the business or other activities of the DAO, particularly if these are conducted on-chain. We call these the “protocol smart contracts”.⁴³ In this context, a ”protocol” is a set of rules by which a particular system is to operate. Developers may develop a protocol that might be implemented using smart contracts deployed to a DLT system to perform a particular activity, such as holding tokens, or to achieve a particular outcome, such as managing or distributing capital. For example, DeFi software (often referred to as a “DeFi protocol”) may use smart contracts to implement a system for performing various financial operations.

• 2.58    Charles Kerrigan has suggested that:

the legal analysis of a DAO or other Web3 or blockchain project involves tasks such as breaking down the operation of the smart contracts into their constituent parts, in particular, to show the flow of value created and transferred, and then applying a legal analysis to these.⁴⁴

• 2.59    Smart contracts used by DAOs and the DLT systems on which they operate will generally be based on open-source software. Open-source software is software code that can be used, studied, changed and distributed by anyone.⁴⁵ This allows for and encourages iterative development of the software itself by (often unrelated) developers in a collaborative and public manner. Open-source software is also transparent and verifiable by anyone. It can therefore be audited by third parties to check it will do what it is claimed it will do and identify any vulnerabilities.

• 2.60    As mentioned above, the combination of smart contracts and DLT means that DAOs are said to be “trustless”. This concept is central to these technologies. They reduce or eliminate the need for parties to a transaction to trust one another because assurance is provided by the existence and operation of the software. This is particularly important when dealing with parties you have only interacted with on the internet, who may be anonymous or pseudonymous, and with whom you have no personal or trust-based relationship.

• 2.61    Because of the complexity of the underlying protocol and system software, developers or other unrelated persons might also make a front-end website which allows people to access information relating to the DAO and its underlying code. Importantly, the website is distinct from the smart contract rules and is normally subject to explicit terms which make this very clear. ⁴⁶These websites present information to users about the data on the relevant blockchain and smart contracts and enables users to interact with them. Those interactions may vary considerably based upon the factual circumstances, but may include acquiring governance tokens, proposing or voting on proposals and/or interacting with the DAO’s business or other activities.

Governance

• 2.62    At least as originally conceived, a key feature of DAOs is decisions made by community voting, rather than a centralised authority or management team. As the Ethereum website explains it:

There is no CEO who can spend funds on a whim or CFO who can manipulate the books. Instead, blockchain-based rules baked into the code define how the organization works and how funds are spent.

[DAOs] have built-in treasuries that no one has the authority to access without the approval of the group. Decisions are governed by proposals and voting to ensure everyone in the organization has a voice, and everything happens transparently on-chain.

• 2.63    This community governance in DAOs is often conducted via governance tokens. A governance token is a cryptoasset - fungible or non-fungible depending on the particular DAO⁴⁷ - that grants voting powers or rights to the holders of those tokens. Governance smart contracts provide a means by which members of the DAO who hold governance rights (token holders) can propose and vote on operational decisions and alter variants in the smart contracts. There may also be governance smart contracts which are used to manage the treasury and tokens (including issuance and buying back tokens) and registering new members. Depending on the rules of the DAO, there will be a process for making proposals for a vote, generally to change the smart contract code. Holding more governance tokens is likely to mean greater voting power. Whether a governance token creates a contractual right to be asked to vote on a particular issue will depend on the rules of the organisation.

• 2.64    Votes may be on anything to do with the governance or activities of the organisation as far as this is permitted by the rules of the DAO. For example:

• (1)    At the level of the DAO smart contract(s) (the governance level), voting may relate to a change of the purpose of the DAO or the rules of its operation.

• (2)    At the level of the protocol smart contract(s) (the activity/product/system level), voting could determine, for example, how to allocate funds collected for charity by a charity DAO, how to use an asset that a DAO has purchased, or how to allocate grants.

• 2.65    Smart contracts may be used to give effect to the outcome of a vote. This may be direct (“on-chain”) and automatic, with the options built into existing code so that the outcome of the vote is automatically implemented. Alternatively, it may be some version of indirect (“off-chain”) voting and implementation. In the latter case, votes may be cast on-chain or simply in message boards or chat groups, and the smart contract code must then be updated to reflect the result by one or more developers. Here, the reliance on human actors - and therefore the need for trust among participants - is obvious.⁴⁸ In some cases, the rules of the DAO may say that the results of all or certain types of votes are “advisory” only, rather than there being an undertaking to implement the outcome.

• 2.66    Whether the effect of votes is automatically implemented, or relies on implementation by human actors, affects how certain the rights of the token holders are, how “decentralised” and “autonomous” the arrangement is, and how “trustless”.

• 2.67    Token-based governance may mean that decisions are slower and less efficient than in a traditional organisation when a single officer or central board is empowered to make quick decisions when necessary. Particularly at the beginning, when there are many decisions to make, decision-making may be limited to a small group (such as the original developers), before voting rights are distributed more widely over time in what is referred to as “progressive decentralisation”.

• 2.68    Another risk is the concentration of power in situations where individuals retain or accumulate large numbers of tokens with corresponding voting power, which would frustrate the supposed aim of distributed and decentralised control. In one study of “decentralised finance DAOs”, token holding was shown to be highly concentrated in a small population of holders.⁴⁹

• 2.69    As in many other situations where individuals are asked to vote, voter participation in DAOs is often low. This may be due to voter apathy and/or lack of understanding when decisions are on complex and technical matters. Low participation could compromise the functionality of the organisation as well as affecting the veracity of claims to distributed control. If this is an issue, a DAO may allow for delegation of voting power to another party, or the setting up of sub-committees to determine matters on a particular topic requiring specialist knowledge. In some cases, voting is rewarded with additional governance tokens.

Token holders

• 2.70    It is likely that the original developers of the DAO will keep some - potentially a majority - of the tokens. Other participants might acquire tokens in various ways, including by:

• (1)    investing directly (often by providing early-stage investment directly to developers) and being given tokens in return for their investment;

• (2)    buying them from existing token holders;

• (3)    being given them as a result of their contribution to the DAO (for example, participation in code updates, or even simply by voting on a governance decision).

• (4)    transfer via an unsolicited airdrop. Some products/protocols comprised of smart contracts are designed to distribute tokens in this manner, whereby tokens are sent, by operation of the smart contracts, to certain public addresses that may be controlled by multiple different users. This may be motivated by, for example, a desire to increase the number of token holders, perhaps to ensure a spread of control or to raise the profile of the DAO.

Governance and other tokens: functions and status

• 2.71    As indicated above, tokens may be sold to participants as potential investments, purchased in the hope that the tokens will increase in value, or may be marketed simply as an opportunity to participate in the DAO and its governance. They might be given away for free for the reasons listed above. If the DAO offers a product or service, it might be a pre-condition of access to that product or service that one is a token holder.

• 2.72    A DAO may issue more than one type of crypto-token. ⁵⁰For example, it may issue governance tokens, discussed above, which allow participation in votes on how the DAO operates. In addition, it might separately issue another type of token native to the DAO which, for example, gives access to products or services, or may transfer nonnative tokens such as ether from its treasury in return for participation. The DAO may, as its business activity, issue native tokens which can be used as a form of “currency” to exchange for other goods or services, or may otherwise deal in or with other tokens (particularly those organisations which are set up to provide decentralised finance (DeFi) or crypto-wallet services).

Tokens as objects of personal property rights

• 2.73    Governance tokens that give the holder voting/governance rights may, depending on the terms and conditions of the particular DAO, represent contractual rights. DAO tokens are also likely to be transferable and therefore tradable, and to have a price. In this way, tokens give participants a way to share in the success of the DAO: if the

DAO does well, the value of the tokens goes up, and participants may be able to sell their tokens for profit. In our digital assets report, ⁵¹we explained that crypto-tokens can be the object of property rights in themselves, regardless of whether or not they attach to another right (such as a contractual right to vote).

• 2.74    A governance token may therefore be the object of a property right as an asset in its own right, as well as evidencing a contractual right. Property rights are, in principle, recognised against the whole world, whereas personal rights such as contractual rights are recognised only against someone who has assumed a relevant legal duty (in this case, for example, potentially the DAO and other participants).

• 2.75    We discuss the process of transferring tokens in detail in our work on digital assets. In brief, tokens can be transferred on-chain between participants on a distributed ledger by effecting a “state change”.⁵² They could also potentially be moved off-chain by a “change of control”.⁵³

Tokens in the regulatory context

• 2.76    It is beyond the scope of our work to look in any detail at regulation, but we make some key observations here and develop them in Chapter 6.

• 2.77    Cryptoassets are generally unregulated in the UK. ⁵⁴However, activities relating to cryptoassets are regulated in this jurisdiction under three regulatory frameworks:

• (1)   Anti-money laundering framework

Cryptoasset businesses that fall within the scope of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs)⁵⁵ must register with the FCA before starting business.⁵⁶ The FCA must determine that the applicant’s management and owner are “fit and proper” ⁵⁷and that the applicant has satisfactory anti-money laundering systems and controls in place.⁵⁸ The MLRs apply depending on what is done with the cryptoassets and whether this creates a money laundering risk.

• (2)    Financial promotions framework

This framework sets out what financial promotions are and are not permitted and is relevant where certain products or activities are aimed at or otherwise “capable of having an effect in” the UK. Cryptoassets have recently been brought within this regime, as we explain below.

• (3)    The regulated activities framework

This framework sets out all the activities that fall within the financial services regulatory framework under the Financial Services and Markets Act 2000 (FSMA). It applies to cryptoassets where the features of a cryptoasset mean that it falls within the definition of a “specified investment”. If so, firms are required to obtain FCA authorisation in order to operate where they undertake “specified activities” in relation to “specified investments”. The specified activities and investments are set out in Schedule 2 to FSMA and in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the RAO). ⁵⁹In some ways, governance tokens might look like company shares in that they may be issued in exchange for investment into the DAO, and give corresponding voting rights, which could result in their being regarded as specified investments.⁶⁰

• 2.78    DAOs may fall within these frameworks as a result of activities linked to their governance tokens: for example, advertising their tokens to potential participants and issuing governance tokens to participants. These activities are common to many DAOs in terms of how DAOs are set up at an organisational/governance level (that is, token-based governance). In Chapter 6, we explain how these areas of regulation might apply to DAOs at this level. For our purposes, these issues are separate from the activities that occur at the product level, which relate to the interaction between the DAO and users of its business or service. Activities which are carried out at that level are activities that may fall within these regulatory frameworks in the same way as if they were being carried out by a traditional organisation. DeFi DAOs are the most obvious example where this would be the case.

Participants

• 2.79    Here, we describe the main categories of participants that might be found in the DAO ecosystem, some of which we have already touched on. As mentioned above, the personal identity and location of some or all of these participants may be anonymous or pseudonymous. Challenges in identifying individuals give rise to various difficulties, from compliance with law or regulation requiring personal data (such as money laundering regulations) to identifying responsible persons when enforcement action is required.

• (1)    Software developers: DAOs are all likely to involve software developers (software engineers who design and write software) developing computer code that is used to create distributed ledger/blockchain systems and smart contracts. These individuals may operate through an incorporated development company (“DevCo”) established to hire software developers and manage the day-to-day operations of the project or may exist as a more ad-hoc group of loosely related contributors. ⁶¹In the crypto space, including for DAOs, developers may work together without ever meeting or knowing each other’s real identities, and it is possible that aspects of the software may be developed without the full knowledge of all developers.

• (2)    Token holders: The developers or founders are likely to reserve some tokens for themselves, but token holders may also include people who have bought, earned or been given tokens at a later date. Some DAOs allow anyone to participate by becoming a token holder, while others may have conditions or require an application or commitment to contribute in some way to the operation of the DAO. Token holders are likely to have the right to vote on changes to the smart contracts, effectively voting on decisions as to how the DAO is run, but often do not in fact use those rights.

• (3)    Investors/shareholders: Particularly in DAOs using recognised legal entities such as limited companies, there may be other investors, including potentially equity shareholders, instead of or as well as governance token holders.

• (4)    Operators/contributors: Depending on the type of DAO, these may include:

• (a)    Contributors, who are individuals who participate in and contribute to the organisation. Software developers are one form of contributor. Others may participate in operational functions such as treasury management and voting oversight. Contributors are often paid for their work, usually in native tokens, stablecoins, or other crypto-tokens. This could be in the form of grant funding (to an individual who has proposed a project to the DAO which has been approved), a bounty (which is automatically distributed to the contributor upon completion of a task), a salary or revenue sharing (where contributors are compensated according to the revenue generated by a product they create). Contributors may or may not hold tokens.

• (b)    Node operators (miners/validators) who support the underlying distributed ledger/blockchain. They may be token holders as a result of receiving tokens as payment for their role in the functioning of the DLT system. Unless they are also governance token holders, they are unlikely to have any right to participate in the operational or governance decisions of the DAO.

• (c)    Managerial operators that operate the day-to-day functioning of the DAO such as multi-signature signers who oversee treasury or other wallets, deploy code changes to smart contracts, manage voting by token holders, and other operations in accordance with the DAO’s purpose. They may be employees and/or rewarded for this contribution with tokens.

• (d)    Executives such as directors, partners etc if using a legal structure.

• (5)   Customers/clients: if the organisation offers an external service or product,

such as DeFi.

Funding/treasury

• 2.80    Most DAOs will require some kind of funding to build their community and further their aims, even if these are not profit-making, and will often obtain this by selling tokens to investors. They may also, for example, seek sponsorship from individuals or organisations, and ultimately may make money from their business or other activities. The proceeds of the sale or other profit will not necessarily be distributed to the founders (as would be the case with a company or partnership). Depending on the particular DAO, proceeds or profit may be distributed to token holders or used, as determined by member voting, to further the DAO’s objectives.

WHAT IS A DAO, LEGALLY SPEAKING?

• 2.81    Above, we have described the key concepts relating to DAOs and in particular how they are generally driven by the operation of software code. Beyond this, there remain important legal questions as to the proper legal characterisation of any particular DAO, and the relationships between various participants in such arrangements.

• 2.82    A DAO may choose to adopt traditional, legally-recognised organisational structures, such as limited companies, partnership models, offshore funds or DAO-specific legal entities (which have recently been introduced in some jurisdictions), or a combination of several of these. It could register as a charity or co-operative, if it meets the requirements for such vehicles. The entity could be co-extensive with the DAO, or it may be used only for a specific function, such as to employ the developers, or to hold real world property. If only part of the DAO is “wrapped” in a legal entity, there may be questions about the nature of the relationship between the legal entity and the nonwrapped part of the DAO, and about the legal characterisation of the non-wrapped part.

• 2.83    It may be easy to say what a particular DAO is if it has chosen to use one or more recognised legal entities and is therefore a hybrid arrangement or digital legal entity according to our “spectrum” approach introduced above.⁶² Where there is a legal entity in any capacity, the legal entity or entities in question will be subject to the usual legal, tax and regulatory requirements of the jurisdiction in which they are set up.

• 2.84    But a DAO may have taken no active steps to set up a legal entity. A group of people - developers, token holders etc - may have worked together or interacted with each other without giving any thought to their collective legal status or legal liability, or may have chosen to avoid existing legal forms for philosophical reasons. We call these “pure DAOs”. Critically for our purposes, where the participants have not made a positive choice as to status, it may be necessary to work out retrospectively what the arrangement is or was from a legal perspective. Whether the participants like it or not, the arrangement still exists in the real world with its rules and liabilities. This could be a difficult exercise, especially if the DAO does not fit easily within existing structures that can arise as a matter of law (rather than requiring active registration), such as general partnerships or unincorporated associations, discussed further in Chapter 3.

• 2.85    Particularly in the case of pure DAOs which may have no particular link with any single jurisdiction, it may be difficult to identify which country’s laws or regulatory regimes apply to determine these issues - but that is a separate question which will have to be answered on a fact-specific basis.⁶³ We include more explanation of the private international law issues in Appendix 3.

• 2.86    What a particular DAO is from a legal perspective will affect a great deal of its potential analysis, including the rules for its operation, the liability of participants, how it can enter contracts and own property, and how it is taxed. DAOs that have taken active steps to include a recognised legal entity within their structure are therefore very different from those that have not. The difference in the kinds of issues that arise between these different types of arrangement is so great that in some respects it is difficult to talk about them together, even if they are all “DAOs” according to our very broad definition.

• 2.87    Our impression is that, as DAOs have developed over the past few years, more or perhaps most DAOs are proactively adopting legal entities with separate legal personality. As discussed further below, this will aid their ability to transact in the “real world” (for example, by opening bank accounts and entering into contracts) as well as limiting participants’ potential personal exposure to legal liabilities, but inevitably moves them further away from their original goals.

Why does it matter what a DAO is?

• 2.88    It may be necessary to characterise the legal relationship between various actors within a DAO for a variety of reasons. For example, to answer key questions such as: Who is liable if something goes wrong? How can a DAO enter into contracts and hold funds? The are no answers of universal application for DAOs because answers to these questions will be fact-specific and relevant to the DAO in question. Below we introduce some key areas in which characterisation will be relevant.

Liability

• 2.89    A key question for DAOs and their participants is who will be liable if something goes wrong. What happens when actions by or on behalf of the DAO give rise to liability in tort (such as negligence), or if there are any regulatory breaches or criminal conduct? Who or what is responsible for the actions of the DAO?

• 2.90    The issue is particularly stark when the use of open-source software allows unscrupulous actors to identify and exploit weaknesses. In such circumstances, other participants and users of the DAO may be harmed, and/or the actions may breach regulatory or legal requirements, giving rise to civil actions or criminal prosecutions. In such circumstances, can and should the DAO (or some/all of its participants) be held liable?

Civil liability

• 2.91    The prospect that all, or certain types of, DAO participants could be held personally liable for acts of or associated with the DAO (either individually or on a joint and several basis) might seem somewhat shocking given the actual level of control that any individual might have and the lack of trust-based relationship between participants. ⁶⁴But where the DAO has no separate legal personality and does not use an incorporated form, it is a distinct possibility.⁶⁵

• 2.92    As we discuss in Chapter 3, a legal analysis of a DAO could conclude that all or certain participants within a DAO are part of a general partnership or unincorporated association, or part of a network of contractual and/or agency relationships. This may in turn give rise to individual participants having personal liability for the actions of the DAO, because the DAO does not have its own legal personality that can shoulder these liabilities. For example, in a general partnership, all partners are jointly liable for the debts and obligations of the partnership.⁶⁶ This also raises questions about whether some participants (such as a DAO’s founders, or those who hold most tokens or have the power to amend the code) can be held “more liable” than other participants whose involvement is more passive or who in practical terms have less control.⁶⁷

• 2.93    If the DAO has used a formal legal entity such as a company with a legal personality separate from that of its participants, the answers are likely to be more straightforward and the DAO itself will shoulder much of the burden since, as a legal person, it can hold property, enter contracts and sue and be sued in its own name, and the “corporate veil” is only lifted in limited circumstances.

Criminal liability

• 2.94    The situation in criminal law is similar but there are some important differences and distinctions. Most criminal offences are created with natural persons in mind, but such offences may explicitly or implicitly extend to associations (such as companies).⁶⁸ How a particular offence committed by a DAO or a DAO participant could be prosecuted therefore depends both on how the DAO is characterised and the nature of the offence itself.

• 2.95    Some statutes include provisions which acknowledge that at least some of the offences created are intended to apply to bodies corporate. For instance, it is common for legislation creating offences to include provisions whereby if the offence is committed by a body corporate, directors or other senior officers can be guilty if the offence is committed with their consent or connivance or is attributable to their negligence. Some statutes provide that an unincorporated association or general partnership can be guilty of an offence in its own name, despite its lack of legal personality.

• 2.96    Many offences that apply explicitly to non-natural persons are regulatory offences, and often these are “strict liability” offences that do not depend on whether the act was intentional.

• 2.97    However, most general criminal offences require a particular state of mind (or “mental element”), such as an intention to carry out the act or to bring about some result, knowledge of certain matters, recklessness or dishonesty. When an organisation can be prosecuted for an offence requiring a particular mental element, the question arises as to whose state of mind is to be attributed to it.

• 2.98    In England and Wales, the general rule for attributing liability to companies is the “identification principle”. This states that where a particular mental state is required, only the acts of a senior person representing the company’s “controlling mind and will” ⁶⁹can be attributed to the company - usually a small number of directors and senior managers. However, under the Economic Crime and Corporate Transparency Act 2023, section 196, where a senior manager of a body corporate or a partnership, acting within the scope of their actual or apparent authority, commits one of a number of economic crimes (including theft, fraud, false accounting, money laundering, or bribery) the organisation is guilty of the offence.⁷⁰

• 2.99    There are other rules for general partnerships and unincorporated associations, discussed in Chapter 3.⁷¹

• 2.100    The particular legal characterisation of any DAO could have potentially serious consequences for the criminal liability of the DAO as an entity, and of its individual participants. However, the liability of both the DAO and its members will be highly dependent upon the particular offence alleged to have been committed, and whether explicitly or implicitly it extends to the particular type of entity (if any) that the DAO uses or is found to be.

Capacity to enter contracts, own property or hold funds

• 2.101    For example, if a party purports to contract with a DAO, they need to know with whom or what they are contracting. If a DAO has not used some formalising element such as a limited company, it is likely to have no separate legal personality and therefore no ability to, for example, enter contracts or own assets. How then is property owned or a contract entered? And if the DAO holds money on behalf of its token holders, in what capacity is that money held?

Roles and responsibilities

• 2.102    What duties do the various participants (including developers, token holders, and potentially miners/validators) owe each other, third parties and the world? Those who participate in DAOs in various capacities, including in governance and/or software development for example, need to know the content and extent of their duties. Might they, for example, have duties to token holders akin to those of a company director to shareholders? And might developers owe a duty to other participants in the organisations to safeguard their economic interests, either as fiduciaries ⁷²or through a tortious duty of care?

Regulation and tax

• 2.103    If a DAO requires authorisation for its activities - for example, if it carries out regulated financial services - it will be necessary to know what the organisation is in order to determine who or what must apply for authorisation.

• 2.104    The starting point for determining the tax liabilities of a DAO will be its legal characterisation. ⁷³For example, companies and general partnerships (in England and Wales at least) are subject to differing tax treatment,⁷⁴ and if the DAO is not found to be a single entity, it may be that individual participants must carry the tax liability.

Individual participants may also have personal tax liability. A DAO’s tax liabilities must be assessed on a case by case basis, and the issues are complex. Particularly in cases where the legal characterisation is unclear, Ernst & Young has noted that:

it’s likely to be difficult for both taxpayers and authorities to determine whether individuals and entities have properly self-reported taxable income. ... This increases the level of complexity faced by DAO participants, with legal status open to various interpretations by courts, creating mismatches and potential double taxation, tax risks and liabilities.⁷⁵

• 2.105    The borderless nature of a DAO also raises questions about where tax is payable -but these questions arise (albeit with perhaps easier answers) with many types of organisation that operate across jurisdictions. They are the subject of international agreement and again will be easier to answer in respect of a recognised legal entity.

JURISDICTION AND EXTRA-TERRITORIALITY

• 2.106    Companies and other traditional organisations are usually required to establish in a particular location, for example by registering with a domestic registrar in the relevant jurisdiction and/or by establishing a head office in that country in order to carry on business there. The assumption is that the organisation will be subject to the legal, regulatory and tax provisions of the jurisdiction in which they are set up. For example, a company registered in the UK at Companies House will be subject to UK company law and other applicable laws, and will be liable for UK corporation tax. If it wishes to offer financial services such as dealing with investments or offering insurance in the UK, it must be authorised by the relevant UK regulator, the FCA. The FCA also has arrangements in place for international firms providing financial services in the UK.⁷⁶

• 2.107    As we have touched upon above, a DAO that has not used a domestic legal entity in its structure or otherwise established itself in any one jurisdiction may not be tied to, or associated with, any particular place.⁷⁷ This is not entirely novel; it is possible for people in different countries to have an unregistered business partnership and still carry on business.⁷⁸ DAOs do however present some additional challenges. The underlying DLT system may be said to exist “everywhere and nowhere”; ⁷⁹there may be nodes all over the world. The participants in a DAO - its creators and users - may equally be spread all over the world and, perhaps uniquely, may be difficult to identify or locate. In response to our call for evidence, European Crypto Initiative (EUCI) suggested that:

The decentralised nature of a DAO and particular ways of user interactions with the underlying protocol make it impossible to know how many individuals engage with the protocol and smart contract from a particular jurisdiction.

There are three main points why it may be hard to claim a DAO belong[s] to one particular jurisdiction: (1) DAO participants can engage in governance and operations through self-custodial wallets, which do not necessarily provide the regular personally identifiable information but rather pseudonymous information, (2) DAO members may use several different interfaces through which they access the protocol and use smart contract (which is more on the backend of the system), and (3) the websites/interfaces through which one can access DAO smart contract can be deployed and operated on decentralised hosting systems, which do not collect IP addresses.

• 2.108    The international or borderless nature of some DAOs may mean that it is challenging to know to which laws it is subject. This may give rise to different questions and answers in different areas of law. For example:

• (1)    Private law. Private law concerns relationships between private parties (including individuals and businesses). Most of what we have discussed above, and the main focus of our paper, is private law. What an organisation is for legal purposes - for example, a company, a general partnership, a collection of contracts - is a question of private law. So too are questions such as how or when civil liability applies, for example negligence or breach of contract. When there is an international element to a private law question, as will often be the case with DAOs, a body of law called private international law will be used to determine (a) which country’s courts can rule on the questions and (b) which jurisdiction’s laws those courts should apply. Broadly, private international law will look to identify a jurisdiction with which the dispute has a connection. This is a complex area of law, particularly in the context of the crypto ecosystem, and we are looking at it separately.⁸⁰ However, it is worth remembering that if a DAO has no obvious link to England and Wales, then the courts in this jurisdiction may not necessarily be able to hear a dispute relating to that DAO, and/or may not be able to apply the laws of England and Wales to determine the answer.⁸¹ We include further detail about private international law in the context of DAOs in Appendix 3.

• (2)    Public law. Public law is concerned with the actions and activities of public bodies. It includes, for example:

• (a)    Regulatory law. Regulatory law - such as financial services regulation or health and safety regulation - concerns the exercise of functions by a public agency. It sets out the regulations and allows the relevant agency to enforce regulations, investigate breaches and bring enforcement proceedings or prosecutions. Regulation is broadly a matter of public law. Whether domestic regulatory rules apply in an international or quasiinternational context will depend on the terms of the regulatory rule itself. For example, depending on its drafting, a regulatory rule may apply only to businesses based in England and Wales, or may apply more broadly, to all businesses having some operations or customers in England and Wales.

• (b)    Criminal law. The starting principle in this jurisdiction is that the criminal law of England and Wales applies only to acts committed in England and Wales.⁸² Where no part of the conduct takes place in England and Wales, a specific statutory provision is usually required for acts committed wholly outside the jurisdiction to be able to be prosecuted here. ⁸³Typically, this will depend on either the act or the defendant having a particular connection with England and Wales (or the UK). There are a number of serious offences that can be prosecuted in England and Wales where the criminal act took place abroad, if the perpetrator is a UK national or habitually resident in the UK. In the case of some offences applying to bodies corporate or unincorporated associations, the necessary connection might be whether the body is incorporated under domestic law or carries on business in England and Wales.

It may be difficult to say that the activities of a DAO are “committed” in England and Wales - or indeed in any one jurisdiction - if the DAO has no physical presence and is distributed across an international network of computers, with most activity happening online. However, it may be -depending on the particular offence in question - that the DAO would be caught by provisions allowing for extraterritorial application, for instance as a result of the DAO engaging in business within England and Wales, or where a gain or loss occurs in England and Wales as a result of fraudulent activity carried out by the DAO.

• (c)    Tax law. Taxes are imposed by public authorities on individuals, businesses and other entities. They are generally a matter for state governments. In the context of a DAO with no obvious jurisdiction, it may be difficult to know where it or its participants should be taxed and in what capacity (as this will depend on its legal characterisation). The doubt can lead to “potential double taxation, tax risks and liabilities”.⁸⁴ Andersen LLP has noted that, from the perspective of taxation, concepts such as the location of “central management and control”, ⁸⁵remain key to determining tax residence. However, they also note that “this approach remains rooted in a time that is far removed from the way that businesses operate today.”

2.109 Some of these questions are interconnected - for example, a DAO’s tax treatment may fall to be determined by its legal characterisation, which is generally a matter for (domestic) private law. But to a large extent, each of these areas of law is separate and has its own rules for dealing with questions of an international or extraterritorial nature, and they are not straightforward. Although the questions might concern the same DAO, the assessment of the applicable law and its extra-territoriality may be quite different under different areas of law.

• 2.110    In many cases, DAOs may not have given any thought to the laws to which they might be subject. However, if the point were to be considered, individuals and entities have some choice as to which law applies for private law purposes to govern their relationships with other private parties. For example, a valid contractual choice of law will determine the law governing the private law relationship between the parties under a contract. However, that choice of law will not affect the regulatory regime that applies to the parties as a matter of public law, because parties cannot contract out of mandatory rules.

• 2.111    Because of the very wide variety of arrangements that could constitute a DAO, it is not possible to draw general conclusions about which laws DAOs might be subject to, and across how many different jurisdictions. In this paper, we talk about how various aspects of the private and public law of England and Wales might apply to DAOs. It must always be kept in mind, however, that, depending on the arrangements of the particular organisation and the detail of the relevant law or regulation, those rules may simply not apply.

A SPECTRUM OF DAOS: PURE DAOS, HYBRID ARRANGEMENTS AND DIGITAL LEGAL ENTITIES

• 2.112    As indicated, we use the term “DAO” to cover a wide range of technology-mediated structures or organisations of participants that use smart contracts, DLT and, usually, some kind of community voting. While the original idea of a DAO was somewhat anarchic, our understanding is that DAOs are increasingly using legal entities within their structure. This may be partly due to litigation in the United States revealing that DAOs may attract legal characterisation and liability as an entity (or as a collection of individuals) in any case. It could also be attributed to increased interest in the benefits of DLT and smart contracts among individuals and organisations who do not necessarily hold to the original DAO ideologies. And in general, as the idea of a DAO has been tested and expanded, their activities and legal implications have begun to resemble those of traditional organisations. They have started to hold off-chain, real world assets, and have sought to formalise arrangements such as employment contracts for employees.

• 2.113    Using a legal entity within the structure of a DAO will connect the DAO with a particular jurisdiction and can provide a variety of benefits including:

• (1)    separate legal personality giving the DAO the capacity to enter contracts and hold assets in its own name (and to sue and be sued in its own name);

• (2)    limited liability for their participants, so that participants cannot be held liable for an amount larger than their current and promised investment in the DAO;

• (3)    (potentially) clearer characterisation of relationships between participants and with the outside world;⁸⁶

• (4)    the ability to interact more easily in the off-chain world more generally, such as by opening bank accounts;

• (5)    increased certainty about tax status and jurisdiction; and

• (6)    clearer integration in frameworks for compliance and regulation.

• 2.114    For some DAO participants, using a legal structure might involve significant compromises in their philosophy. This could include an inevitable and significant degree of centralisation, loss of anonymity or pseudonymity for some or all of its participants, the introduction of reporting requirements, and the addition of duties (such as directors’ duties) which may frustrate the focus on community voting. As has been noted:

Many traditional legal entity structures require hierarchies (e.g., officers and boards of directors) and include concepts (e.g., stockholders, fiduciary duties, etc.) that are antithetical to notions of decentralisation.⁸⁷

• 2.115    Whatever the philosophy or priorities behind a particular DAO, whether it does or does not actively incorporate a legal entity can make a significant difference to its legal implications. Here, we introduce (in our own terminology) some different ways that a DAO might be arranged, sitting along a spectrum:

• (1)    “pure” DAOs: arrangements implemented through smart contracts with very limited off-chain activity, no incorporated legal structure and, often, a rejection (deliberately or otherwise) of dependence on law and legal institutions for their existence (although they may well still attract legal and regulatory consequences);

• (2)    hybrid arrangements: arrangements combining smart contract-based coordination with deliberate use of one or more legal forms or separate legal entities; and

• (3)    digital legal entities: arrangements where an incorporated legal entity adopts digitalisation through the use of smart contracts or DLT in its operations or governance.

• 2.116    This wider spectrum allows for variations and/or subcategories to be identified now or over time as the concepts mature and new technologies develop. Technological innovations may also change the nature of the forms available and/or practices used. The proliferation of artificial intelligence (AI) technologies represents one such path of potential change, with the suggestion that “the broader notion of an autonomous organisation entirely run by (centralised) AI is likely to outlive the decentralised nature of the underlying infrastructure that supports it”.⁹⁰

Pure DAOs

• 2.117    Pure DAOs sit at the more decentralised and autonomous end of our spectrum: they are decentralised (in some or all of the various ways described at paragraph 2.34 above) and reject dependence on law and legal institutions for their existence.⁹¹

• 2.118    The key characteristic of a pure DAO is that it deliberately does not use any legal entities within its structure. Instead, it relies on technology (code, smart contracts and DLT) to set the rules according to which participants in the organisation interact (including for the purposes of governance) and to automate certain processes and functions. Its governance processes are designed to allow for decentralised governance, for example, decision-making within the organisation is dispersed amongst participants rather than sitting with a central decision-making body.

• 2.119    Despite not actively choosing to use a legal entity within its structure - and perhaps consciously hoping to avoid legal characterisation entirely - a pure DAO may be found to include a general partnership or unincorporated association, or involve a collection of legally-enforceable contracts between participants, or even a trust structure. This is because these legal characterisations can arise under the law of England and Wales without the need for incorporation or registration.⁹² Some pure DAOs take steps to structure their rules and decision-making processes to try to avoid such legal characterisations. This may be for ideological reasons (rejection of dependence on or interference by law and legal oversight) or it could be for practical reasons (the rules relating to these legal entities are not attractive to participants).

• 2.120    Pure DAOs represent - or hope to represent - DAOs as originally conceived. However, although there are many organisations currently in existence that call themselves DAOs, few, if any, are likely to be pure DAOs at the most decentralised

• ⁹⁰    Stirling & Rose LLP, in their response to our DAOs call for evidence.

• ⁹¹    Although, as we discuss in Chapter 3, they may well still attract legal and regulatory consequences.

• ⁹²    We discuss this further in Chapter 3.

and autonomous end of the spectrum. Some pure DAOs may intentionally structure themselves so as not to be fully decentralised and autonomous (because, for example, the founders and/or software developers want to retain some control over the direction of the organisation). Alternatively, this may be a temporary situation because the organisation aspires to become more decentralised and autonomous as it matures. This could occur where the founders and/or software developers progressively decentralise the organisation by taking steps such as permitting more decision makers to join or introducing new smart contracts to perform different processes. It may also arise as a matter of circumstance - for example, because not enough other participants buy/receive tokens, or because they do not use their tokens to vote, leaving control factually centralised among a few active participants.

Hybrid arrangements

2.121 Hybrid arrangements combine smart contract-based coordination (that is, a pure DAO arrangement) with one or more legal forms or entities. The pure DAO elements of the hybrid arrangement’s governance will exhibit characteristics of decentralisation and autonomy while those relating to the legal entities within the arrangement are likely to be more centralised and less autonomous. Encompassing some of the functions of a DAO within a legal entity is sometimes known as ‘wrapping’.

2.122 Different hybrid arrangements use legal entities in different ways as part of their structure. They may use them just for specific functions, for example, to hold intellectual property rights relating to software or to employ staff. Where legal entities are used in this way, the greater part of the hybrid arrangement’s governance is likely to remain within the pure DAO element. As such, the hybrid arrangement will be more towards the decentralised and autonomous end of the spectrum. Alternatively, a hybrid arrangement may use legal entities in such a way that some or all major governance decisions are made by the governing body of the legal entity. One reason for adopting this approach may be where the arrangement wants to ensure limited liability for participants making governance decisions; whether this is fully successful may depend on how the residual technological features are operated and the relationship between the wrapped entity and non-wrapped residual part of the DAO.⁸⁸

Digital legal entities

2.123 A digital legal entity is an incorporated legal entity which makes use of technology such as DLT and smart contracts in its formal governance and/or operational arrangements. The use of this technology is enshrined in the rules of the legal entity. These types of entities are largely theoretical in this jurisdiction due to statutory restrictions on the form of, for example, shareholdings and fund interests, but a potential example could be a limited company that issues shares in the form of tokens recorded on a distributed ledger (tokenised securities), conducts formal decisionmaking processes, such as shareholder resolutions, and/or maintains registers such as shareholder registers on-chain.

2.124 Digital legal entities are distinct from hybrid arrangements because the use of technology is exhaustively formalised as part of the governance of the incorporated legal entity. In contrast, hybrid arrangements include incorporated legal entities in their structure but also retain some smart contract-based coordination which is in addition to those legal entities (the pure DAO elements), which a digital legal entity would not.

2.125 DLT-based systems (either exclusively or in conjunction with non-DLT-based systems) may be applied to digitalise the operation and administration of the entity. For example, a private company limited by shares may wish to use various technologies to issue tokenised shares,⁸⁹ substantially automate shareholder voting, or use DLT-based rather than centralised registers. ⁹⁰While there are some points of close association with hybrid forms which may use the term “DAO” as part of their structure, we use the term “digital legal entity” to refer to an entity that is not associated with any pure DAO, as we have defined this. Rather, a “digital legal entity” is simply a legal entity such as a company that employs extensively the technology which underpins DAOs in its governance or operations.

Analysing DAOs along the spectrum

2.126 For any organisation seeking clarity on issues of liability and legal characterisation, the answers will depend on the precise arrangements within that organisation, including its structure. The approach to answering the key legal questions above will differ for each of pure DAOs, hybrid arrangements and digital legal entities:

• (1)    Digital legal entities are likely to be the most straightforward to understand legally. As an incorporated legal entity, a digital legal entity’s characterisation and associated rules will be contained in statute and/or case law.

• (2)    In contrast, pure DAOs do not consciously use legal entities and therefore it may be necessary to consider the roles and relationships between participants in any particular pure DAO, as well as the role of code and the interaction between participants and the code.

• (3)    For hybrid arrangements, both of the above approaches will need to be followed as well as considering the relationship between participants, the code and the legal entities used. The relationship between the legal entity and the “residual” DAO will also be important, including whether and to what extent the DAO participants are able to direct the actions and decisions of the legal entity.

What kind of entity to use, and where?

2.127 For hybrid arrangements and digital legal entities, key questions will be what type of legal entity or entities to use, and in which jurisdiction? Depending on the priorities of the DAO’s decision-makers, both give rise to important considerations such as:

• (1)    What benefits does a particular legal entity give (such as limited liability) and at what cost (for example, loss of anonymity; reporting requirements; directors’ duties?)

• (2)    What are the laws (including, for example, employment law), regulatory requirements and tax arrangements in a particular jurisdiction?

2.128 There are a range of different legal entities in this jurisdiction and abroad that could be used, although there does not appear to be any “perfect” entity fit. Few if any DAOs are currently set up under the laws of England and Wales. Some other jurisdictions provide more flexible options which may be better able to accommodate the novel features of such arrangements. Some jurisdictions including Wyoming have introduced DAO-specific forms of legal entity, designed to attract DAOs to the jurisdiction, but these have sometimes been criticised for being more onerous on DAOs rather than less. Most DAOs using legal entities are established in US states where the founders are based or, in some cases, offshore locations such as Cayman Islands or Guernsey, which provide greater levels of anonymity for participants, plus tax and other benefits.⁹¹

NEXT STEPS

2.129 We have not been asked to make formal recommendations for law reform at this stage, and in any case we think consideration of DAO-specific reforms such as the introduction of a DAO-specific legal entity would be premature at this stage, for reasons we explain in Chapter 5. However, we have identified a few areas where further work would be useful to explore how some of these new types of arrangements for collaboration could be accommodated under the law of England and Wales, including:

• (1)    proceeding with the Law Commission’s planned review of trust law. This will consider - in general terms rather than in the DAO context specifically - the arguments for and against the introduction of more flexible trust and trust-like structures in England and Wales;

• (2)    considering the case for the introduction of a limited liability, not-for-profit

association with separate legal personality similar to the unincorporated nonprofit association structure sometimes used by DAOs (along with other organisations) in the United States; and

• (3)    a review of company law to identify reforms to make it easier for organisations to leverage DLT and other technology at the governance level of a legal structure, potentially facilitating the establishment of digital legal entities.

We expand on these in Chapter 5. In Chapter 6, we identify options for possible further work in the context of regulation and tax. A full list of next steps relating to further work that we have identified can be found in Chapter 7.

• Chapter 3: Pure DAOs: legal characterisation and liability of participants

• 3.1    A pure DAO is an arrangement implemented through smart contracts deployed to a DLT system intended to adhere closely to the original ideological conception of a DAO introduced in Chapter 2. It is not in its own right a recognised legal entity in this jurisdiction and it does not intentionally use any legal entities within its structure. Instead, it relies on code (smart contracts and DLT) to implement and enforce the rules according to which participants in the organisation interact (including for the purposes of governance) and to automate certain processes and functions. In a prototypical arrangement, a series of smart contracts set out the rules as to how a system or product (that is, the activity of the pure DAO) will function, such as a DeFi protocol, for example. Governance smart contracts then provide a means by which members of the pure DAO who hold governance rights (token holders) can propose and vote on various operational and constitutional decisions as well as alter variants in the smart contracts. There may also be governance smart contracts which are used to manage the treasury and tokens (including issuance and redemption of tokens) and to register new members.

• 3.2    Participants interact with the protocol or governance smart contracts using DLT and with each other using online modes of communication. Some participants will be involved daily while others only rarely. Commentators often talk about a DAO ecosystem or community when referring to DAOs and their participants. This is a reflection of the pervasive narrative among some commentators and market participants that a pure DAO is not a single entity and is not controlled by a centralised decision-making body; instead it is better understood as an ecosystem containing code, smart contracts and a community of participants who interact with each other and with smart contract code in different roles.

• 3.3    Indeed, some commentators and participants suggest that this ecosystem is outside the scope of law and regulation. The theory goes that this is because power, control and decision making are dispersed between the smart contracts and participants to such a degree that there is no single person or group of people working together or in control of the system or product to which a pure DAO is linked. Further, some commentators argue that the ecosystem has no need for outside control and interference from, for example, the law of a particular jurisdiction, because the rules of the game are contained in automated smart contracts and recorded on transparent, immutable distributed ledgers. For these commentators, this level of decentralisation and autonomy is the ultimate expression of a DAO.

• 3.4    However, pure DAOs are of course subject to law because it is not possible for any entity unilaterally to declare otherwise. That is not to say, however, that the law is always able neatly to make sense of such organisations. What we have found is that existing law in this jurisdiction leaves some questions unanswered when it comes to characterisation of a pure DAO and the legal basis of relationships between its participants.

• 3.5    While a pure DAO is not a recognised legal entity in its own right, it is nevertheless possible (and arguably necessary) for a group of people who organise themselves as a pure DAO to attract some form of legal characterisation. This could happen retrospectively - for example, if questions arise about the locus and allocation of liability. There are a vast number of DAOs and therefore any assessment of their structure and characterisation will be fact specific. It is not possible to reach conclusions about DAOs in general, given their variations. In this chapter we therefore provide a legal analysis of common features of DAOs and discuss whether these could result in certain participants within a DAO being part of a general partnership or unincorporated association, or part of a network of contractual relationships or some other arrangement. We also consider various ways of allocating liability to pure DAOs or to some/all of their participants.

A SIMPLE EXAMPLE OF A PURE DAO

• 3.6    We begin this chapter with a simple example of how a pure DAO can come into existence. This example is designed to help readers who are new to the topic.

• 3.7    Alinie, Bartek and Clara are software developers who want to create a pure DAO to govern a DeFi platform. They plan to use smart contracts and DLT to create a financial services product that automates certain processes and reduces reliance on actors that function as intermediaries.

• 3.8    They want to make their pure DAO as decentralised and autonomous as possible. As a first step, they design and write computer code together⁹² and develop a protocol for a DeFi product. The protocol sets out the rules as to how the computer software they have written (including smart contracts) operate together to allow that system to function and to perform various financial transactions. They also write a governance smart contract which provides a means to alter the protocol smart contracts and a treasury smart contract that will manage the operation of the treasury. The treasury is a wallet which will hold funds invested in the pure DAO or earned by it as fees from the DeFi product. The treasury is intended to be used to fund bug fixes and system upgrades when needed, to incentivise users through staking/liquidity mining and by rewarding contributors (such as, for example, participants who are involved in the promotion of the DAO’s product).

• 3.9    Alinie, Bartek and Clara implement their protocol by deploying the smart contracts they have designed on an open-source basis to a public DLT system.

• 3.10    The protocol has been designed to generate software protocol-specified crypto tokens called “ABC tokens”. Holders of ABC tokens have governance rights over the protocol. This means that they can suggest changes to the smart contract code making up the underlying protocol and also vote on changes suggested by other token holders. They can propose and vote on a range of operational decisions, such as interest rates and liquidity ratios in the DeFi system/product. If a change is voted on and accepted by token holders, the governance smart contracts then effect changes to the smart contracts of the underlying protocol. They also manage the DAO treasury.

• 3.11    Some ABC tokens have been allocated to Alinie, Bartek and Clara, and others have been offered to potential investors. Several people accept their offer and become holders of ABC tokens in exchange for depositing crypto tokens into ABC DAO’s treasury. ABC DAO now has treasury funds and a small number of token holders operating out of a range of different jurisdictions.

• 3.12    Alinie, Bartek and Clara have designed ABC DAO with the goals of decentralisation and autonomy in mind. They do not want ABC DAO to be under the control of any single individual or group of individuals or to be subject to the external influence of state laws and regulations. To this end, decision making within ABC DAO is dispersed amongst all token holders; there is no centralised decision-making body or group of token holders with additional decision-making powers. Where possible, processes and functions of the pure DAO are automated or governed by smart contracts; for example, the results of certain votes are implemented automatically by the smart contracts rather than requiring one or more developers to actively make changes to the smart contracts. ⁹³The developers have made a conscious decision not to use any legal entities within ABC DAO’s structure and all of its processes and activities are carried out online on the DLT system for all participants to see. They hope that ABC DAO will become further decentralised as the number of token holders increases and are actively seeking out further investors and considering giving away tokens in order to achieve this goal. Diagram 1 shows one example of how participants may interact in a pure DAO such as that set up by Alinie, Bartek and Clara.

  1	Alterations to the protocol smart contracts or product offering are determined automatically as a result of the outcome of governance votes, or in some cases, by development work commissioned for the DAO as a result of voting by token holders.
  2	The relationship between token holders in the governing DAO and users of its protocol or product will depend on the factors discussed in chapter 3 of our scoping paper.
  3	Token holders hold governance tokens that allow them to participate in the DAO. Their capacity to participate is determined by the DAO’s smart contracts. The governance contract allows token holders to alter those contracts. In some pure DAOs there will be “sub-DAOs” or committees, a smaller group of people accountable to the DAO but responsible for particular aspects of the organisation, such as treasury management. For simplicity, here we present a completely decentralised DAO in which all governance authority rests with all token holders.
  4	When a pure DAO engages a counterparty to perform work on its behalf, who is liable on the contract will depend on the factors discussed in chapter 3 of the scoping paper.

The components used above are indicative and non-exhaustive examples that may be used.

The actual composition and functionality of the smart contracts will be fact specific.

ISSUES ASSOCIATED WITH PURE DAOS

• 3.13    We have explained that pure DAOs sit at one end of our “spectrum”: purely on-chain entities that stick closely to the purist philosophy that they are, or should aspire to be, truly “decentralised” and “autonomous”. This approach would not support an arrangement incorporating, for example, a limited company.

• 3.14    As a result of these features, the questions/challenges associated with pure DAOs are likely to include:

• (1)    What is the DAO, legally speaking?

• (2)    What is the relationship among the participants, and between the participants and third parties? Are there, for example, fiduciary as well as contractual duties owed by the developers?

• (3)    How can the DAO hold assets, including its treasury?

• (4)    Who is liable if things go wrong? Are all participants personally liable regardless of the extent of their actual participation and/or control?

• (5)    Can it apply for regulatory authorisations?

• (6)    What are the tax liabilities of the DAO and its participants?

• 3.15    The answers will depend on the precise arrangements of the pure DAO in question and may be difficult to arrive at. We do not therefore seek to answer these questions comprehensively but instead explain some of the key considerations.

• 3.16    In particular, the legal characterisation of a DAO will help to answer some of these questions. In the next section, we therefore look at some of the different ways that a pure DAO might be characterised in law.

• 3.17    As we have explained in Chapter 2, it may not always be clear which jurisdiction’s laws apply to a pure DAO. We discuss questions of private international law in more detail in Appendix 3. For the purposes of this chapter, we assume that the applicable law is that of England and Wales.

CHARACTERISING A PURE DAO UNDER THE LAW OF ENGLAND AND WALES

• 3.18    We have said that a pure DAO deliberately does not use any legal entities within its structure and is not a recognised legal entity in its own right. It may even be the case that participants are working together or interacting with each other without giving any thought to their collective legal status or personal legal liability. However, situations may arise in which it is necessary to characterise the legal relationship between various participants within a DAO and determine what a DAO is as a matter of law.

• 3.19    The question of what a DAO is as a matter of law may arise, or require definitive answers, only retrospectively and in a particular context; for example, if legal action is taken against the pure DAO or some or all of its participants. This could involve, for example, a civil action by an injured third party, enforcement action by a regulator or prosecution under criminal law. We focus particularly on civil actions as we think these are more likely to result in a court being asked to define the legal status of a pure DAO or answer questions about the relationship between various participants.

• 3.20    For example, could developers be liable to participants if a product or system goes wrong or if their expectations of participation are not met? Could developers or token holders be liable to users of the DAO’s services if governance or operational decisions cause users to suffer loss?

• 3.21    It has sometimes been suggested that certain DAOs are so decentralised and autonomous that no single person or group of people can control or direct the DAO or be held liable for its activities. Take the example of a DAO in which the code does what it is programmed to do and developers and token holders have very little control over the operation of the code day-to-day; the code is designed to require little or no maintenance for its continued operation and votes on changes to the code are rare. Some people may argue that this is merely code operating autonomously rather than a business being operated by token holders; a DAO is a technology and not an entity.

• 3.22    Arguments along these lines were made⁹⁴ in litigation in the United States in which a regulator took enforcement action against a DAO. The argument was rejected, broadly on the basis that it was the actions of the participants that the regulator sought to regulate, not the technology itself, and that the DAO was not merely technology.⁹⁵

• 3.23    We think it is very unlikely that a DAO, or its participants, would (or should) be found to be beyond the reach of the law merely because of the technology used in their arrangement. At some point, choices are made by someone about the purpose of the DAO and what the code should do. Furthermore, in reality, there is usually a group of people who have the technical ability to stop or make changes to the smart contract code.

• 3.24    That is not to say, however, that any loss or dispute will be actionable. As in any dispute, it will be necessary to show that, for example, there has been a breach of a contract that exists between the parties, or that a party has breached a fiduciary or tortious duty, or that there has been an unjust enrichment.

• 3.25    These questions are, of course, not unique to pure DAOs, or to DAOs at all. We look at the questions in the specific context of pure DAOs because of the particular challenges to which they give rise. If a DAO uses, for example, a company structure, company law will assist in answering many questions that might otherwise arise. For example, in most cases, the company shoulders the liability if it breaches a contract or causes harm that is actionable in tort, ⁹⁶and it is the company itself that is liable for tax. Where this is not the case, as in a pure DAO, it may be necessary to look more closely at the roles of the different participants and the relationships between them.

This can assist in determining the status of participants, and their rights and responsibilities, both to each other and to third parties (either as a individuals or members of an organisation).

• 3.26    The court will first need to ascertain how the particular DAO operates, as far as this is relevant to the dispute it is considering. It may need to know, for example, the roles and responsibilities of different participants, which participants have decision making and governance rights, what those rights are and how they have been exercised. The court may also need to consider issues of agency between participants. The governance mechanisms, participation levels of token holders and precise details of the relationships between participants will vary between different DAOs.

• 3.27    After the facts are established, existing legal principles will be applied to the novel situation: a group of participants who interact and operate with decentralised control over what are often largely automated operations. There is also the question of who or what is the defendant - has the claim been brought against the DAO itself (and is that possible if it has no legal personality), individually named participants (such as the founders), or some or all categories of participants in the DAO? This question may itself be something the court has to decide.⁹⁷

• 3.28    How a particular pure DAO is characterised will be a fact-specific enquiry decided based on the application of long-established, technology-neutral tests under the general law. As a consequence, the legal duties that members of a particular DAO may have to each other and to any counterparties will not arise from some arbitrary designation and are not, for lawyers at least, wholly unpredictable.

• 3.29    Because these tests are technology neutral, they do not cease to apply because DAO participants operate on a blockchain rather than through in-person interactions. DAOs will neither be unfairly exposed to, nor unfairly protected from, the relevant characterisation and legal consequences in England and Wales merely because of their use of novel technology. With that said, some of the common features of DAOs make it less likely that the tests for some of these legal characterisations will be met.

• 3.30    The application of established law to disputes relating to pure DAOs raises questions which, to date, the courts in this jurisdiction have not yet been asked to consider. The issue has, however, arisen in litigation in the US, with DAO token holders found to be members of an unincorporated association as defined under specific pieces of US legislation. ⁹⁸General partnerships and unincorporated associations can come into being through a combination of factual circumstances and legal attributes, without the participants making an active choice to form an entity. This differs from, for example, a limited company, the establishment of which requires active steps, including registration with a company registrar (such as Companies House in the UK).

• 3.31    This, together with the United States decisions mentioned above, has led to intense interest in the market about whether participants in a pure DAO could be found to be partners in a general partnership or members of an unincorporated association in other jurisdictions or contexts.

• 3.32    Given the prevalence of these questions in DAO commentary, we start by considering whether either of these characterisations is likely under the law of England and Wales, and what the consequences of them would be. Although there are some commonalities, the differences between jurisdictions mean that the reasoning in the United States case law will not necessarily be instructive in this jurisdiction. ⁹⁹We conclude that such characterisations may be possible in this jurisdiction in the case of a particular DAO under consideration, depending on its precise arrangements, but may put a strain on the general conception of such organisations. General partnerships do not seem to be a good fit for the archetypal DAO for many reasons and it might be unfortunate (for DAOs/DAO participants and, potentially, for the law of general partnerships) if they were routinely characterised in this way. An unincorporated association (as described in this paper as a not-for-profit arrangement) may be a better fit for some DAOs given that it has fewer strict default rules.

• 3.33    In this chapter we also look at other ways in which a pure DAO and the relationships between its participants could be categorised, and at how liability could be attributed where a pure DAO does not include a general partnership or unincorporated association.

DAOS AS GENERAL PARTNERSHIPS?

• 3.34    General partnerships have existed in the UK for hundreds of years. They are now defined in the Partnership Act 1890 (the Partnership Act), and a general partnership exists when the definition in the Act is fulfilled. From the statutory definition, three conditions must be satisfied for a general partnership to exist:¹⁰⁰ (1) there must be a business; (2) which is carried on by two or more persons in common; (3) with a “view of profit”.

• 3.35    Business is defined in the Partnership Act 1890 to include “every trade, occupation, or profession”. ¹⁰¹This wide definition encompasses almost all commercial activities. ¹⁰²A general partnership may arise in relation to a business generally or for a particular transaction, area, or project.¹⁰³ However, the fact alone that some activity is profitable does not necessarily turn the activity into a business.¹⁰⁴

• 3.36    For a partnership to exist, the persons¹⁰⁵ must carry on their business “in common”.¹⁰⁶ That is, “together”. ¹⁰⁷This implies the following:¹⁰⁸

• (1)    There must be a single business. This may, however, involve different and unrelated activities or divisions.¹⁰⁹

• (2)   Members must be carrying on that single business together for their common

benefit, accepting some level of mutual rights and duties between themselves. ¹¹⁰Persons carrying on wholly separate businesses or else seeking only to improve their own individual profitability will not be partners. ¹¹¹Equally, activity by a person in their individual capacity does not form part of a partnership business.¹¹² However, the business can be a benefit for someone else, for example, where partners decide to apply all profits to a charitable purpose.¹¹³

Members must have accepted (expressly or impliedly) some mutual rights and obligations between themselves, in particular:¹¹⁴

• (a)    the existence of a duty of good faith may be “highly indicative” that a partnership exists;¹¹⁵

• (b)    the absence of mutual rights and obligations indicates that no partnership exists; but

• (c)    the mere acceptance of some mutual rights and obligations is not, alone, sufficient to show that a partnership exists.¹¹⁶

• (3)    Members must be carrying on that single business (at least in part) on their own behalf. If they all run the business entirely on behalf of a single third party, there is no partnership; but if they run the business on behalf of themselves and one or more third parties, there may be a partnership.¹¹⁷

The business must be carried on with “a view of profit”.¹¹⁸ That is, the participants must intend to make a profit. This feature distinguishes partnerships from societies or clubs.¹¹⁹ A partnership will only exist if the profits are intended to be realised for the common benefit of the participants.¹²⁰ This does not mean that there must be equal profit sharing between partners and does not even preclude the partners from carrying on a business with the object of applying the profits towards a charitable purpose.¹²¹ However, if a number of firms associate together with a view to promoting high standards in the professional services which they supply to their respective clients and, thereby, to improve the individual profitability of each firm’s business, this will not be sufficient.¹²²

• 3.37    Whether the three conditions are satisfied in a particular instance is a mixed question of fact and law. ¹²³The three conditions are the only essential preconditions to the existence of a general partnership.¹²⁴ Various evidentiary aids to determine whether a particular relationship constitutes a general partnership are also provided by legislation¹²⁵ and case law; but these aids are subsidiary to the three conditions set out in section 1 of the Partnership Act itself. The three conditions therefore represent the “ultimate test” of whether a general partnership exists.¹²⁶

When would a DAO be a general partnership?

• 3.38    A frequent concern of stakeholders is that pure DAO participants will be characterised as a general partnership, making them jointly liable for liabilities incurred by one another and subjecting them to onerous duties to act on each other’s behalf, contrary to participants’ expectations. It is possible for a pure DAO to meet the statutory test for a general partnership: use of novel technical features, such as on-chain voting, does not preclude this. Nonetheless, many DAOs have organisational characteristics that may make it unlikely that a court would conclude that the participants agreed to carry on a business in common with a view to profit and bear mutual duties as partners as a result. These include the decentralisation of governance to an often pseudonymous and changing membership, the nature of the activities of archetypal pure DAOs, and the means by which participants are able to make financial gains.

• 3.39    There could be significant differences between how different pure DAOs are set up and for what purpose. Depending on the details of a particular arrangement, it is possible that some or all participants in a pure DAO could be characterised as partners in a general partnership under the law of England and Wales. However, several things must come together in order for that characterisation to arise.

• 3.40    At first glance, some DAOs could appear to be a natural fit for characterisation as a general partnership: where participants are exercising governance rights over a DAO’s activities and are making financial gains as a result of their involvement with the DAO. What we have observed, however, is that some of the features common to many pure DAOs strain the usual understanding of general partnerships. Similarly, some of the usual features of general partnerships contrast with how a pure DAO is likely to operate in practice and with how DAO participants see themselves. None of this means, however, that the legal test for a general partnership is not or cannot be satisfied by a pure DAO, rather that the ways DAOs usually operate may make it unlikely in many cases.

• 3.41    Here, we summarise some features of pure DAOs that appear to strain the usual idea of a general partnership. For readers who would like more detail about how these features of pure DAOs could interact with the legal test for a general partnership, we include further discussion and analysis in Appendix 4.

• (1)    In most traditional partnerships, individual partners will be carrying out similar roles and may be expected to have similar expertise, to have received similar legal advice, and to participate in a relatively similar way with shared responsibility. In a pure DAO, despite the ideological emphasis on decentralisation and equality, it may be that certain participants - for example, the founders and/or developers - may be more involved in determining the purpose of the DAO and its business aims, and to have influence over what the DAO does. They might also be more likely to be known to each other and might reasonably be expected to know about the legal and regulatory environment in which they are operating (for example, if they decide to set up a DAO that provides DeFi services) than token holders who become involved at a later date. And other participants - such as miners and validators - perform certain functions but may not be involved in decision making. There might therefore be a case for arguing that only some of the DAO participants should be regarded as partners. Indeed, any general partnership might have users or administrators or other third parties whom they interact with but who are not partners or members. However, which if any participants could be regarded as partners will depend on the facts of the particular case.

• (2)    Members of a general partnership must be carrying on a single business together for their common benefit. In a pure DAO, this may not be the case even where DAO participants are financially motivated, if, for example, they are individually interacting with code solely for their own personal financial gain rather than for a common benefit. Token holders could see a benefit from a capital value increase in their token holdings, they could receive further DAO tokens or they could benefit from the DAO buying back their tokens. They may also use their tokens to earn fees and interest by participating in lending or staking. Miners/validators may be rewarded with DAO tokens or other cryptoassets for their involvement in supporting the infrastructure and/or functioning of a DAO and users of a DAO’s services may do so with a view to a profit. This kind of arrangement may not align with the requirements for a general partnership (but may still be an unincorporated association, as we discuss from paragraph 3.67).

• (3)    Holding a token in a pure DAO is what gives the holder a right to be involved in its governance. A token holder can freely transfer their token holdings to outsiders on the secondary market. Any new token holder would have all the power of the previous token holder. A share of a partnership is not generally transferrable in this way. Rather, the organisation’s rules will set out how a partner or member can leave, and how a new one can join. These are generally two separate processes and not a matter of the outgoing person being automatically replaced by a new person as a result of the outgoing person transferring their partnership position or membership to the new person.

• (4)    As we discuss in more detail in Appendix 4, when a partner leaves a general partnership, the partnership technically dissolves and a new one is formed. In the DAO context, this could technically mean that the partnership is being dissolved and re-constituted multiple times a day as token holders trade their tokens. Further, unless agreed otherwise, a former partner will remain liable to third parties for any liabilities incurred during their time as partner and a new partner will not take on these liabilities. It is unlikely that DAO token holders will realise that they could retain liability after they have sold their tokens.

• (5)    Pure DAOs can have a very large number of participants (including hundreds or thousands of token holders) who are not known to each other. This is in contrast to the classic characterisation of a general partnership as a relatively small group of people who know each other and may even be bound together by ties of friendship and mutual confidence. Even in, for example, a large law firm with hundreds of partners, there will be a rigorous process for admitting new partners such that partners are expected to trust and have confidence in each other even if they do not have direct personal relationships. The shared trust between the partners is reflected in the fact that partners are jointly liable for the actions of the other partners. Holding DAO participants liable for the acts of a huge number of unknown participants is potentially more difficult to justify from a policy perspective (but again, it may well be the legal result and is not necessarily incompatible with the statutory definition).

• (6)    General partnerships (and unincorporated associations) usually have rules dealing with key aspects of the organisation’s existence and activities. ¹²⁷This is because the partners (or members) are likely to be aware that they are part of the relevant organisation and want to set out clearly the “rules of the game”. These may include an explanation of how partners can join and leave and how any funds will be used or distributed. It is possible for pure DAOs to have a set of natural language rules which set out some information about how the pure DAO operates and the roles and responsibilities of different participants. However, this will not always be the case and any rules that do exist (either in natural language or in the code of smart contracts) may not cover some of the key aspects one would usually expect to find in the rules of a general partnership.

Legal consequences of characterisation as a general partnership

• 3.42    Being characterised as a general partnership would have the benefit of legal certainty: there is a wealth of case law and guidance concerning how partnerships operate and the rights and liabilities to which they give rise. Participants would not have to navigate a new set of legal requirements and expectations. That said, there are clear disadvantages associated with this classification, most notably the lack of limited liability and the fact that every partner is bound by, and potentially liable for, the actions of another partner, and difficulties in compliance with requirements such as transparency as to membership. Here, we pick out some of the key consequences of being a general partnership and consider their potential impact in the context of a pure DAO.

No separate legal personality

• 3.43    A general partnership is not a distinct entity from the individual partners composing it.¹²⁸ It has no separate legal personality. This creates a number of inter-related problems for partners.

• 3.44    Because it is not a legal person, a partnership cannot itself own assets, grant security or enter contracts. Nor can it acquire rights or obligations. The rights and liabilities of a partnership are the rights and liabilities of the partners and are enforceable by and against them as individuals.¹²⁹

• 3.45    The inability for a pure DAO in its own name to own property and contract with third parties could obviously be problematic for those DAOs who wish to do any of these things. At the very least, a pure DAO is likely to hold cryptoassets in its treasury and will therefore need to be able to hold assets as a matter of law, and may wish to contract directly with users of its services.

• 3.46    Of course, partnerships have developed solutions to the challenge of having no separate legal personality. In particular, contract and agency can enable the partners legally to achieve in practical terms what the partnership itself cannot do in strict legal terms. Every partner is an agent of the partnership and of the other partners, and a partner’s acts bind the partnership and the other partners, provided that they have acted in the usual course of business.¹³⁰ A partner can, for example, enter into a contract on behalf of the partnership. For instance: a third party and the original partners may agree that the contract is to be performed by the partnership as from time to time constituted;¹³¹ and certain partners might legally own partnership assets on trust for all the partners.¹³² Thereby, a law firm partnership might own an office, contract with services providers, have bank accounts, employ staff, and engage with clients.

• 3.47    Some of these typical workarounds adopted by traditional partnerships may be more burdensome and/or less ideologically attractive to DAOs. For example, owning assets via trustee(s) and contracting via agent(s) both involve entrustment to a small number of persons - while, by contrast, DAOs are conceived of as “trustless” and decentralised. That said, given that the treasury is likely to be controlled in fact by a small number of participants acting through a multi-signature arrangement, and that only a small number of participants are likely to be involved in third-party interactions, the reality of a DAO may be mapped relatively easily onto this legal analysis.

Civil liabilities

• 3.48    As a consequence of a partnership having no independent legal existence from its partners, the default position is that partners share joint liability for the “debts and obligations” (such as contractual liabilities) of the partnership. ¹³³The unprotected position of partners contrasts with the protected position of shareholders in a limited company: the shareholders are liable only for the amount unpaid on the nominal value of their shares (not the market value) and so, for fully paid-up shares, shareholders have no further liability for the company’s debts. Similarly, for a company limited by guarantee, liability is limited to the amount each guarantor agreed to guarantee.

• 3.49    Partners are also jointly and severally liable for “any wrongful act or omission of any partner acting in the ordinary course of the business of the firm, or with the authority of [their] co-partners”. ¹³⁴This extends to liability for “loss or injury” to any person who is not a partner in the firm, “or any penalty incurred”. This could include, for example, tortious acts, regulatory liability or breaches of contract, but only to the extent that the acts were carried out in the ordinary course of business or with the partners’ authority.

An injured party could sue one or more individual partners or, as discussed below, the partnership itself.

• 3.50    This risk of personal liability may be even more problematic for DAO participants than for partners in a traditional partnership because traditional partners may be better able to control or understand their potential liability. For instance: (i) a partner in a small law firm partnership may be in a stronger position to trust and influence their fellow partners’ decision-making than a token holder in a large decentralised DAO; (ii) a traditional partnership may be better advised and as a result may, for example, have good insurance and/or have liability limited by contract as far as possible; (iii) a DAO may operate in a more nascent and uncertain regulatory and liability landscape than, say, a law firm or farming partnership; (iv) a partner in a traditional finance firm may have a deeper understanding of the relevant law and regulation than a token holder in a DeFi DAO; and (v) the identities of token holders may not be known to other token holders or to third parties, meaning that certain token holders who happen to be prominent or known may be held liable for the entire liability without a realistic prospect of contribution from their fellow token holders.

Change in partners

• 3.51    When there is any change in the identities of partners, the ‘old’ partnership is technically dissolved and ‘new’ partnership is formed even if the name is the same. Any partnership name is merely a convenient way to describe the group of persons associated together at that point in time.¹³⁵ When a partner joins or leaves, that name takes on a new meaning.¹³⁶

• 3.52    When a partner joins or leaves, the new partnership and leaving partners may agree contractually between themselves to take on the rights and obligations of the old partnership. However, transferring an obligation owed to a third party generally requires the consent of the third party, and cannot be done unilaterally by the partners. In other words (unless the parties agree otherwise):

• (1)    a new partner does not become liable to third parties for debts, contractual obligations or tortious liability incurred before they became partner;¹³⁷ and

• (2)    a former partner remains liable to third parties for debts, contractual obligations and tortious liability incurred during their time as partner.¹³⁸

• 3.53    When token holders join or leave a DAO, participants tend to think of the DAO itself as pre-existing and continuing to exist - this is inherent in the language of “joining” and “leaving” a DAO. In practice, people talk of large partnerships in the same way. For example, the law firm Slaughter and May ¹³⁹would describe itself as having existed since 1889 not 2024 when the last change in partners occurred. Hence, the real question for a DAO is not linguistic, but rather the extent to which it can replicate the effect of being a continuing entity despite no such entity existing at law.

• 3.54    Regarding contractual rights and liability, a DAO might achieve the effect contractually, that is in the terms of agreements (i) between the participants themselves and also (ii) between the DAO (in reality, the participants) and third parties. Contractual solutions, however, may require a conscious effort to be made, and might not assist members of a DAO who were unaware of the issue.¹⁴⁰

• 3.55    Further, there are limits to what can be achieved contractually: contractual arrangements could not pass primary responsibility for tortious liability to noncounterparties or pass regulatory liability to a particular participant (as the regulation itself will determine who or what category of person is subject to it). As a consequence, even with careful drafting between participants, an outgoing DAO participant may not leave behind primary liability for torts and regulatory breaches committed by the DAO (that is, by the participants at the time) during their time as a participant.¹⁴¹

Suing and being sued

• 3.56    The Civil Procedure Rules of England and Wales permit a partnership to sue and be sued in the partnership’s name.¹⁴² The name of the partnership, however, remains only a shorthand for the names of the individual partners at the time when the cause of action accrued. Suing in the name of the partnership does not abrogate the need to identify the correct parties to the claim; that is, the partners at the time when the cause of action accrued (which may be different from the partners at the time of the proceedings).

• 3.57    To this end, the other side has the right to receive “a written statement of the names and last known places of residence of all the persons who were partners in the partnership at the time... .”148 Known token holders may be liable to sanction by the court, including striking out their claim or defence unless they comply. Many DAOs would struggle, or find it impossible, to comply with this obligation due to having a large, shifting and/or pseudonymous membership. If a defendant partnership does not produce all names, the claimant can still sue the partnership and the partners whose names are known, increasing the exposure of those few individuals.

Disputes between partners

• 3.58    Partners owe their fellow partners fiduciary duties; that is, duties of loyalty and utmost good faith.¹⁴³ For example, a partner must: (i) not make a profit which should have been the firm’s; ¹⁴⁴(ii) disclose conflicts of duty; (iii) not compete with the partnership business without the partnership’s consent; ¹⁴⁵and (iv) not profit personally from information received in the course of the partnership business.¹⁴⁶

• 3.59    Some DAO participant agreements expressly exclude fiduciary duties between token holders. Where this has not been done, however, the courts have no power to relieve partners from liability. Unlike company directors and trustees, ¹⁴⁷partners who face claims arising from breach of duty cannot apply to the court for relief on the ground that they have acted honestly and reasonably.

• 3.60    In DAOs where participants agree to exclude completely all fiduciary duties between themselves, it becomes increasingly questionable whether the token holders can truly be said to be a carrying on a business “in common”, and so whether the token holders are in partnership in the first place.

Criminal liability

• 3.61    Under section 10 of the Partnerships Act 1890, where a penalty is incurred as a result of a wrongful act or omission by a partner acting in the ordinary course of the business of the firm, the firm is liable to the same extent as the individual partner. Therefore, where a criminal offence extends to a partnership, the partnership may be liable where the act was committed by an individual partner.

• 3.62    In the case of common law offences, a partnership has no existence separate from the partners and it has been suggested that the partnership cannot therefore itself commit an offence. ¹⁴⁸Criminal liability might be attributable to individual partners. For statutory offences, the position will depend on the wording of the relevant provision, some of which provide that a partnership can commit an offence in its own right. For instance, the offence of corporate manslaughter can be committed by a corporation; certain departments and public bodies; a police force; or a partnership or trade union which is an employer.¹⁴⁹

• 3.63    Some offences that extend to partnerships will be “strict liability” offences that do not depend on whether the act was intentional. Others will require particular participants in a partnership to have a particular state of mind (or “mental element”). This could be an intention to carry out the act in question or to bring about some result; knowledge of certain matters; recklessness; or dishonesty.

• 3.64    Where an offence explicitly extends to partnerships, provision will generally be included to enable the prosecution of the partnership (typically providing, for example, that it should be prosecuted in the name of the partnership and any financial penalty will be payable from the funds of the partnership and not by individual partners).¹⁵⁰ There may also be provision so that where the partnership is convicted of an offence, an individual partner will be guilty if they consented to or connived in the offence or (sometimes) where commission of the offence was attributable to their negligence.¹⁵¹

• 3.65    Although members of a partnership are jointly liable for the debts and obligations of the partnership, individual partners who are not a party to the criminal conduct would not have any individual criminal liability (unless there is provision in the statute for them to be individually liable on the basis of consent, connivance or negligence).

Tax and financial regulation

• 3.66    General partnerships are transparent for tax purposes, meaning that the individuals are taxed rather than the partnership itself. A general partnership can be a “firm” or “person” for the purposes of financial regulation. We discuss the application of tax rules and financial regulation to DAOs in more detail in Chapter 6.

DAOS AS UNINCORPORATED ASSOCIATIONS?

• 3.67    Unincorporated associations are not a creation of statute. There is therefore no statutory definition or statutory test for their existence. ¹⁵²The courts have provided a description on numerous occasions ¹⁵³but there is no singular definition arising out of case law which operates as a test. Where the courts have provided a description, this is often to distinguish an unincorporated association from some other arrangement such as a general partnership or straightforward contractual arrangement between parties.

• 3.68    In what is considered the leading case of Conservative and Unionist Central Office v James Robert Samuel Burrell (HM Inspector of Taxes), Lord Justice Lawton described an unincorporated association as:¹⁵⁴

... two or more persons bound together for one or more common purposes, not being business purposes, by mutual undertakings each having mutual duties and obligations, in an organisation which has rules which identify in whom control of it and its funds rests and on what terms and which can be joined or left at will.

• 3.69    According to this description, an unincorporated association is (broadly) a group of people who have agreed a set of rules to collaborate for a purpose other than a common business purpose. The classic characterisation of an unincorporated association fitting this description is that of a local sports club or society. However, it would be incorrect to assume that unincorporated associations are only used for small-scale operations. Unincorporated associations can be used by larger clubs or, for example, by (unincorporated) charities to receive grants from local authorities to carry out services. In Burrell, the Conservative and Unionist Central Office was found to be an unincorporated association which spanned the whole country and in Weinberger v Inglis, ¹⁵⁵the original form of the London Stock Exchange was found to be an unincorporated association, as we discuss below.

• 3.70    While Lord Justice Lawton’s description of an unincorporated association in Burrell is widely accepted, it is not the only way in which this term is used and is not accepted by all commentators to be a definition of the term.¹⁵⁶ The term appears sometimes to refer to a residual category of organisation, covering arrangements that are not incorporated entities or partnerships but are something more than a group of disparate individuals. Where the term is deployed in this way, it is not always limited to nonbusiness associations. For example, the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 apply to firms providing certain services by way of business. “Firm” is defined as “any entity that, whether or not a legal person, is not an individual and includes a body corporate and a partnership or other unincorporated association”.¹⁵⁷ In Spree Engineering & Testing Limited v O’Rourke Civil & Structural Engineering Limited,¹⁵⁸ an arrangement was found not to be a general partnership (because it did not satisfy the statutory requirements) but was described variously as a “non-integrated joint venture” and “unincorporated venture” to be treated as an unincorporated association despite the fact that it was an arrangement for business purposes.

• 3.71    Characterisation as an unincorporated association by the courts may not be determinative in establishing the mutual duties of participants: these derive from the contractual, trust or agency relationships between them and therefore much depends on the specific facts of their collaboration and agreements. This differs from general partnerships, for which meeting the statutory definition under the Partnership Act 1890 results in the application of the default and mandatory duties the Act includes. We discuss the legal consequences of characterisation as an unincorporated association below.

When would a DAO be an unincorporated association?

• 3.72    It has sometimes been suggested by DAO commentators that a DAO with a for-profit purpose will be a general partnership and where a DAO has a non-profit purpose it cannot be a general partnership and will therefore be an unincorporated association. However, a relationship that fails to satisfy the test of a general partnership will not necessarily satisfy Lord Justice Lawton’s description of an unincorporated association. Similarly, a relationship that looks like an unincorporated association but that has a business purpose will not automatically be a general partnership. In any legal analysis being carried out, the characteristics of a specific pure DAO will need to be carefully checked against the criteria for each type of organisation. Such an analysis may identify a general partnership or an unincorporated association or may conclude that the pure DAO is neither of these and that it is some other kind of arrangement.¹⁵⁹

• 3.73    There are some features of pure DAOs which will require careful review when considering whether participants of a particular DAO form an unincorporated association. We summarise these here and provide further discussion and analysis in Appendix 4:

• (1)    If an analysis adheres strictly to the description in Burrell, then much is likely to turn on the common purpose of DAO participants, and whether this is a business purpose. This may be obvious where the activities of a DAO are not business or profit oriented, for example where the purpose is a social club, to build a community or provide advocacy or lobbying. However, where participants are able to make a financial gain as a result of their involvement with the DAO, a careful assessment will be required to understand the nature of the common purpose (if any) between these participants. Even applying the requirement for a non-business purpose, it may be possible for participants to be members of an unincorporated association despite individually profiting from their participation in the DAO.

A situation could arise where, for example, DAO participants have agreed to cooperate for the non-business purpose of governing a DAO according to the rules set out in the DAO’s smart contracts but they are also able to make a financial gain. This could be analogous to the situation in Weinberger v Inglis.¹⁶⁰ In that case, membership of the original form of the London Stock Exchange entitled the members to have entry to and trading rights within the Stock Exchange building. Although this had the appearance of being part of a business venture, close examination of its true purpose showed that members were merely entitled to use the exchange for individual pursuit of profit.

Similarly, token holders with governance rights in a pure DAO may be acting for individual pursuit of profit rather than running a business together.

• (2)    Another key consideration is the existence of rules. An unincorporated association will arise where a group of people agree to co-operate for a mutual purpose. The resulting association will have rules which deal with key aspects of the organisation’s existence and activities. By interacting with the code associated with a pure DAO, token holders could be seen as agreeing to cooperate for the mutual purpose of governing the pure DAO. The code (and any natural language documentation associated with the pure DAO) could be the source of the rules of the unincorporated association. There is no prescribed list of topics which should be covered in the rules, although Lord Justice Lawton’s description refers to “rules which identify in whom control of it and its funds rests and on what terms and which can be joined or left at will”. If the code and natural language associated with a particular pure DAO do not cover some of the key aspects one would usually expect to find in the rules of an unincorporated association, then taken together they may not be sufficient to function as rules of an unincorporated association.

• (3)    Holding a token in a pure DAO is what gives the holder a right to participate in its governance. A token holder can freely transfer their token holdings to outsiders on the secondary market. Any new token holder would have all the power of the previous token holder to participate in the pure DAO. Similarly, an unincorporated association can accommodate a changing membership and its rules will generally set out how a member can leave and how a new one can join. However, membership of an unincorporated association is not generally transferrable in the same way as for token holders in a pure DAO. This method of joining and leaving a pure DAO may not prevent it being characterised as an unincorporated association, but it appears at odds with the approach traditionally taken in such associations. This could arguably strain the characterisation as applied to pure DAOs.

Legal consequences of characterisation as an unincorporated association

No separate legal personality

• 3.74    An unincorporated association does not have a legal identity separate from its members.¹⁶¹ This causes many similar problems for an unincorporated association as for a partnership. For instance, an unincorporated association cannot itself own assets or enter contracts because there is no legal entity to own the assets or enter the contract.¹⁶² However, as with partnerships, these difficulties can be overstated, and in practice unincorporated associations hold property and enter contracts through trust and agency relationships.¹⁶³

Civil liabilities

• 3.75    Unlike partners in a partnership, members of an unincorporated association do not necessarily or generally have liability for the liabilities of the organisation. Members are not generally liable for each other’s acts. ¹⁶⁴Instead, members are generally only liable for their own acts or the acts of their agents. ¹⁶⁵Unlike in general partnerships, members are not automatically agents of the other members or the association, but it may still be the case that a member is found, on the facts, to be an agent of one or more other members and therefore able to bind them and expose them to liability.

• 3.76    In traditional unincorporated associations, members normally have no further liability beyond paying their subscription fees (if any). ¹⁶⁶For example, members do not become liable under an association’s contracts simply because of their membership.¹⁶⁷ Again, the normal rules of agency apply to determine which association members are liable as principals under the particular contract. ¹⁶⁸For instance, the association rules may authorise a member to sign on behalf of the association as a whole; if so, all members will be liable for a breach. Alternatively, the signatory may be authorised by the management committee; if so, the members of the management committee may be liable (assuming the rules do not state otherwise).

• 3.77    Questions of agency and related questions may be difficult when applied to a pure DAO. A pure DAO’s white paper, member agreements, or governance rules (to the extent any of these exist) are less likely directly to cover questions of agency or liability. DAOs do not tend to have “executive committees” like a traditional club, although many include smaller groups such as working groups or teams with particular responsibilities.

• 3.78    Those members who are found to be contractually liable are jointly and severally liable, allowing a creditor to pursue just one member for the whole debt or damages. ¹⁶⁹This liability is unlimited, unless liability is limited by contract, for example to the amount of the association’s funds.

• 3.79    As with departing partners, a liable member’s departure from an unincorporated association will not necessarily free that member from liability; similarly, an incoming member will not necessarily take on liability for existing contracts.¹⁷⁰

• 3.80    In terms of non-contractual liability, members of an unincorporated association are also not automatically liable for each other’s torts, crimes or regulatory offences. Generally, if members are liable, it is for their own acts or the acts of their agents.

• 3.81    A claimant cannot sue the unincorporated association itself for harm caused (since there is no entity to sue),¹⁷¹ even if the harm has apparently been caused by the acts of the association as a whole. Instead, the claimant must establish which members of the association are liable for the harm done to the claimant. A member’s tortious liability may either be primary - that is, for the member’s own acts or omissions - or secondary, that is for the acts or omissions of their agents or employees.¹⁷²

• 3.82    No special rules apply to determine whether a tortious claim exists against members of an unincorporated association, and, if so, which members.¹⁷³ The identity of the liable party or parties is fact sensitive and dependent upon the tort in question. The answer may depend, for instance, on which individuals undertook the tortious activity or assumed responsibility, and in what capacity they did so. A claimant may therefore have to prove that the particular member or group of members owed them a duty of care: for example, the members of a sub-committee responsible for a football stand were personally liable when it collapsed.¹⁷⁴

• 3.83    All members of a DAO can therefore be liable for a certain harm if this is established by the claimant in the usual way. For example, all the members of an association may be liable for harm of a single type that they have collectively caused. ¹⁷⁵A member who is pursued for on the basis of such joint and several liability may seek contributions from other liable members.¹⁷⁶

Suing and being sued

• 3.84    The starting point is that the unincorporated association itself cannot be a defendant (or claimant) to a private law claim. In some cases, civil judgments have been made against associations in their own name, without reference to any individual representatives.¹⁷⁷ Although the weight of judicial reasoning to date supports that an unincorporated association cannot be sued in its own name, the issue is not entirely settled: there remains some scope to argue that an association can be sued in its own name, particularly if the claimant is not seeking damages from the association¹⁷⁸

• 3.85    In principle, all the liable members could or should be joined as defendants in any claim.¹⁷⁹ In practice, however, most claims against unincorporated associations are brought against representatives of the liable members: ¹⁸⁰the Civil Procedure Rules provide that a claim can be brought by or against one or more individual members as representatives of the remainder, provided the representatives have the same interest in the claim. ¹⁸¹A judgment against representatives binds the members represented, but may not be enforced against any member who was not a party to the proceedings, except with the permission of the court.¹⁸²

• 3.86    For a claim by or against a representative, it is essential that the representative has the “same interest” in the claim as the other members represented. ¹⁸³This does not depend upon the person(s) represented giving consent or “even [being] aware of the existence of the action, in order to be bound by the result”. ¹⁸⁴But a judgment or order may only be enforced by or against a person who is not a party to the claim with the permission of the court. These matters could be relevant in the case of a DAO if only some participants are named as defendants, but all participants (or a particular subset of them) have “the same interest”.

Disputes between members

• 3.87    The duties and liabilities between members of an unincorporated association derive from the rules of that association. Members may sue for breaches of the contract underlying the association as they might any other contract, for instance, seeking damages for the losses caused by a breach, an injunction to prevent a breach or a declaration of the correct legal position.

• 3.88    As a general rule, association members do not owe each other an additional duty of care beyond any specifically agreed between members or undertaken by an individual member. ¹⁸⁵For example, a member could decide to assume a particular duty, in which case they should perform that duty with reasonable care and skill; ¹⁸⁶or the rules of the association could assign duty for certain matters to a particular group of members, in which case those members should perform the duty with reasonable care and skill.¹⁸⁷

• 3.89    Nor do members generally owe each other fiduciary duties, unlike partners in a partnership.¹⁸⁸ This may be welcome to the many DAO participants who desire not to have fiduciary duties between themselves.

Criminal liability

• 3.90    Liability of an unincorporated association or its officers or members for criminal offences or failure to comply with regulatory requirements will depend on the terms of the offence or requirement.

• 3.91    In contrast to the position for civil liability where the unincorporated association itself cannot be a defendant, some criminal statutes provide that the association itself can be liable. ¹⁸⁹The statute may provide that the officers of the association can be liable.¹⁹⁰ The term “unincorporated association” is not defined in statute but does not appear to be restricted to non-business associations.¹⁹¹ For offences of strict liability, ¹⁹²all individual members of the association may be liable;¹⁹³ for other offences, it may be that only those members who had the requisite mindset, for example those who intended to carry out the illegal act, may be liable.

• 3.92    In R v RL and another, the Court of Appeal held that the fact that individual members of a body corporate are not criminally liable for an offence committed corporately (unless they were a party or were made liable by a “consent or connivance” provision) does not mean that the same was true of members of an unincorporated association.¹⁹⁴ The court said:

It is a necessary consequence of the different nature of an unincorporated association that all its members remain jointly and severally liable for its actions done within their authority.¹⁹⁵

• 3.93    The trial judge had therefore wrongly ruled that there was no case to answer in respect of the two officers who were being prosecuted alongside the association (although it held that a fresh trial of the individuals was not in the interests of justice and directed their acquittal).¹⁹⁶

• 3.94    The offence in RL was an offence of strict liability. However, there are some offences which can be committed by an unincorporated association (that is not a partnership) and which require a mental element, but there is no authority as to which natural person’s mental state is to be attributed to the association. Given that the offence was intended to apply to an unincorporated association, whose knowledge or state of mind was for this purpose intended to count as that of the association? Smith and Hogan previously suggested that:

When an unincorporated association is prosecuted, presumably the court must proceed by analogy to the law relating to corporations. Such associations have officials corresponding to the controlling officers of corporations and it is inconceivable that the association is liable for the act of any one of its members who has no part in the general management of its affairs.¹⁹⁷

• 3.95    Following RL, it is clear that the Court need not operate by analogy with the law relating to corporations when considering the liability of individual members for actions of the unincorporated association. However, if the court is considering which natural person’s mental state constitutes that of the unincorporated association for the purposes of criminal law, proceeding by analogy with corporations is still likely to be the only viable approach.

Tax and financial regulation

• 3.96    An unincorporated association is taxed separately to its members, meaning that corporation tax is payable by the association itself. An unincorporated association can be a “firm” or “person” for the purposes of financial regulation. We discuss the application of tax rules and financial regulation to DAOs in more detail in Chapter 6 and note that “unincorporated association” is not restricted to non-business associations in these contexts.

OTHER POSSIBLE CHARACTERISATIONS OF A PURE DAO

• 3.97    As we have discussed above, it may be possible to find that participants in a pure DAO have formed a general partnership or unincorporated association. However, if neither characterisation is possible or appropriate for a pure DAO, what else might it be? Below, we consider whether a pure DAO could be a collection of contracts, a trust structure, or whether the actions of participants in a DAO could give rise to standalone liabilities in fiduciary duties or tort.

A collection of legally binding contracts

• 3.98    General partnerships and unincorporated associations both have their foundations in contract. But participants in a DAO may have obligations to one another under contract, even if their relationship does not amount to a general partnership or unincorporated association. One example would be where a DAO is carrying on an activity to directly make money for its token holders (so it is not an unincorporated association according to Lord Justice Lawton’s description) but the relevant contractual arrangements fall short of the intention to create mutual rights and duties required for a business in common and a general partnership. One commentator has described such DAOs as “contractarian joint ventures”.¹⁹⁸ In any event, there are a number of relationships and interactions within a pure DAO which have the potential to be the subject of legally binding contracts.¹⁹⁹

• 3.99    If a pure DAO has no separate legal personality, it cannot itself enter contracts with other parties. And contracts require an agreement between legal persons: it is not possible, for example, for a smart contract to enter into a contract in its own right, although a smart contract can of course operate to bind a legal person. There may, however, be contracts between the various participants in a DAO. If a participant contracts with a third party, purportedly on behalf of the DAO, they may either be liable to the counterparty solely and personally (if the DAO is not classified as a general partnership or unincorporated association), or may be found to be agents of some or all of the other participants (on the basis of standard agency principles). Whether developers could be liable in contract to participants if a product or system goes wrong, or whether token holders could be liable to each other or to users in contract, will, of course, depend on whether a contract exists.

• 3.100    Examples of participants who might wish to demonstrate contractual relationships include:

• (1)    Token holders. Does holding a token give the token holder a contractual right to vote on proposed changes or, for example, to share in the profits of the DAO? Against whom could this right be enforced?

• (2)    Users interacting with a DeFi App.²⁰⁰ In the normal course of things, terms of service would set out the nature of a user’s rights and responsibilities vis-a-vis a business or other organisation with which they are interacting. This may be less clear in the context of a DAO. What rights do users have against “the DAO”, and/or some or all of the DAO decision makers (that is, the token holders and/or developers) if, for example, services are not provided in the way they expect?

• (3)    DAO contributors. A contributor may do something for the pure DAO (such as miners and validators verifying transactions and adding new blocks to the blockchain) in the expectation that they will receive tokens on the completion of their task. Do they have a contractual right to receive the reward? Against whom could they enforce it if the smart contract does not issue the reward as expected?

• 3.101 Pure DAOs rely on code (smart contracts and DLT) to implement and enforce the rules according to which participants interact (including the capabilities associated with the pure DAO’s tokens), automate certain processes and functions and incentivise good behaviour. Pure DAOs also have very limited off-chain activity and often do not seek to rely on law and legal institutions (some actively reject such dependence). As a result, where one might expect a natural language contract to exist to govern a relationship, including in the examples given above, there may just be participants interacting with code or interacting with each other via code. What does this mean from the perspective of contract law? Importantly, it does not necessarily mean that there is no contract; only that the contract may look a bit different to the natural language contracts we are used to seeing.

3.102 As discussed above, questions about the characterisation of a pure DAO and the relationship between participants may only arise retrospectively and in a particular context. A court could be asked to consider whether one or more legally binding contracts exist between participants in a pure DAO. In doing so it will apply the normal rules of contract formation under the law of England and Wales: that is, there must be (a) agreement (offer and acceptance), (b) consideration, (c) certainty and completeness of terms, and (d) intention to create legal relations. ²⁰¹The code in a smart contract can constitute a legal contract, as we discuss in detail in our separate advice to Government on smart legal contracts. ²⁰²Therefore the absence of any natural language documentation will not preclude the existence of a legally binding contract. However, there are other reasons why these requirements might not be satisfied in relation to a particular pure DAO.

3.103 In particular, the intention to create legal relations may be absent. Participants in a pure DAO may see no need to have legally binding contracts because they are confident that the technology will ensure that things will run as intended and therefore contractual liability and recourse to the courts is not necessary. In some pure DAOs participants may articulate their ideological opposition to oversight by courts or a legal regime and state that they do not intend to create legal relations through their interactions. In both situations, the courts may accept that the participants did not intend to enter binding contracts - but a mere statement that no contract exists is not necessarily decisive. Another source of uncertainty as to the existence of a legally binding contract arises where the use of technology may result in novel interactions which do not easily satisfy the requirements. For example, identifying offer and acceptance where unsolicited airdropped tokens are transferred to a public wallet. For readers who would like more detail about how the elements of contract formation can be satisfied in the context of DAOs, we include further discussion in Appendix 5.

3.104 To establish the existence of a contract, it will also be necessary to identify, at least in general terms, the other party. As we have said above, that party must be a legal person but it is possible for a participant or user to establish that they have a contract with one or more developers (for example, particular parties with whom they have been interacting), even if the developer or developers are only identifiable by a public address rather than personal details. ²⁰³There might also be questions of agency as mentioned above - could one developer or participant be regarded as the agent of others, such that they are all co-principals and an action could be brought against any one of them? ²⁰⁴It could be that a general partnership is a party to the contract, or the members of an unincorporated association. This engages the rules about liability of partners/members that we have discussed above.

Legal consequences of the existence of a contract

3.105 If contractual relationships can be identified, this will answer some questions of liability if, for example, there has been a breach of contract that is actionable by a pure DAO participant or third party such as a user of the pure DAO’s services. It may still, however, be challenging to establish exactly what the terms of the contract are if they are not written down (whether in code or otherwise), or to enforce any resulting judgment if participants are pseudonymous.

3.106 Where contractual relationships are consciously created, the terms of the contract are likely to exclude liability for certain things, explicitly or implicitly. For example, a service agreement for users may provide that changes to the code may be made from time to time, including those that may negatively impact upon users, and that the pure DAO (or its participants) excludes contractual liability for loss caused as a result.

Trust arrangements

3.107 A trust arises when one person (the settlor) transfers property to another person (the trustee) to hold for some other person (the beneficiary). ²⁰⁵In essence, trusts are asset management structures and are ways of holding property such that the property’s management is separated from its benefits.²⁰⁶

3.108 For a particular arrangement to be effective as a trust it needs to satisfy the “three certainties” necessary to create a trust under the general law:²⁰⁷

• (1)    certainty of intention;

• (2)   certainty of subject matter; and

• (3)   certainty of objects.

3.109 As we discuss in Chapter 4,²⁰⁸ a hybrid arrangement might actively include a trust as part of its structuring and in general there may be good reasons for trust arrangements to be put in place in respect of crypto-tokens or other objects of property rights. However, a trust does not necessarily need to be set up by a trust deed. It can be created informally, including by an oral declaration in respect of property other than land. ²⁰⁹If a person, by words or conduct, evinces an intention to hold or transfer property to be held for someone else’s benefit, that can be sufficient to demonstrate the intention to create a trust (“certainty of intention”), regardless of whether the word “trust” is used.²¹⁰

• 3.110    Crypto-tokens and most other assets which a DAO might hold in its treasury are capable of being property. ²¹¹They will therefore be capable of being held on trust so long as they can be identified (“certainty of subject matter”).²¹²

• 3.111    For a non-charitable trust to be established in England and Wales, there needs to be certainty as to which persons are intended to benefit from the trust (“certainty of objects”). We do not consider it clear that pseudonymity of token holders would always prevent a trust from arising due to a lack of certainty of objects. We discuss the reasons for this in greater detail in Chapter 4.²¹³

• 3.112    In some circumstances, a pure DAO may be found to include a trust relationship. If control of a DAO’s assets is truly democratic and fully decentralised, it is very unlikely that any trust relationship will exist between participants. Although the word “trust” does not need to be used to generate a trust, one will not be imposed unless there is an intention to create such a relationship. It is unlikely that this can be established where assets are managed and distributed by smart contracts according to the votes and distribution entitlements of token holders. This is because it is not usual for a token holder to intend that they exercise their rights for someone else’s benefit.

• 3.113    However, where token holders delegate management of particular assets to “subDAOs” or “committees” (for example, to a small group with multi-signature arrangements in respect of the treasury), with the expectation that those assets be managed for the benefit of members of the broader DAO, it is possible that those assets could be viewed by the courts as held on trust, applying general principles of trust law.

• 3.114    Whether a trust exists can only be assessed on a case-by-case basis. Not all circumstances in which assets are contributed for investment purposes will constitute a trust. If a right to be repaid (including with interest or a particular return) is maintained, but the contributed assets are otherwise at the free disposal of the transferee, the relationship will be one of contract, rather than trust. ²¹⁴This is because the settlor has not communicated the intention that the assets transferred be held or managed by the transferee for the benefit of someone other than themselves, which, as noted above, is necessary to create a trust. If a person is held to be a trustee with respect to particular assets, they must manage those assets in good faith in the interests of the beneficiaries in accordance with their fiduciary duties and the general law. ²¹⁵The beneficiaries will be entitled to apply to court to ensure that they do so, seeking due administration of the trust.²¹⁶

Joint ownership of assets

• 3.115    It is possible for legal title to objects of property to be held by two or more persons. This can either be as a joint tenancy, where both persons jointly hold title to the entire property, or as a tenancy in common, where each person owns a specified share. ²¹⁷A joint tenancy will arise where there are no indications of an intention to sever the interest in the property and where the “four unities” are present:²¹⁸

• (1)    unity of possession, meaning each tenant is equally entitled to possession of any part of the property;

• (2)    unity of interest, meaning the interest of each tenant is of the same extent, nature and duration as that of the others;

• (3)    unity of title, meaning each tenant holds under the same document or act; and

• (4)    unity of time, meaning the interests all vest at the same time.

3.116 A tenancy in common will arise where there is an indication of an intention to sever in the grant of property, either through explicit words or when construing the document as a whole. It can also arise where an equitable presumption applies or where there is subsequent severance.²¹⁹

3.117 If a pure DAO holds property, it might be characterised not as a form of organisation, but as the participants holding property in one of the ways described above. However, in most cases a pure DAO would not hold property without a specific purpose. Participants usually pool tokens and other property to deploy particular aims. We therefore think it is more likely that some pure DAOs will choose to use joint ownership arrangements as a constituent part of their organisational structuring, and not as a joint ownership arrangement with nothing more.

Arrangements falling short of legally binding contractual agreements etc

3.118 If a pure DAO is not characterised as a general partnership or unincorporated association and there are no legally binding contracts or trust arrangements between the participants, this does not of course mean that they are outside the reach of the law. The relationships between participants, and between participants and third parties will still be subject to other legal analyses and so participants may still have liability, for example, in torts such as negligence, ²²⁰by way of fiduciary duties,²²¹ or unjust enrichment. ²²²Criminal and regulatory law will also still apply.²²³

3.119 In all such cases it will be necessary to establish the relevant facts giving rise to legal liability according to existing rules. The novel questions to which pure DAOs give rise will concern which legal person or persons can be pursued or held responsible. This will potentially give rise to questions such as whether there are agency relationships between different participants, or whether the requisite grounds for vicarious liability are made out on the facts.²²⁴ Questions of private international law may also arise where participants are in more than one jurisdiction.²²⁵

FIDUCIARY DUTIES FOR SOFTWARE DEVELOPERS?

3.120 One question currently being asked in the market is whether software developers owe fiduciary obligations to users of their software and owners of cryptoassets manifested by that software. This question has received attention as a result of the recent Tulip Trading litigation, which concerned software developers albeit not in the context of a DAO.²²⁶

3.121 Put (very) simply, a fiduciary is an individual upon whom the law imposes an obligation of “single-minded loyalty” to another — their principal. This obligation exacts a unique and significant constraint on the fiduciary’s personal autonomy. Importantly, it forbids any self-interested behaviour by the fiduciary, where the fiduciary’s personal interests conflict with their duty to their principal. The remedy for breach of a fiduciary obligation is not designed to repair any harm to the principal; rather, it generally requires the fiduciary to disgorge the disloyal benefits the fiduciary has acquired. Such obligations are imposed in certain settled categories of relationship, such as between trustee and beneficiary or between partners in a partnership (and exceptionally in other cases), in order to give the principal the protection the relationship demands. Development of fiduciary duties outside of these categories may occur but is uncommon.²²⁷

3.122 Given the significance of software in the crypto ecosystem including DAOs, it gives rise to questions such as the potential liability of developers to users of the software and/or owners of cryptoassets that rely on that software. Below, we look briefly at the power that developers have to change software generally and in the DAO context. We then consider the duties and liabilities to which this might give rise, focusing on fiduciary duties.

Developer publishing power and its limitations

3.123 In general, developers exercise a very significant power over software: the ability to publish that software in the first place and the ability to change it on an ongoing basis.²²⁸ Where complex software is published on an open-source basis, there might be more than one developer who has the power to publish (or publish updates to) that software. However, even where developer software publishing power is held by more than one developer, it tends to remain centralised in a relatively small number of developers. For example, only a few individuals have “merge authority” over the official code repositories for Bitcoin Core and Geth.²²⁹

3.124 For the purposes of this paper we focus only on developer publishing powers in relation to open-source code (as opposed to closed-source code),²³⁰ because DAOs make use of at least some form of open-source code. One of the primary purposes of open-source software is to distribute it widely to facilitate and encourage further development and iteration of that code. ²³¹Therefore, it is generally expected — and is in general also a good thing — that open-source code is updated throughout its lifecycle. Developer software publishing power must therefore be exercised at some point in that lifecycle. This means that there is inevitably some level of discretion on the part of developers as to how to exercise that software publishing power.²³² Conventionally, developers have considerable control over the content of software that is developed and released. This is neither surprising nor novel: developers have designed and published open-source software for many years.

• 3.125    Outside of a DAO context, developer software publishing power is limited to the ability to publish software to a public open-source repository. For example, in general (that is, outside of the DAO context), a developer does not have the power to push a software update to the participants who can choose whether (or not) to run the software as part of the network. Nor does a developer have the power otherwise to compel persons who choose (not) to run the software to adopt a software update.

• 3.126    In practice, this means that the broader community of participants that run the opensource software, such as miners / validators, exchanges, individuals, and other developers that build on top of networks, also have some degree of power. ²³³The users must voluntarily and affirmatively accept any new version of the software.²³⁴ While new versions of software are highly influential, participants also have a real and viable alternative: they can continue to run the prior version of the open-source software. ²³⁵Significantly, this means that developers lack the ability to operationalise changes alone.

• 3.127    In the DAO context, the situation is slightly different. Because a DAO is founded on its smart contracts, any changes to those contracts will take effect for all participants/users. If someone does not like the changes, their principal option is to exit the DAO, for example by divesting themselves of their tokens or by otherwise not dealing with the DAO any further. This is sometimes known as “rage quitting”.²³⁶

• 3.128    However, the ability of developers in a DAO to change the code in the first place should be curtailed by the governance rules of the DAO; that is, developers should not generally make changes unless the change has been proposed and voted on according to the governance rules. Developer power might also be limited by the technology. It may be that votes on whether to change the smart contracts are conducted on-chain and that the options are pre-coded, so that the results of a vote are implemented deterministically by the code rather than manually by developers. However, this will only be possible with some types of votes, whose results are preprogrammable (such as, for example, a vote to change an interest rate in a DeFi protocol). Other types of votes will necessarily concern more complex or nuanced changes which have to be effected manually. In such cases, the results of a token holder vote are effectively the developers’ mandate to change the code in accordance with the vote.

• 3.129    Limits on developer power in a DAO may change over time. For example, the founders/core developers may retain a lot of control at the outset, gradually relinquishing it as the DAO beds in and as tokens are issued to other participants giving them the right to vote. Of course, if the developers retain a large proportion of the issued tokens then in fact they will retain a lot of the voting power and therefore de facto power over the code.

A developer fiduciary obligation?

• 3.130    In Tulip Trading, ²³⁷the High Court and the Court of Appeal considered whether a software developer of open-source software used by network participants in four Bitcoin networks might owe a fiduciary duty to owners of the assets (such as bitcoin)

in that system. The case did not concern a DAO, however, it is still of some relevance because of its consideration of the existence of fiduciary duties for developers in the crypto ecosystem.

• 3.131    In that case, the claimant alleged that it owned certain bitcoin associated with two public addresses, and that the private keys to access those bitcoin (that is, to transact or perform other operations in respect of those bitcoin within the system) were inaccessible due to a hack. ²³⁸The claimant alleged that the defendants, as software developers, controlled the systems upon which the bitcoin existed and thereby owed fiduciary duties to the claimants.²³⁹

• 3.132    While breach of a fiduciary obligation can give rise to the remedy of disgorgement of profits, ²⁴⁰the claimant in Tulip Trading did not seek disgorgement of profits (likely because no profit was made by developers). Instead, the claimant sought an order that the defendants take certain steps which would effectively restore control of the claimed bitcoin to the claimant — a remedy which falls outside the scope of remedies for breach of fiduciary obligation. Unlike in most well-recognised status-based relationships which give rise to fiduciary obligations, in Tulip Trading there was no entrustment of property from the owners of bitcoin to the developers. ²⁴¹Instead, the basis of the claimant’s claim was that no person (except possibly the alleged hacker) had access to those bitcoin due to a hack.

• 3.133    These issues were considered as part of a procedural question as to whether service out of the jurisdiction against the defendants was permitted so that the substantive claim could be brought before the courts of England and Wales. The facts and merits of the substantive claim were therefore not fully considered by either the High Court or the Court of Appeal. However, in allowing the claimant’s appeal and allowing the claimant to effect service out of the jurisdiction, the Court of Appeal did find that there was an arguable case that a developer might owe an obligation of single-minded loyalty to the users of bitcoin software. In particular, the Court of Appeal found that there was an arguable case that:²⁴²

The content of the duties includes a duty not to act in their own self interest and also involves a duty to act in positive ways in certain circumstances. It may also, realistically, include a duty to act to introduce code so that an owner's bitcoin can be transferred to safety in the circumstances alleged by Tulip.

• 3.134    If a developer exercising developer software publishing power could have a fiduciary obligation imposed on them for doing so, then that might theoretically also be true of a DAO or its participants that either exercised similar power or provided oversight or checks on that power.

• 3.135    The current law of England and Wales does not recognise such a developer fiduciary obligation. Indeed, as the Court of Appeal noted:²⁴³

For [the claimant’s] case to succeed would involve a significant development of the common law on fiduciary duties.

• 3.136    As the Court of Appeal acknowledged, the strength of the arguments in favour of a developer fiduciary obligation is likely to be highly fact-specific and differ significantly depending on a variety of factual considerations, including the nature of the protocol, network, blockchain system, smart contract and/or token in question, as well as their respective levels of decentralisation. ²⁴⁴Other factors that are likely to be material are the terms of any relevant licence(s), and the extent to which developers have relinquished practical and legal control over core parts of the protocol, network, blockchain system smart contract and/or token in question.

• 3.137    There is little to suggest that such a development would be a positive one from a legal or practical perspective. ²⁴⁵The lack of proximity between a developer and an owner of bitcoin ²⁴⁶and the significant limits on developer publishing power ²⁴⁷discussed above are likely to make an obligation of “single-minded loyalty” to a particular owner (or class of owners) extremely difficult to describe and delineate. In particular, the way in which developer publishing power works (and is limited) encourages and incentivises developers to act in their own interests (or at least in accordance with their own mind) when developing and publishing code. Developers do not in general act or participate in a relationship that requires self-denial or that owners’ interests are placed ahead of their own.²⁴⁸ Moreover, even if such an obligation of “single-minded loyalty” to a particular owner (or class of owners) did exist, it would likely lead to intractable conflicts for developers, given the potential multiplicity of their interests.

• 3.138    In the context of a DAO, the developers’ publishing power is further limited by the distributed control effected by token holder voting. And by the nature of a DAO, which the developers may have set up with a particular commercial or other goal in mind, it would seem inappropriate to impose fiduciary duties which would forbid the exercise of self-interest where the risk of conflicting interests is obvious. The same arguments apply in respect of DAO token holders. Although there might be alternative arguments in respect of DAOs, we have discussed in this chapter various other ways in which a DAO or its participants might be held liable for actions causing loss, which are likely to be sufficient.

3.139 Tulip Trading was discontinued by the claimant in April 2024. ²⁴⁹Although this of course alleviates the threat of liability for the relevant developers, it means that the High Court will not consider the issue in more detail. Clarification of the existing common law position in respect of fiduciary duties of the type that may have resulted from Tulip Trading would likely help make England and Wales a more legally certain jurisdiction for market participants to use open-source code to structure their organisations and operations. The potential imposition of fiduciary duties is particularly important for contributors to the ongoing development of open-source software, including those in the crypto ecosystem and DAOs. The imposition of fiduciary duties in these circumstances would likely have a major chilling effect, and potentially be extremely destructive, for open-source software development in the jurisdiction.²⁵⁰ Developers of open-source software protocols would benefit from clear guidance as to their legal position, but this would go significantly beyond the scope of our current work. Lack of certainty on this issue could significantly reduce the willingness of software developers/engineers to contribute to technological developments under the law of England and Wales.²⁵¹

Providing clarity on the scope for fiduciary duties of software developers

• 3.140    While any decision on the matter that the High Court might have made in Tulip Trading would have been highly fact-specific, a judgment would have presented an opportunity for the court to review in detail the law of fiduciary duties and to consider how it could be applied to developers of open-source software. The common law analysis of this point will now be delayed until future litigation provides the appropriate vehicle.

• 3.141    Although the issue is not specific to DAOs or even to DLT/smart contract-based software development, it is clearly of relevance to the potential liability of DAO developers (and possibly even other DAO participants) and their willingness to operate in this jurisdiction. Given the uncertainty left by the questions raised in Tulip

Trading, we have considered whether and how further clarification could be achieved on this matter.

• 3.142    We do not think that the mere fact of being a developer of open-source software (whether in a DAO or otherwise) could or should give rise to fiduciary duties. There would be no policy or legal justification for such a characterisation merely on the basis of the act of software development (without something more in terms of the particular relationship between particular parties), and it would have a severely chilling effect on the development of open-source software. We do not think therefore that there is a case for the introduction of a statutory fiduciary duty on software developers. Rather, we think this is properly a matter for the common law, and that, just as in non-DAO situations, the application of existing legal principles might, in some specific situations, lead to a particular developer or group of developers being found to be a fiduciary in a particular set of circumstances. We think such situations are likely to be very rare.

• 3.143    We think it would be helpful for someone - whether the courts (for example, through a test case²⁵²) or perhaps a body such as the UKJT - to set out the existing law of fiduciary duties and consider - in general terms - whether and when developers might be acting in a position of power that could equate them to, for example, directors of a company or trustees of a trust such that the imposition of fiduciary duties might be appropriate and legally sound. This question is perhaps particularly relevant to developers in DAOs who may be in a position to encode and change the rules for an organisation. Even with such guidance, how the law applied in any particular case would have to be a fact-specific decision.

Next steps

• 3.144    Consideration should be given as to whether a fuller analysis on the applicability of the law of fiduciary duties to software developers could be conducted to temper the possible chilling effect of Tulip Trading.

• Chapter 4: Hybrid arrangements

• 4.1    The “pure DAOs” we have discussed in Chapter 3 represent the origin and the core of the ideological concept of a DAO. Indeed, some industry commentators maintain that only exclusively on-chain, smart-contract governed, decentralised and “trustless” organisations are worthy of the name. However, some DAOs have nevertheless chosen to use legal entities in their structures. In this paper we refer to these as “hybrid arrangements”.

WHY DO DAOS USE LEGAL ENTITIES?

• 4.2   The objectives of many DAOs (in the broader sense), be they financial, cultural,

charitable, or technical, still require engagement with existing legal and social structures for regulating economic activity. As explored in the previous chapter, choosing not to adopt an organisational form designed for participation in these structures can leave participants in pure DAOs exposed to uncertain or unexpected liabilities. Choosing not to choose does not necessarily render a DAO alegal, but rather exposes it to an uncertain characterisation as, potentially, a purely contractual arrangement, a general partnership, or an unincorporated association. ²⁵³This characterisation can then result in a greater imposition of the legal system, in terms of potential liability of participants, than if the DAO voluntarily adopted a more considered legal structure. In some circumstances, this may include DAO participants intentionally structuring their relationship through a partnership agreement or an association agreement. However, to avoid the liability risks and mutual duties which involvement in such entities - particularly general partnerships - entails, many turn instead to incorporated legal entities.

• 4.3   Stakeholders, particularly law firms advising DAOs, have told us that many in the

industry are moving towards using incorporated entities to perform certain activities and functions within a DAO. This is known as “wrapping”. Adoption of a “legal “wrapper” can facilitate a DAO’s ability to protect its members from liability and interact with the off-chain world. ²⁵⁴As well as advantages, there are trade-offs resulting from the use of distinct legal entities. The most significant advantages are the limited liability of members and a separate legal personality for the “DAO”. These can not only limit the liability of members to their contribution, but also facilitate off-chain transactions (from holding property and entering contracts to simply opening a bank account), promote counterparty confidence, improve legal predictability and, depending on the form chosen, achieve tax advantages (including increased certainty about applying tax rules).

• 4.4    The costs of adopting a distinct legal form are that most of them were not designed with DAOs in mind, and at first glance require a degree of centralisation, identifiability and accountability that are inconsistent with a DAO’s core operating model and ideology. This challenge of “DAO-entity fit” means that even legislative attempts to introduce DAO-specific entities have been forced to make trade-offs. Even so, the popularity of a variety of legal entities on offer internationally for use in DAOs suggests that these trade-offs are not a deal-breaker for all DAOs.

• 4.5    This chapter considers in more detail why DAOs would make use of distinct legal entities in their structure, what obstacles arise from the problem of DAO-entity fit, and what structuring varieties are common, depending on the DAO’s purpose. We then consider what legal entities in England and Wales could best meet a DAO’s objectives, before considering options internationally. In the following chapter, we consider whether any changes or additions to the available options could make this jurisdiction more attractive to DAOs and digital legal entities, while maintaining the integrity of the business organisation landscape.

Separate legal personality and limited liability

• 4.6    As “DAOs” have developed as an omnibus concept, growing in size and sophistication and increasingly interacting with the off-chain world, their activities and legal implications have begun to look a lot more like those of traditional organisations. Many of the challenges faced by DAOs are therefore not unique.

• 4.7    As we have explained in Chapter 3, a partner in a general partnership is part of an association of individuals, each presumptively exposed to personal liability for the losses of the partnership. The same can be true of individuals in an unincorporated association or those bound by contract, depending on the terms of their agreement. Even where no contractual relationship exists, individuals acting together could still be exposed to liability; for example, in torts such as negligence, or by way of fiduciary duties, unjust enrichment or under a trust. This makes such ventures risky for the individual, who potentially risks losing far more than the amount they have invested in the endeavour: all their personal assets could be exposed. Additionally, without a discrete recognised legal identity, many common operational activities - hiring employees, contracting with services providers, compliance, and payment of tax - can become practically challenging.²⁵⁵

• 4.8    Solutions to many of these challenges have been developed in this jurisdiction over the past 200 years, and in many others. To mitigate the risk of unlimited personal liability, ²⁵⁶most business enterprises seek some form of limited liability, usually by operating through an entity with separate legal personality.²⁶³ Certain entities created and recognised by law - again most notably companies²⁶⁴ - are given separate legal personality through incorporation. The act of incorporation creates a legal “person” having a discrete legal identity subject to its own rights and duties separate from the individuals who set it up and participate in it: its owners, managers, and employees.²⁶⁵ Each is regarded as a distinct person in law.²⁶⁶ Separate legal personality provides an entity with capacity to own property,²⁶⁷ conduct business,²⁶⁸ enter into contracts,²⁶⁹ be regulated, pay tax, commit torts,²⁷⁰ incur liabilities and be a claimant or defendant in legal proceedings - that is, to sue or be sued.²⁷¹

The legal recognition of an entity as having its own personality also allows those involved to limit their liability. The limited company rose to prominence more than a century ago.²⁷² Liability could be limited in two ways:²⁷³ either by reference to a member’s shareholding (in the case of companies limited by shares)²⁷⁴ or by a statutory undertaking by a member to contribute to the assets of the company (in the case of companies limited by guarantee).²⁷⁵

The two are often tightly coupled. In England and Wales, Private Fund Limited Partnerships have limited liability but are not incorporated, so lack separate legal personality. Conversely, unlimited liability companies are incorporated but lack limited liability: Companies Act 2006, s 3(4). See R Harris, “A New Understanding of the History of Limited Liability: An Invitation for Theoretical Reframing” (2020) 16(5) Journal of Institutional Economics 643, 650 (legal personality created ‘asset partitioning’-corporations owning and managing assets-but pre-dated ‘asset shielding’ (or limited liability) in insolvency). Entities in other jurisdictions are discussed below.

An exception, albeit comparatively uncommon, is the “unlimited liability company” that is incorporated with separate legal personality but without limited liability: Companies Act 2006, s 3(4). The Limited Liability Partnership is an incorporated entity with separate legal personality: Limited Liability Partnerships Act 2000, s 1.

Salomon v Salomon & Co Ltd [1897] AC 22 (HL) at 51.

In re the Sheffield and South Yorkshire Permanent Building Society (In Liquidation) (1889) 22 QBD 470 at 476 (Cave J): an incorporated entity, such as a company, has “a legal persona just as much as an individual”.

Macaura v Northern Assurance Co Ltd [1925] AC 619 (HL) at 630, Lord Sumner; Lonrho v Shell Petroleum Co Ltd [1980] QB 358 (CA) at 362, 365-366 per Shaw LJ aff’d Lonrho v Shell Petroleum Co Ltd (No 2) [1982] A.C. 173 (HL).

Gramophone and Typewriter Limited v Stanley [1908] 2 KB 89 at 105-106.

Hazell v Hammersmith and Fulham LBC [1992] 2 AC 1, at 39F; Lee v Lee’s Air Farming Ltd [1961] AC 12 at 25.

By being vicariously liable for the acts of its agents/employees: Lister v Hesley Hall Ltd [2001] UKHL 22.

Adams v Cape Industries plc [1990] Ch 433 at 536; The Albazero [1977] AC 744 at 807.

Following the introduction of the Limited Liability Act 1855 (later replaced by the Companies Act 1862 that laid the foundations for the Companies Act 2006). For a detailed history, see J D Turner, "The Development of English Company Law Before 1900" (2017) Queen's University Centre for Economic History Working Paper Series, No. 2017-01 cf R Harris, “A New Understanding of the History of Limited Liability: An Invitation for Theoretical Reframing” (2020) 16(5) Journal of Institutional Economics 643 (arguing full limitation of shareholder liability is of more recent origin).

Companies Act 2006, s 9(2)(c).

Companies Act 2006, ss 9(4)(a) and 10.

Companies Act 2006, ss 9(4)(b) and 11.

• 4.10    A member of a general partnership incurs liability for all debts and obligations of the partnership during the term of membership, regardless of any agreement to the contrary between the partners. In contrast, a member of a company is generally not liable for the company’s debts or anything beyond the amount that they have invested in the company.²⁵⁷

• 4.11    Limited liability is often viewed as the defining attribute of the corporation and fundamental to a capitalist economy.²⁵⁸ Although now ubiquitous, this was once a radical departure from the traditional view that the owner of a business must take responsibility for its debts. ²⁵⁹The risk of moral hazard is clear: an entrepreneur who is not liable for the full consequences of their actions may be incentivised to take undue risk; risk that may be shifted from owner to creditor. ²⁶⁰Various explanations have been advanced for the vital role of limited liability in economic growth, including encouraging capital formation, ²⁶¹improving commercial efficiency, ²⁶²and facilitating market liquidity. ²⁶³Notably, limited liability may, theoretically, reduce agency costs²⁶⁴ by decreasing the need to monitor agents and other shareholders as well as providing a means for members/principals to divest their interests to others.

• 4.12    Limited liability has been described as a “privilege”,²⁶⁵ to be exercised subject to creditor safeguards. For members, the privilege is that any loss is limited to the amount of capital they have invested in the company (that is, the amount they have paid, or have agreed to pay, for their shares). If the company goes into liquidation, the members are only liable up to this amount. They are not liable for anything more, such as the debts of the company or the costs of the liquidation.²⁶⁶ Creditors cannot pursue them individually.

• 4.13    In return, creditors are provided with transparency. Therefore, under the law of England and Wales, to obtain limited liability status, a company must be registered with the state.²⁶⁷ It must file annual accounts and disclose the names of its directors as well as, more recently, “people with significant control” (or “beneficial owners”).²⁶⁸ The documents that provide the membership ²⁶⁹and constitution ²⁷⁰of the company are also publicly available.²⁷¹ The details of how these disclosures are made have changed over the years and differ between the many available types of legal entity. As well as different structures for business ventures, there is also a range of legal entities available for non-profit or member-based endeavours.²⁷²

• 4.14    However, despite the many variations, the basic principle remains: limited liability is provided in return for obligations of disclosure, ²⁷³primarily for the protection of third parties, including tax authorities, as well as other reasons of public policy. This contrasts with, for example, foundations in the Cayman Islands and Panama, which provide greater levels of anonymity for participants.²⁷⁴

• 4.15    Limited liability can play a role in a business’ competitiveness and functionality in the broader economy, but, as demonstrated in recent litigation in the US, cannot be simply assumed to exist in relation to DAOs.²⁷⁵ Below, we consider to what extent the advantages and trade-offs relating to limited liability status can be reconciled with other features of DAOs, at least as originally conceived.

A simple example

• 4.16    Let us return to the example of Alinie, Bartek and Clara, the software developers launching a DAO who we met in Chapter 3. They decide that they want to explore the possibility of a hybrid arrangement for their DAO because they are concerned about potential liabilities and also want to protect some intellectual property.

• 4.17    They know that using legal entities can help them but they are mindful that a hybrid arrangement may require some centralisation and loss of autonomy. They identify what is important to them and what aspects of the ideology underlying DAOs they are willing to depart from (the trade-offs they are willing to make). They then talk to some advisors who suggest an out of the box solution of legal entities which has proved popular with some of their other clients. They consider the suggestion but decide instead to work with their advisors (lawyers and tax advisors) to develop a bespoke structure.

• 4.18    Their chosen structure uses legal entities strategically, taking into account their personal take on the DAO philosophy, their desire to protect themselves from personal liability and protect their intellectual property, and the business needs of the DAO.

THE ISSUE OF DAO-ENTITY FIT

• 4.19    How can a DAO secure the legal and commercial advantages of limited liability and separate legal personality while staying true to its novel operating model? This is the central question underpinning DAOs’ use of distinct legal entities, and the answer will vary depending on a DAO’s industry, whether it is a business or non-profit, its priorities and the extent of its commitment to decentralisation and a “trustless” system. One market participant has suggested that: ²⁷⁶

[i]n evaluating a desirable jurisdiction and entity type [...] maintaining the benefits of a DAO and limiting trust in anything other than code should be primary considerations.

• 4.20    This quotation emphasises the priorities of DAOs as initially conceived, but the reality is much more variable and these goals may ultimately be compromised to accommodate other practical considerations. While different DAOs will place different weights on different concerns, generally, a DAO is likely to seek many of the following objectives when considering how it will structure itself:

• (1)    limiting the liability of participants: principally developers, users, and token holders;

• (2)   enabling off-chain activity such as the employment of developers and the

ownership of off-chain property;

• (3)    maximising the degree of decentralisation and autonomy by limiting the control of: (i) managers; (ii) any individual entity and (iii) state involvement in formation and ongoing operations (such as reporting obligations);

• (4)    facilitating, or at least not unduly inhibiting, the transfer of governance interests of token holders;²⁷⁷

• (5)    facilitating pseudonymity of participants;

• (6)    accommodating the DAOs’ preferred governance mechanics, whether these involve on-chain voting by token holders or some kind of off-chain decision making forum;

• (7)    providing a suitable basis for complying with any regulatory compliance requirements;²⁷⁸

• (8)   enabling distributions to members where relevant to the purpose of the

arrangement; and

• (9)    minimising tax risks for participants so that they can understand their tax liabilities and, where applicable, identifying an entity that is liable for, and capable of, paying tax.

• 4.21    It is not clear that any one legal structure can achieve all of these objectives in equal measure. In response to our call for evidence, Coalition of Automated Legal Applications (COALA) and BlockchainGov (in a joint submission) told us:

Attempts by DAOs to use legal wrappers are often ineffective and generally fit poorly so a sense of legal certainty is not necessarily achieved from their use [...] The requirements and duties imposed by the legal wrapper do not necessarily match the DAO’s behaviours and operations, or the legal wrapper applies to some things but not all aspects of a DAO and thus does not offer the comprehensive container to understand a DAO’s activities as it does for a traditional organisation.

• 4.22    Most legal entities are designed for centralised operations. Taking advantage of their benefits - most notably separate legal personality and limited liability - requires acceptance of what might be considered by some to be trade-offs that are at odds with the core tenets of DAOs discussed in Chapter 2. Examples include:

• (1)    Many legal entities require specific authority to be placed with particular individuals, such as directors or designated members. This limits the extent to which the DAO can remain wholly decentralised.

• (2)    Registration with the state in exchange for the benefits of legal personality generates disclosure obligations in respect of membership, persons of significant control, and officer identities. This militates against the usual pseudonymity and often transient nature of DAO participants, particularly token holders.

• (3)    In creating jurisdictional ties, registration could also have implications for the extraterritorial and borderless nature of DAOs, potentially centralising decision making in specific jurisdictions.

• 4.23    However, as noted above, there are a variety of legal forms available internationally which have been adopted by DAOs as part of their structure. This suggests that the preservation of some key novel features of DAOs combined with acquisition of useful legal attributes is an achievable middle ground for some DAOs.

Structuring varieties

• 4.24    What are the different ways in which a DAO can integrate distinct legal entities into its structure? Just as with the degree of decentralisation of DAOs generally, use of a distinct legal entity is not “all or nothing”. A distinct legal entity may be used strategically to carry on a particular project or carry out a particular function, like governing the DAO treasury to facilitate the DAO’s interaction with off-chain counterparties. Alternatively, an entity could operate as a “full wrapper”, encompassing the entire DAO and defining the token holders’ interests in the legal entity by reference to their interests in the DAO.

• 4.25    Some arrangements might use a domestic single-company structure; others may be more akin to sophisticated transnational structures using multiple jurisdictions and entity types: fundraising entities may take one wrapper, while token issuers, or member collectives, another.

• 4.26    As we discussed in Chapter 2, hybrid arrangements can fall over a wide spectrum in terms of their level of decentralisation and autonomy. As the discussion below seeks to demonstrate, the level of decentralisation and autonomy can vary within and between full wrappers, partial wrappers and DAO-adjacent entities depending on which distinct legal entities are used and the rules with which they are implemented.

Full wrapping

Diagram 2: A fully-wrapped DAO

The components used above are indicative and non-exhaustive examples that may be used.

The actual composition and functionality of the smart contracts will be fact specific.

• 4.27    A DAO may use a legal form or legal entity to wrap itself fully. Typically, a legal entity will be chosen which has separate legal personality from its members and affords limited liability to its members. By being entirely wrapped, the legal entity effectively is the DAO for the purposes of its activities: the latter is encompassed within the former. Typically, this means that all members of the DAO (principally the token holders) will also be members (for example, shareholders) of the entity and will therefore have the usual limited liability protections of members of incorporated entities.

• 4.28    Limited liability will be afforded to token holders acting in their capacity as members of the legal entity, rather than because they hold tokens in the DAO in and of itself. For the purposes of the activities carried on by the legal entity, participants in the legal entity will only have the decision-making power that entity grants them under law. Voting on-chain by token holders can be influential but it will not be the formal decision-making process unless that is authorised by the governing documents of the legal entity, which in the case of, for example, a company limited by shares in this jurisdiction, is unlikely to be possible. Tokens are not shares or tokenised securities. Token holders will still need to be shareholders or otherwise appointed to a decisionmaking role within the entity to be directly involved in governance and directly exercise decision-making powers.

• 4.29    As identified above, some factors associated with the use of legal entities are fundamentally at odds with the DAO concept. Where the entity and the DAO are, effectively, the same thing, this is particularly acute. The act of fully wrapping the DAO is effectively an explicit recognition and acceptance of these consequences.

  Partial wrapping and DAO-adjacent entities

  Diagram 3: A partially-wrapped DAO

  
  
  
  

• 4.30    A “partial wrapper”, as the term suggests, does not encompass the entire DAO. This structure allows for a legal entity to wrap a part of the DAO that undertakes certain activities, such as acting as token issuer/seller or conducting off-chain activities such as holding certain assets. ²⁷⁹For example, a component managing the treasury may be wrapped while allowing other parts of the DAO to be wrapped in a separate entity or remain unwrapped.²⁸⁰

• 4.31    By contrast with a full wrapper, some or all of the activities in a partially wrapped DAO are undertaken by the legal entity, but the DAO’s token holders are not necessarily members of the entity. Consequently, acts of the entity and those of each of the DAO token holders are acts of separate legal persons. DAO participants therefore cannot directly benefit from the limited liability afforded to the entity. The partial wrapper may provide a means of indirect protection from liability by performing certain operations of the DAO, as opposed to these actions being carried out by the DAO through the votes of its token holders. In this sense it acts as a way of siloing or isolating parts of the DAO that present particular risks or which can use structures to optimise operations; for example, a purpose trust holding intellectual property or issuing tokens for grants. This use of an entity can also push taxable activities into favourable jurisdictions in a manner similar to traditional organisations. However, there may be questions about the nature of the relationship between the entity and the software/participants that make up the “residual” part of the DAO. It will also be important to consider what, if any, control the members of the DAO can have in respect of the legal entity, and the liability consequences that could result. The use of partial wrappers therefore involves distinct but often as severe trade-offs as those faced when using a full wrapper. Since not all DAO participants will govern all activities, decentralisation is far from assured.

• 4.32    DAO-adjacent entities achieve a similar functional result to partial wrappers but have a more specific justification, namely, the preservation of DAO governance where possible. DAOs taking this approach are similar to partially wrapped ones in their use of distinct legal entities as special purpose vehicles in which the DAO participants may not have a direct interest. But the purpose of a DAO-adjacent entity is to be an intermediary, a distinct legal unit designed for carrying on specific activities but ultimately subject to the governance of the whole DAO.²⁸¹

• 4.33    Delphi Labs refers to these entities as “BORGs”: a form of entity that is enhanced by utilising DAO-connected smart contracts so that it is “legally governed by autonomous technologies through tech-specific rules implanted in their charter documents”.²⁸² These forms of arrangement use the concept of “code deference” to link the DAO as a governance mechanism with the governing documents of the entities in question.²⁸³ An illustrative example of the objective is that provided by Brummer and Seira:²⁸⁴

• [A] corporation could revise its charter and bylaws to provide that, to the extent possible under law, the results of the DAO’s smart contract protocol are determinative of the rights and obligations of the shareholders.

• 4.34    A DAO-adjacent entity, then, can be viewed as a specific type of partial wrapper designed to separate the organisation that interacts with third parties off-chain (and its assets) from the DAO, which operates exclusively on-chain. Accountability to the DAO is maintained through code deference enshrined in the governing documents of the entity, although the extent of this may be necessarily limited by any mandatory rules of the entity form used.

• 4.35    For some commentators, this is an appealing way to achieve some of the benefits of wrappers while preserving the conceptual integrity of the DAO.²⁸⁵ Nevertheless, all structures come with trade-offs: formal code deference may increase the risk that DAO participants intended to be shielded from liability, not being members of the distinct legal entity, are nonetheless deemed to control it and be exposed as a result.²⁸⁶

DISTINGUISHING DIGITAL LEGAL ENTITIES

Diagram 5: A digital legal entity

Members

The Legal Entity

The components used above are indicative and non-exhaustive examples that may be used.

The actual composition and functionality of the smart contracts will be fact specific.

• 4.36    A “digital legal entity” in our terminology refers to an incorporated legal entity which has been digitised such that certain governance or operations of the entity which may otherwise have been performed by humans are replaced or augmented using distributed ledger technologies and smart contracts. It is not driven by the DAO ideology of decentralisation and autonomy and, unlike a hybrid arrangement, there is no residual token-based decision making outside the legal entity.

• 4.37    For example, if companies are authorised to issue shares as tokens recorded on a blockchain, that would suggest the company is moving towards being, or being operated as, a digital legal entity. ²⁸⁷A digital legal entity can be distinguished from a DAO fully-wrapped as a company, which would issue shares alongside DAO governance-tokens that exist exclusively on-chain. In a sense, the concepts are the inverse of one another: a fully-wrapped DAO uses a company to facilitate its off-chain interactions and limit the liability of its members; a digital legal entity (in this example a company) tokenises its shares and share register to benefit from the efficiency advantages of decentralised technology. All the while, however, the organisations operate very differently: the company (at this stage) is still centralised with a board of directors, and the DAO’s conduct is still driven by its smart contracts as varied by governance token holders who likely exercise similar control over the entity. We briefly discuss options for reform that could facilitate the digitalisation of existing legal entities in Chapter 5.

DOMESTIC OPTIONS

• 4.38    In this section we discuss the legal forms and legal entities available in England and Wales that could be used by DAOs as part of a hybrid arrangement. We do not consider every available legal form and legal entity, only those that are commonly used in this jurisdiction or that may be attractive for DAOs. We discuss the attributes of each and any challenges that can arise relating to DAO-entity fit.

Companies

• 4.39    The framework for company law in England and Wales is set out in the Companies Act 2006. The Act provides for limited companies (which we discuss below), community interest companies (which we discuss from paragraph 4.54 and overseas companies²⁸⁸ (which we do not discuss further in this paper). Companies established under the Act must be incorporated, that is, they must comply with certain registration requirements and become registered with Companies House.

• 4.40    Limited liability companies under the law of England and Wales are either limited by shares or by guarantee. ²⁸⁹A company is limited by shares if its members’ liability is limited to the amount, if any, unpaid on the shares held by them. A company limited by guarantee limits the liability of its members by way of an undertaking to contribute to the assets of the company in the event of it being wound up.309A company limited by guarantee, unlike that limited by shares, will not obtain its working capital from its members. It also cannot, because of the absence of share capital, distribute dividends. As such it is generally seen as more suited to non-profit purposes.

• 4.41    In this chapter we are primarily concerned with how legal forms and legal entities are used by DAOs with hybrid arrangements. However, we note here that companies are often used in the early stages of developing smart contracts for DAOs which may go on to be pure DAOs rather than hybrid arrangements. These developer corporations (“DevCos”) are used to hire software developers to develop the initial DAO software, and typically retain control over certain aspects of the smart contracts themselves. In a pure DAO, when the governance smart contracts are activated, control of the smart contracts is typically passed from the DevCo to the DAO token holders.²⁹⁰ The DevCo may continue to exist once the pure DAO is in operation, but outside the pure DAO as a service provider which can be instructed by the pure DAO if necessary to update to the code of the smart contracts. In a hybrid arrangement, a DevCo could sit within the DAO’s structure and retain decision making powers in relation to the code. While many DevCos are established as Delaware C-Corps (which is a standard practice for US venture capital funded enterprises), there is no reason why a company incorporated in England and Wales could not be used instead.

• 4.42    Below we consider, independently of DevCos, how companies incorporated under the law of England and Wales are one potential candidate for fully wrapping a DAO.²⁹¹ The governance process of a company is governed by its articles and statute. While the articles and resolution procedures provide an opportunity for members to establish and operate governance practices that reflect a degree of fit with the objectives of the DAO, companies present the paradigm example of the entity-fit challenges introduced above. The scope of mandatory rules, the default position in the articles, the activities requiring special resolutions, and the engagement of DAO members are all constraints on their suitability for DAOs. The ability for members to compel directors to take or refrain from taking certain actions against the exercise of their general power to operate the company may therefore be significantly curtailed.

• 4.43    Starting with the most obvious problem, companies are required to have at least one director (whose personal details such as name and address must be declared).²⁹² This requirement for directors requires a degree of centralisation that is a poor conceptual fit for DAOs. Companies must also keep a register of members,²⁹³ and declare information about any person or entity with significant control over the company.²⁹⁴ As touched on above, this is at odds with the pseudonymous nature of DAO membership. Certain acts - statutory disclosures, for example - can only be made by the company through its directors, not by its members. Companies are also required to make a number of returns to Companies House, including annual accounts (unless exempt) and notification of the creation of a charge or mortgage, and notification of certain changes including of registered office, company name, director or a director’s personal details. Again, this may challenge the DAO ethos.

• 4.44    The introduction of the company as a wrapper prescribes a legal change to the governance dynamics that would otherwise exist in a DAO.²⁹⁵ In particular, it gives rise to issues concerning the involvement of members in decision-making. A company’s articles determine the division of powers between the members and directors in the operational governance of the company except where mandatory rules apply.²⁹⁶ In the default model articles, directors typically have discretion to operate the company in accordance with their duties which includes “exercis[ing] all the powers of the company”.²⁹⁷

• 4.45    Directors owe fiduciary duties to the company that cannot be waived by contract.²⁹⁸ These duties are owed to the company, rather than the members.²⁹⁹ While the directors have a duty to promote the success of the company for the benefit of its members as a whole,³⁰⁰ this does not equate to carrying out the actual wishes of the members. ³⁰¹Even where shareholders can vote on a particular matter, ultimately, the directors cannot legally prioritise the will of members over their directors’ duties (or other legal and regulatory requirements).

• 4.46    Voting on governance proposals is key to the operation of DAOs as originally conceived. DAO votes may be performed off-chain or on-chain and are formulated and enacted based upon rules adopted by the DAO. In companies, resolutions are the statutorily prescribed equivalent. ³⁰²Written resolutions are the normal mechanism for engaging members in decision-making in private companies³⁰³ and may be proposed either by a member or a director through statutorily mandated processes. ³⁰⁴The process varies according to the nature of the resolution.³⁰⁵

• 4.47    Minimum voting majorities for a resolution to be adopted are set by the Companies Act 2006, not the individual company. ³⁰⁶Modern practice is to require a special resolution (requiring a 75% majority) to compel or prohibit specific action taken by directors. ³⁰⁷Our research suggests that a significant proportion of DAOs suffer from lack of token holder engagement and use the views of the voting members to determine the adoption or rejection of a governance proposal. By contrast, written resolution majorities are based upon all members with voting rights.³⁰⁸

• 4.48    The actual process of voting, however, appears to present far fewer problems. A written resolution may arguably be performed in a manner consistent with most off-chain and on-chain governance proposals.³⁰⁹ Token holding may be used to determine the weight or quantum of a member’s vote by providing for this in the articles.³¹⁰

• 4.49    In a fully-wrapped DAO, membership of the DAO (by virtue of a token holding) and the legal entity (by virtue of a shareholding or guarantee) are congruous. This means the company structure will be a better fit for relatively stable, rather than transient, memberships. ³¹¹DAO governance tokens can be, and are, frequently transferred.

• 4.50    Shares in a company limited by shares are, in principle, freely transferable subject to the company’s articles. ³¹²However, most (if not all) private companies restrict transfer ³¹³and registration ³¹⁴to ensure control and management of the company. Whether restricted or not, the logistics of transfer, although not insurmountable, are an administrative burden.³¹⁵ This may be mitigated if the articles eliminate the need for certificates³¹⁶ or shares in the company are themselves tokenised, however this kind of tokenisation is not currently permissible for UK companies.³¹⁷

• 4.51    Interests in companies limited by guarantee are non-transferable.³¹⁸ Effecting a membership change requires an existing interest be terminated and a new interest created by application and approval by the directors. ³¹⁹The absence of a transfer process may mitigate any real or perceived complexity but is inconsistent with the free transfer of tokens without director involvement.

• 4.52    The distribution of profits also differs between companies limited by guarantee and by shares. A company limited by shares has an implied power to make distributions to members by way of dividend unless its articles of association provide otherwise.³²⁰ The power to do so flows from the conception of the company limited by shares as a vehicle for private enterprise motivated by profit. As a company limited by guarantee has no share capital, companies limited by guarantee cannot distribute profits to members by way of dividends. Any provision in the company’s articles of association or any resolution of the company purporting to give any person a right to participate in the profits of a company, otherwise than as a member, is void. ³²¹The effect of such a restriction may be viewed as either a benefit or an impediment, depending on the purpose of the DAO. A company limited by guarantee lacks the ability to distribute profits but may still be profit generating. This may be a good fit for some non-profit DAOs.

• 4.53    The challenges of DAO-entity fit for companies are not unique to UK company law. The corporation in the United States is similar to the UK company. Brummer and Seira note that “few DAOs organize themselves as corporations” for this reason,³²² instead opting to use one of the more flexible limited liability company models discussed below.

Community interest companies

• 4.54    Limited companies are generally used for commercial businesses set up principally to make a profit and provide returns to shareholders. The Community Interest Company (CIC) ³²³was established to provide a form for businesses with a primary purpose of community benefit rather than private profit. ³²⁴The rationale is to leverage the limited company framework³²⁵ for non-charitable organisations which aim to benefit the community or which have a social purpose.³²⁶ CICs can be set up as companies limited either by shares or guarantee. CICs limited by shares are permitted to pay dividends but these are subject to restrictions. Distributions are either subject to a 35% dividend cap³²⁷ to shareholders as non “asset locked bodies”³²⁸ or subject to constraints that further the purpose of the CIC, are only to “asset locked bodies”, and are subject to the consent of the Regulator.³²⁹

• 4.55    Community interest companies must incorporate in the same way as other companies and, in addition, register with the Office of the Regulator of Community Interest

Companies (“CIC Regulator”). To have registration approved by the CIC Regulator, organisations must provide the CIC Regulator with evidence that they will satisfy the community interest test. This is a requirement to carry on activities that “a reasonable person might consider [are] for the benefit of the community”.³³⁰ The “community” includes a “section of the community (whether in the United Kingdom or anywhere else)” ³³¹that “share a common characteristic which distinguishes them from other members of the community”.³³² Activities for political purposes and those benefitting “only the members of a particular body or the employees of a particular employer” do not meet this characterisation.³³³

• 4.56    The CIC Guidance states that “it is expected that the community will usually be wider than just the members of the CIC.”³³⁴ It may be possible to argue that a “community” is constituted by the wider participants in a DAO ecosystem including users, node operators, developers and other contributors who receive DAO tokens or other remuneration, as well as exchanges and their users where tokens are locked or staked to generate liquidity. The activities of the CIC could be a benefit to that community as a whole or potentially just to token holders (as a section of that community).

• 4.57    However, the CIC Guidance states that "it is expected that the community will usually be wider than just the members of the CIC” and regard would have to be had to the prohibition against benefiting “only the members of a particular body”. ³³⁵ Developing software and providing governance services for the benefit of other participants may be examples of activities that serve a community broader than the DAO itself.

• 4.58    Many of the same issues that arise for DAOs in relation to limited companies (for example, the requirement for nominated officers and various returns) apply also to CICs and may in some cases be exacerbated. For example:

• (1)    In addition to Companies House, there is an additional regulator for CICs - the Regulator of Community Interest Companies³³⁶ - and therefore another level of state involvement. The CIC Regulator has wide-ranging enforcement powers that directly address governance autonomy: the power to appoint or remove directors, appoint a manager, order the transfer of shares or extinguishment of member interests, and to present petitions for winding up.³³⁷ However, these enforcement powers are to be used only to the extent necessary to maintain confidence in CICs and the regulator is described as “light touch”.³³⁸

• (2)   The CIC regime places “asset lock” restrictions on the distribution of profits.

Distributions are either subject to a 35% dividend cap to shareholders as non “asset locked bodies” or subject to constraints that further the purpose of the CIC, are only to “asset locked bodies”, and are subject to the consent of the Regulator. ³³⁹The asset lock is designed to ensure that assets and their proceeds are retained and applied exclusively for the designated purpose of the CIC. It may, depending on the facts, create a greater degree of entity fit for nonprofit DAOs. For example, it may mitigate agency issues by reducing directors’ discretion to make distributions (e.g. out of treasury). Even so, it may be seen as causing unwarranted centralisation and a requirement of state approval that further undermines decentralisation and autonomy.³⁴⁰

Trusts

• 4.59    As we have noted earlier, ³⁴¹a trust arises when one person (the “settlor”) transfers property to another (the “trustee”) to hold for some other person (the “beneficiary”) or for some legally enforceable purpose, ³⁴²with the intention of creating a trust.³⁴³ Trusts are effectively asset management structures:³⁴⁴ a way of holding property that separates management of the property (carried out by the trustees) from the benefits.³⁴⁵ Trusts are relationships between beneficiaries and trustees. A trust is not a legal person in itself.³⁴⁶

• 4.60    In Chapter 3, we raised the possibility of trusts arising by matter of fact in circumstances in which DAO members pass control of crypto-assets to an individual or subset of members to hold or manage on their behalf (even if, generally, DAOs seek to avoid this centralisation of authority and discretion). ³⁴⁷While the application of the law is the same, here we focus on the intentional use of a trustee, which may be an incorporated legal entity such as a company, to achieve a measure of asset partitioning and liability protection for DAO token holders, as beneficiaries.

• 4.61    An express trust may be created informally in cases where the property is other than land. ³⁴⁸Under the law of England and Wales, in order effectively to settle a trust it needs to satisfy the “three certainties”: certainty of intention (to create a trust relationship), subject matter (the trust property), and objects (those entitled to the benefit of the property, the beneficiaries).³⁴⁹ Trusts are usually established using a trust instrument which identifies the trustees and the intended beneficiaries of the trust. The trust instrument generally provides that assets cannot be used or sold to benefit anyone other than the beneficiaries identified.

• 4.62    The trust instrument provides the main source of the trustee’s powers. The general law³⁵⁰ applies where it provides mandatory rules, most importantly that the trustees act in good faith in the interests of the beneficiaries, or the trust instrument does not deal with a relevant matter.³⁵¹

• 4.63    Trusts, though mainly offshore purpose trusts, ³⁵²have been used in DAOs as part of a structure where certain assets (such as intellectual property rights ³⁵³or tokens³⁵⁴) are transferred to the trustee by the DAO (its founders or token holders). They have also been used to allow DAO token holders, listed as beneficiaries of the trust, to profit from a DAO’s investment in off-chain assets, such as bonds. ³⁵⁵While in each of these cases a trust under the law of England and Wales was not used, there is no reason why equivalent assets could not constitute trust property in this jurisdiction.

• 4.64    As the trustees carry out the managerial function that may otherwise be performed by the token holders, using a trust structure reduces the potential that token holders and other participants will be held liable for the actions of the DAO. Actions are taken by trustees, who are not part of the DAO and are, in the first instance, personally liable on contracts they sign or tortious activity that they incur.³⁵⁶ If they incur a liability in due administration of the trust, they are entitled to indemnity from the trust assets, and indemnity to which counterparties may be subrogated, ³⁵⁷but, unless the trust instrument provides otherwise, are not entitled to be indemnified for negligently incurred liabilities. There is an old rule, subject to criticism and abolished in New South Wales, ³⁵⁸that a trustee may be entitled to recoup from the beneficiaries’ personal assets if the value of the trust assets is insufficient to cover a liability properly incurred.³⁵⁹ Therefore, in England and Wales, a trust structure does not guarantee beneficiaries complete limitation of their liability to the assets held on trust. Even so, trusts remain popular and usually effective asset partitioning devices for a range of purposes.

• 4.65    A trust enables trustee engagement in off-chain activities, subject to the obligations under the trust instrument and the general law. While not legal persons, trusts may effectively replicate many of the incidents of separate legal personality: legal title to assets is held by the trustees; commercial acts (such as entering into contracts, operating bank accounts) are done in the name of the trustees. Similarly, tax obligations are often borne by the trust, subject to rules concerning settlor-interested and bare trusts.³⁶⁰

• 4.66    The main source of governance - the trust instrument - is broadly flexible, providing a high degree of potential fit with the DAO (or the wrapped component). ³⁶¹Trust instruments have limited prescribed formalities, are not a matter of public record, and do not require registration or have ongoing reporting obligations per se.

• 4.67    A key challenge for the use of trusts by DAOs is identifying the beneficiaries: only legal persons (and therefore not unincorporated associations or general partnerships) may be beneficiaries under a trust. This generates identification issues if DAO members wish to retain pseudonymity. However, there is a plausible argument that certainty of objects is achieved even if the beneficiaries are listed as the class of legal persons with control over the DAO’s governance tokens at any given point, as was attempted by MakerDAO in its RWA Trust.³⁶²

• 4.68    If a DAO meets the criteria of an unincorporated association, and the trust is used as part of the DAO’s structure to hold assets on behalf of all members of the DAO, pseudonymity of members is likely to be the main obstacle, rather than definition of the class. In re Denley’s Trust Deed, the scope of the beneficiary principle was considered and Goff J (as he then was) held that if the purpose of a trust is for the benefit of ascertainable beneficiaries and affords them standing to apply to the court to enforce the trustee’s duties, the beneficiary principle is fulfilled and the trust is permissible.³⁶³ While membership of the DAO may fluctuate as governance tokens are exchanged, it is clearly possible to ascertain at least which public addresses hold them at any given time.

• 4.69    Where a trust is intended for the benefit of particular persons (as opposed to a discretionary trust in which trustees are given discretion over to whom to distribute capital and income), the trust will fail if the words used do not enable the trustees to draw up a complete list of all those intended to take an interest under the trust.³⁶⁴ A trustee in a DAO in which members are pseudonymous may well be able to draw up a complete list of entitled public addresses, but could this count as “those intended to take an interest” where the trustee does not know the real person controlling those addresses? This is not a settled question. It may be of assistance that only conceptual uncertainty as to the intended list will invalidate the trust: mere practical difficulty, for example in tracing absent beneficiaries, will not do so. ³⁶⁵However, it is clearly arguable that the inability to tie ownership of a governance-token to real world identity, because of intentional pseudonymity, is just such a conceptual uncertainty. This is likely among the reasons why DAOs intentionally employing trusts as part of their structure have primarily employed offshore purpose trusts.

• 4.70    The test for a valid discretionary trust is more permissive. Where there is a trust to distribute among members of a class of beneficiaries to be selected, it is enough that it can be said with certainty whether any particular person is a member of that class. ³⁶⁶The test is satisfied if some persons are able to prove that they are members of the class - the selectors do need not be able to enumerate the whole class. On this test, we consider it less likely that pseudonymity would invalidate the trust: a real person could demonstrate an entitlement to be considered for distribution by proving ownership of a governance token. However, the use case for discretionary trusts in DAOs may be less clear: it provides just the centralisation of authority, and indeed discretion, that DAOs seek to avoid. With that said, we recognise it may not be impossible to design a discretionary trust for use in a DAO that is functionally deployed in a way to benefit all token holders.

• 4.71    The greater obstacle to pseudonymity may be tax registration obligations, rather than trust doctrine itself.³⁶⁷ Additionally, in the case of a fixed trust, the trust instrument would need to specify that the assets are held on trust for members in accordance with the rules of the DAO, to avoid granting token holders a right to sever their proprietary interest and leave with DAO assets in tow.³⁶⁸

• 4.72    Another key challenge is that trusts are, by their very purpose of separating management and ownership, antithetical to the traditional governance vision of DAOs. Neither beneficiaries nor settlors are able to bindingly direct trustees to take certain actions,³⁶⁹ and if the settlors (as members of the DAO) put all practical control in their own hands in the trust instrument, the court may find no real intention to put the assets on trust.³⁷⁰ Even if trusts are merely used to hold particular property, how that property is managed cannot be directed by the DAO participants directly. With that said, the use of trusts which maintain soft settlor influence, through letters of wishes to the trustees, and which reserve limited powers to the settlor in the trust instrument, not to mention the obvious incentive of trust company providers to comply with settlor interests, are all well established, even under the law of England and Wales.

Co-operatives

• 4.73    Co-operative societies (or “co-operatives”) are membership organisations “for carrying on any industry, business or trade”. ³⁷¹They are required to register with the Financial Conduct Authority (“FCA”).³⁷² They are predominantly governed by the Co-operative and Community Benefit Societies Act 2014 (“CCBSA”) and the FCA Guidance.³⁷³

• 4.74    The FCA’s Guidance defines a bona fide co-operative as “an autonomous association of persons united voluntarily to meet their common economic, social and cultural needs and aspirations through a jointly owned and democratically controlled enterprise”. Depending on the DAO’s purpose, the co-operative model may be appropriate.³⁷⁴ The FCA considers a bona fide co-operative to be determined by “the nature of the relationship between members and the society”.³⁷⁵

• 4.75    A co-operative, when registered, is an incorporated entity with limited liability.³⁷⁶ It is governed by the rules of the society. The rules bind the society and its members.³⁷⁷ The content of the rules is not restricted except to the extent that they are inconsistent with the CCBSA or are otherwise unlawful.³⁷⁸ The content of the rules under the CCBSA is permissive: stipulating only the issues on which provision must be made, not their actual content.³⁷⁹ As such, societies have some latitude to determine the terms of admission and removal as a member, the nature of members' voting rights and other governance arrangements (including “the scale and right of voting, and the method of making, altering or rescinding rules”),³⁸⁰ election of officers, ³⁸¹the power to invest,³⁸² and more.³⁸³ The FCA must approve the rules and, if the rules depart from the model rules, they will be scrutinised. If they depart from co-operative principles, they will be rejected.

• 4.76    The most important principle for primary co-operatives is that they must be one member, one vote.³⁸⁴ This could be desirable for DAOs that genuinely wish control to

be distributed, as it prevents the situation in which a small number of people hold a majority of the tokens and therefore of the voting rights. The Act also prescribes voting methods on certain topics such as dissolution or conversion to a company.³⁸⁵

• 4.77    Co-operatives offer potential for use both in hybrid arrangements and are well positioned to operate as digital legal entities in certain circumstances. As the World Cooperative Monitor Report 2022 noted:³⁸⁶

[T]here is ample room for improvement in the level of digitalization [...] both in terms of the day-to-day management of activities and the online sale of goods and services, but more especially in terms of member participation and communication with stakeholders.

• 4.78    In terms of their use for DAOs in hybrid arrangements, aside from the obvious benefits of separate legal personality and limited liability, members may also benefit from their position as token holders. Co-operative membership may potentially be conditional on holding a particular token;³⁸⁷ the “open membership” principle (requiring co-operatives to be “voluntary” and “open to all persons”) would mean that all such token holders would be permitted to be members. This is supported by the International Cooperative Alliance Guidance Notes:³⁸⁸

The only limit on membership being the limit imposed by the purpose of the co-operative.co-operatives are organised for specific purposes [that] can only effectively serve a certain kind of member or a limited number of members.

• 4.79    Permissiveness in the governance rules (including the ability to set high thresholds for change³⁸⁹) allows for the possibility of tailoring governance mechanisms to achieve an appreciable degree of fit with the characteristics of DAOs generally, and those of particular types or with certain purposes. Indeed, developing model co-operative rules for particular types of DAOs may be a low cost and high value way of providing a more bespoke entity structure for certain applications.³⁹⁰

• 4.80    While the existence of fiduciary obligations on company directors can often be seen as a factor militating against entity fit, ³⁹¹the member-centricity and flexibility in governance rules for co-operatives do not present the same concerns in their application. Indeed, their existence buttresses the enforcement of the rules.

• 4.81    A co-operative’s ability to provide returns is restricted. The society must not exist “mainly for the payment of interest, dividends or bonuses on money invested or deposited with, or lent to the society”.³⁹² Co-operatives can pay interest or dividends on money invested, deposited with, or lent to the society or any other person. However, if these activities are the main purpose or ‘object’ of the society’s actual or intended business, then it does not meet the definition of a co-operative society and the FCA will not register it.³⁹³ This could make co-operatives unattractive for DAOs who wish to have a profit sharing mechanism for token holders who have invested.

• 4.82    The Law Commission is currently undertaking a project to consider modernisation of the CCBS Act 2014, although this is not likely to consider DAOs specifically.

Limited Liability Partnerships (LLPs)

• 4.83    LLPs emerged as a concept in response to the savings and loan (S&L) crisis in the United States during the 1980s. Many S&L organisations, structured as general partnerships, collapsed and became subject to legal claims that, when successful, could result in all partners, including those who were not responsible for the loss, being liable for millions in compensation. In 1991 Texas was the first state to introduce a limited liability partnership structure, and many other American states and Jersey soon followed. LLPs were introduced in the United Kingdom in the Limited Liability Partnerships Act 2000.

• 4.84    LLPs are completely different from general partnerships, Limited Partnerships (LPs), and their modern variation, Private Fund Limited Partnerships (PFLPs). LPs and PFLPs allow people to contribute capital to an investment business and become protected by limited liability (become a “limited partner”), provided they do not engage in the management of the business, which is solely conducted by the “general partner”.³⁹⁴ We do not analyse those entities here because they require a centralisation of management authority antithetical to the core DAO concept.

• 4.85    LLPs, in contrast, have similarities with companies but with greater flexibility over governance. An LLP is an incorporated body, meaning it has a separate legal personality, ³⁹⁵with unlimited capacity as a legal person.³⁹⁶ An LLP is incorporated by registration at Companies House. Given the separate legal personality of the LLP, members act as the LLP’s agents and are only liable up to the amount they have contributed. This is an important contrast with general partnerships. An LLP can only be incorporated by persons carrying on a lawful business “with a view to profit”.³⁹⁷

• 4.86    An LLP has the organisational flexibility of a general partnership (and does not suffer from the organisational restraints of the limited partnership). The members are, for example, free to agree:³⁹⁸

• (1)    how to share profits;

• (2)    who is responsible for management and how decisions are made;

• (3)    when and how new members are appointed; and

• (4)    the circumstances in which members retire.

• 4.87    The accounting and filing requirements are similar to that of a company. However, LLPs have no share capital, there is no obligation for members to contribute capital to the LLP, and any members’ agreement is a private document that does not need to be publicly filed.

• 4.88    The Limited Liability Partnerships Act 2000 does not dictate whether the members’ relationships with each other are fiduciary in nature - the members may decide to provide for this in the LLP agreement. ³⁹⁹The High Court has therefore held that members may only owe each other a duty of good faith as expressly provided for in the LLP agreement.⁴⁰⁰

• 4.89    LLPs, then, appear to offer many of the benefits of companies but with additional, and crucial, flexibility in governance. There does not appear to be any obstacle to a DAO, in the LLP agreement, providing that decisions are made according to on-chain voting by DAO governance token holders. Nor does there appear to be any obstacle to a DAO, in the LLP agreement, providing that new members are appointed automatically on use of a governance token, and “retire” on its sale.

• 4.90    Even so, LLPs present significant administrative compliance challenges and are incompatible with complete pseudonymity. Whenever details of the membership of an LLP change, those details must be reported to Companies House within 14 days.⁴⁰¹ An LLP must also identify at least two “designated members” on registration, who are responsible for maintaining accounting records, statutory registers, and registering with HMRC. ⁴⁰²This requires some degree of administrative centralisation off-chain, but is still compatible with decentralised management more broadly.

• 4.91    LLPs exist in similar format in many American states, and have been expressly recommended as a structure for DAOs by academic commentators.⁴⁰³

• 4.92    LLPs are, like general partnerships, treated as pass-through entities for tax purposes. Members will be taxed individually on their share of the profits.⁴⁰⁴

Table 1: Comparison of England and Wales legal structuring options

OPTIONS IN OTHER JURISDICTIONS

• 4.93    Companies (corporations) and LLPs are available in other jurisdictions, most notably the United States, and offer similar advantages and obstacles for DAO-entity fit as their equivalents in England and Wales. But many overseas jurisdictions also offer entities with no exact equivalent in England and Wales, which appear to offer potential advantages for DAOs seeking a favourable legal structure. This section introduces the entities that we understand are used by DAOs, including those designed with DAOs in mind, and our understanding as to their advantages and disadvantages. The material here is based on publicly available information and views expressed by stakeholders, rather than in-depth comparative research. Stakeholders with more than a general interest in these foreign entities should seek advice from appropriately qualified advisors.

Limited Liability Companies (LLC)

• 4.94    An LLC is an entity available in many US states. It shares some but not all the characteristics of a corporation and has several functional similarities to LLPs.

• 4.95    An LLC comes into existence following registration with the relevant state. Many of its features are equivalent to those of an LLP. These include:⁴⁰⁶

• (1)    The possibility of member management, rather than a requirement for a board of directors.

• (2)    Limited liability and separate legal personality.

• (3)    Mostly used by for-profit entities (although it is possible to form a non-profit LLC subject to Internal Revenue Service (IRS) rules).

• (4)    Allocation of profit, losses and other distributions according to the LLC operating agreement, with default rules in the governing legislation.

• (5)    Transferability of interests according to the LLC operating agreement.

• (6)    Fiduciary duties owed by managers and controlling members can be excluded by operating agreement.

• 4.96    Some of the main perceived disadvantages of LLPs for DAOs are shared by LLCs. In particular, LLCs are subject to the federal Corporate Transparency Act 2024, which would require a DAO using an LLC as a full wrapper to be able to identify its members and thus whether any member controls 25% of the LLC’s ownership interests. ⁴⁰⁷This may be inconsistent with complete pseudonymity even though many LLCs, such as the Delaware LLC, do not otherwise require the disclosure of a register of all members. Even so, the degree of pseudonymity achievable through such a regime is greater than that available to a company or LLP in England and Wales: it is one thing for the DAO to know the real identity of members and be compelled to disclose any who control over 25%; it is another for the regulator to be informed of any change in membership interests within 14 days.

• 4.97    Additionally, membership interests in LLCs have often been regulated as securities under US securities law. Industry commentators suggest that this creates apprehension that DAOs will subject themselves to onerous and unwarranted financial regulatory requirements by adopting such a form.⁴⁰⁸ But this risk may be overstated: if the LLC is truly member managed it will not meet the “Howey” criteria to classify its membership interests as securities. ⁴⁰⁹The Howey test is functional rather than formal: it does not seem likely that a DAO can avoid or wrongly find itself embroiled in its requirements by selecting the wrong entity structure.

• 4.98    The main functional distinction between LLCs and LLPs, beyond their possible use by non-profit entities and member disclosure requirements, arises in the tax context: while LLPs are mandatorily a pass-through entity, LLCs can elect to “check the box” to be taxed as corporations. This offers potential advantages for simplifying tax administration for some DAOs, minimising the reporting and tax calculation requirements of token holders for assets not yet distributed, even if it does imply a greater degree of centralisation.⁴¹⁰

Unincorporated Non-profit Associations (UNA)

• 4.99 Most American states take a similar approach to unincorporated associations as England and Wales. However, in thirteen states, including California, Delaware and Texas, an “Unincorporated Non-profit Association” is treated as a legal entity apart from its members. It may be taxed (or deemed tax-exempt) on an entity-level like a company or an LLC that “checks the box”. And like an unincorporated association under the law of England and Wales, it retains significant flexibility for governance without any particular form of agency-based management.⁴¹¹

4.100 Distributions to token holders for their own use would generally not be “made in furtherance of the non-profit association’s non-profit purposes”.⁴¹² A DAO making distributions would therefore be more likely to be classified as a default ‘for-profit’ general partnership.⁴¹³ However, some in the industry have argued that distributions to members are not necessarily inconsistent with a DAO’s non-profit purpose under state legislation.⁴¹⁴

4.101 An alleged advantage of a UNA is that the “agreement” to form one could be implemented simply by a majority approved governance proposal, meaning one could be adopted by a DAO already in existence.⁴¹⁵

4.102 A UNA must still be registered with the IRS if it receives revenue over $5000. This does not, however necessarily require disclosure of the names of the members, beyond at least two in the originating document.⁴¹⁶ Additionally, because it does not come into existence by incorporation, it seems to be outside the scope of the federal Corporate Transparency Act.⁴¹⁷

4.103 Transfers of membership are feasible, and without the limitations of the process applicable to equity interests. ⁴¹⁸Transfer of DAO governance tokens may therefore be sufficient for such transfers to be effective, given the permissive process for establishing membership.

4.104 The application of UNA principles to DAOs has not received significant judicial consideration. Issues such as the scope of permissible profit distribution are unsettled. However, the attributes of the UNA may correlate with those of DAOs where qualifying non-profit activities can be identified, which may, in some circumstances, include operating a protocol. As Miles Jennings and David Kerr summarise:⁴¹⁹

The UNA is a compelling alternative [to foundation-based structures] that provides legal existence to unincorporated organizational forms, which is analogous to what most DAOs represent.

DAO-specific statutory entities and the COALA Model Law

DAO LLCs, BBLLCs, LLDs

4.105 A few American states have enacted legislation providing for amendments to their general forms of LLC in order to accommodate DAOs, in particular, explicitly providing for the permissibility of decentralised, blockchain-based governance.

4.106 Statutes in Wyoming ⁴²⁰and Tennessee ⁴²¹provide for a separate “DAO LLC”: an LLC that can be “algorithmically” or “smart contract-managed” instead of being “manager managed”. ⁴²²The Vermont “blockchain-based limited liability company”⁴²³ is similar but less prescriptive in operational and technical implementation.⁴²⁴The general intention is to enable DAOs to be wrapped in, and identifiable as, LLCs.

4.107 The Utah limited liability decentralized autonomous organization (“LLD”) ⁴²⁵effectively operates like an LLC but does not explicitly “wrap” the DAO. Instead, it imbues it directly with separate legal personality.⁴²⁶

4.108 The general rationale for technology-specific or DAO-specific legislation is to facilitate entity fit and to improve market certainty as to the consequences of using a particular legal form as part of a structure (thereby improving the attractiveness of the jurisdiction). ⁴²⁷While this legislation may be seen to create a degree of certainty (in the sense of providing a specific entity form), DAO-entity fit remains imperfect. For example, the Wyoming DAO legislation has been criticised for a simultaneous failure to address the issues faced by DAOs using LLCs and the introduction of new restrictions and requirements that do not apply to general LLCs.⁴²⁸ Some of these issues stem from being overly prescriptive with technology-specific concepts.⁴²⁹

4.109 Consultees gave mixed responses to these statutory developments, noting the importance and shortcomings of these efforts. ⁴³⁰COALA and BlockchainGov (in a joint response) stated that the regimes did not work for DAOs so that “to date, no large DAOs and no significant number of DAOs have interacted with these regimes”. They noted the issue of ‘fit’ and seemed to criticise the attempt to fit the DAO philosophy into any existing corporate wrapper.

4.110 Delphi Labs has also considered the legislation to be overly prescriptive as to how DAOs should work, often undermining autonomy, causing unpredictable incentive side effects, and adverse regulatory implications.⁴³¹

4.111 In their response to our call for evidence, Simmons & Simmons LLP similarly emphasised the failure to address the practical issues of entity fit arising from extension of the LLC to DAOs:

Wyoming has recently become a popular jurisdiction where DAOs get registered [...] However, the industry’s view is that the Bill makes the entire process of running and being a member of a DAO unnecessarily cumbersome and restrictive. The reason is that 1) the number of the DAO's members is limited to 99, and 2) they are all required to be registered as shareholders, which means that they need to be issued a shareholder’s certificate upon becoming a member of the DAO (i.e., purchasing the token associated with the project). If the token is subsequently resold, the change of shareholders needs to be registered with the regulator. In the decentralised community this practically strips the DAO of its fundamental purpose -to make entry into/exit from the organisation easy, to be flexible and to grow the number of its members.

4.112 The law firm gunnercooke llp observed that the slow adoption of some DAO-specific entities may not be due to their characteristics, but rather as a result of concerns about regulatory rules to which they are subject:

We have generally steered clients away from using the US DAO frameworks because of concerns around US securities laws rather than specific consideration of the nature of the DAO corporate vehicles on offer.

4.113 Aaron Payas of Hassans International Law Firm Limited (in a personal response) had a more fundamental objection, and considered that “the concept of a legal form contradicts the nature of a DAO”:

As soon as you have a legal entity, the DAO is no longer decentralised and loses its main benefits and, generally, the reason why they are created in the first place.

4.114 In the table that follows, we make a comparison of example legal entities, the Delaware LLC and England and Wales LLP, that may be appropriate as a full-wrapper for for-profit DAOs, noting the key features relevant to DAO-entity fit.

Table 2: For-profit full wrapper example comparison⁴⁵³

Decentralized unincorporated non-profit association (DUNA)

4.115 Wyoming’s Decentralized Unincorporated Non-Profit Associations Act, passed on 7
March 2024, was expressly designed with blockchain networks in mind.⁴³²

4.116 A decentralized unincorporated non-profit association (DUNA) must elect to be formed under the relevant chapter of Wyoming law, and must consist of at least 100 members joined by mutual consent under an agreement that may be in writing or inferred from conduct for a common non-profit purpose.⁴³³

4.117 The DUNA has separate legal personality, ⁴³⁴can hold property in its own name,⁴³⁵ can have perpetual duration,⁴³⁶ transfer membership interests “in accordance with [the DUNA’s] governing principles”, ⁴³⁷and can be treated as an entity for tax purposes.⁴³⁸

4.118 It may engage in profit-making activities, but profits from any activities must be used in furtherance of, or set aside for, the association’s common non-profit purpose. The legislation also includes a carve-out for “reasonable compensation”. A DUNA may:⁴³⁹

Pay reasonable compensation or reimburse reasonable expenses to its members, administrators, and persons outside the organization for services rendered, including with respect to the administration and operation of the decentralized unincorporated nonprofit association (which may include, the provisions of collateral for the selfinsurance of the decentralized unincorporated nonprofit association, voting, and participation in the association's operations and activities).

4.119 While some commentators have interpreted this provision generously, it is for Wyoming courts to determine the ceiling of “reasonable compensation”. This will likely mean reasonable in furtherance of the DUNA’s non-profit purpose.

4.120 The DUNA seems to clarify what already seemed possible in many states’ UNA regimes. It expressly permits conferral of membership automatically if someone becomes a member in accordance with the governing principles of the organisation, facilitating the transferability of DAO tokens. It does not include a requirement to disclose a register of members. Additionally, the DUNA expressly provides that the smart contract is the legal contract for DUNA members: there is no requirement for a separate natural language document.⁴⁴⁰

4.121 Another important distinction from unincorporated associations in England and Wales is that, as with certain other American state UNAs, a DUNA can choose whether or not to be taxed as a company. Further, its limited liability and separate legal personality is achieved without incorporation (though members must elect to form under the DUNA Chapter of Wyoming legislation).

4.122 While the DUNA is the first in force legislation of its kind, a very similar bill passed the Texas House of Representatives in May 2023. It remains before the Business & Commerce Committee of the Texas Senate.⁴⁴¹

Table 3: Non-profit full wrapper example comparison⁴⁶⁴

COALA Model Law

4.123 Four consultees referred to the Model Law for Decentralized Organizations prepared by COALA (the “Coalition of Automated Legal Applications”), a blockchain research and development initiative. The model law, unlike the US statutes, is not an attempt to modify an existing statutory approach. It seeks to provide a set of rules for national legislatures to adopt legislation for DAOs on matters of agency, legal personality, limited liability, governance processes, and off-chain activity.⁴⁴²

4.124 According to COALA,⁴⁴³ the model is designed to:

assist governments in crafting their own DAO laws, so as to recognize full or partial legal personality to DAOs...to endow them with specific legal rights — and obligations — without requiring them to register or conform to traditional corporate law rules, so long as they satisfy the relevant legal provisions through technological means (such as “technological guarantees” afforded by blockchain infrastructure).

4.125 They go on to suggest that:

Those technological means should provide legal protections equivalent to those underpinning traditional corporate legal forms, while taking account of the new opportunities of blockchain technology. At its core, this model law maps the various policy goals underpinning traditional corporate law rules, with a series of technological guarantees that can be regarded as “functional equivalents” to those rules.

4.126 The effort captures many of the themes addressed in this paper. It seeks to address the core issues of DAO-entity fit through the principle of functional equivalence: effectively ‘mapping’ the purpose/objective of a legal rule (such as a requirement to register) and the function of the technology. ⁴⁴⁴Whilst undoubtedly a worthwhile and well-executed endeavour, questions remain as to how this can be achieved: some regulatory measures, such as KYC/AML requirements or a single point of reference for tax administration, are unlikely to be adaptable to DAO objectives and operations.

4.127 The model law has not yet been directly adopted but has served as an inspiration for the legislation in Utah as well as New Hampshire.⁴⁴⁵

Purpose trusts and foundations

Purpose trusts

4.128 Where existing DAOs have used trusts, these are generally formed for a particular purpose, such as the management of a DAO treasury, rather than for the benefit of a person or persons.⁴⁴⁶ Such trusts are “purpose trusts”. For example, dYdX - a prominent decentralised crypto-token exchange - uses a trust for the purpose of wrapping a grants program that applies funds transferred from the DAO treasury to “make distributions to such persons identified by the Trustees in furtherance of the dYdX protocol and ecosystem”.⁴⁴⁷

4.129 Purpose trusts are, however, generally void under the law of England and Wales (except for those settled for valid charitable purposes, enforceable by the Attorney General) because there are no beneficiaries to enforce the trust.⁴⁴⁸

4.130 Many offshore trust jurisdictions have introduced legislative provisions validating otherwise void non-charitable purpose trusts, thereby enabling private purpose trusts.⁴⁴⁹ In theory, the trustee may be held to account through an enforcement mechanism even if this is not performed by a beneficiary with a direct interest in the trust.

4.131 For example, Jersey and Guernsey provide for “enforcement”-based models in which an “enforcer” is appointed to oversee administration by the trustees. ⁴⁵⁰Most recently, Scotland has also introduced a purpose trust regime.⁴⁵¹ Taking inspiration from enforcement-based models, the new regime provides for the appointment of a “supervisor” who is granted powers to enforce the trust.⁴⁵²

4.132 The enforcer is always subject to removal by the trustees, who must (and can only) do so at the request of the settlor.

4.133 The Guernsey special purpose trust is a particularly oft-cited example of a viable wrapper for DAOs. For example, in the dYdX trust, assets were transferred from a smart contract controlled by the DAO to a purpose trust for issuing token-based grants to third parties.⁴⁵³ The rationale for its selection correlates to the notion of “entity fit”:

[t]he Purpose Trust under Guernsey law allows a DAO to retain all the characteristics of a DAO and continue to minimize trust in any group or person.⁴⁵⁴

4.134 The Guernsey trust provides flexibility in terms of governance structure and on the issue of who can serve as trustees and enforcers. DAO token holders retain the legal right to direct, add/remove trustees (and the enforcer) or to terminate the trust and transfer funds. Under the Guernsey trust, the settlor - whichever legal person it is that represents the DAO - can be appointed as the “enforcer”.⁴⁵⁵ Other off-shore trusts such as the Cayman Islands and the British Virgin Islands prescribe restrictions: trustees must include a licensed local trust company,⁴⁵⁶ which inhibits typical DAO committee members from serving as the only trustees.

4.135 A purpose trust in which the trustees can be “directed” by a DAO vote to act in a particular way seems to be a roundabout way of preserving a DAO’s decentralisation and quite inconsistent with its autonomy. It is also inconsistent with the traditional concept of the role of the trustee, even if now statutorily authorised offshore to recognise the common reality of settlor influence. These points of principle do not, however, reduce the potential usefulness of these entities for DAOs wanting to engage off-chain, particularly in a partial wrapper or DAO-adjacent entity structure.

Offshore foundations

4.136 Another popular offshore alternative, largely because of their flexibility of rules, are offshore foundations. Capable of being fully directed by DAO votes, foundations offer perhaps the best example of the DAO-adjacent entity concept as currently employed in the market.

4.137 The foundation is a traditionally civil law concept ⁴⁵⁷originally used for the furtherance of charitable purposes with defined objectives. It is a relatively new addition to the common law in jurisdictions such as the Cayman Islands. ⁴⁵⁸They are not available under the law of England and Wales. Whereas an LLC may be seen as a hybrid between a company and a partnership, Brummer and Seira note the foundation “functions similar[ly] to a mix of a corporation and a trust”.⁴⁵⁹ Private foundations have now emerged for the purpose of holding and administering certain assets, with no direct or implied reference to any beneficiaries. They are often used in investment funds, as holding vehicles and special purpose vehicles for commercial transactions (particularly securitisations), and as private trust companies as an alternative to trusts. In recent years they have been used by DAOs. Consultees mentioned Cayman foundation companies and Panama private interest foundations in particular. We discuss these briefly below.

4.138 Simmons & Simmons LLP noted the attractiveness of the inherent flexibility possible with offshore foundations - particularly the absence of “restrictions” imposed in DAO-specific legislation (and, presumably, in the structures available in England and Wales):

Jurisdictions such as the Cayman Islands, Panama and Switzerland are among the most popular choices for DAOs to incorporate foundations, because in contrast to [DAO-specific entities such as] Wyoming, they do not have onerous legal and fiscal restrictions to slow down the work of the DAO and defy its main objectives of being decentralised and flexible.

4.139 Of course, it is not only DAOs that are attracted to offshore jurisdictions and tax havens. Offshore jurisdictions have established competitive regimes for entity formation generally, with many being highly permissive in the choices that can be made regarding governance and operational attributes. There are notable examples of requirements or restrictions under the law of England and Wales being absent in other jurisdictions to make them more attractive (such as the rules on purpose trusts). When coupled with tax regimes that are often disengaged from international coordination efforts, they may be very attractive for structuring activities. This is especially true when a particular arrangement has no predefined or required ties to a particular jurisdiction, and when the jurisdictional policy is to actively permit loose ties. For DAOs, the general permissiveness of such jurisdictions is attractive given the legal or regulatory requirements in other, more proscriptive, jurisdictions.

Cayman foundation company

4.140 The Cayman foundation company (often referred to as a “Cayman foundation”) is now one of the most used structures for DAO projects. ⁴⁶⁰Cayman foundations are familiar to many industry participants and in particular venture capital investors.⁴⁶¹ Five consultees mentioned Cayman foundations as providing benefits for DAOs over other forms of entity.⁴⁶²

4.141 The Cayman foundation is built on a company model: it is limited by shares or by guarantee with articles, similar to limited companies under the law of England and

Wales ⁴⁶³(particularly to companies limited by guarantee).⁴⁶⁴ While the underlying form may be similar, the substance is far less prescriptive, allowing substantial structural, governance, and operational flexibility that provides the opportunity for a greater degree of entity fit.

4.142 Like companies, Cayman foundations can be formed for any lawful purpose, have separate legal personality, and provide limited liability to members. ⁴⁶⁵They are flexible enough to provide a governance structure that allows for persons other than directors to exercise control,⁴⁶⁶ though must have a secretary registered in the Cayman Islands.⁴⁶⁷ The company must prescribe objects, ⁴⁶⁸which may appear similar to those in purpose trusts. However, these are only required to be performed under two circumstances. The first is if the foundation company memorandum expressly declares so. The second is if the memorandum designates persons with standing to enforce the foundation company’s obligation to carry out its objects, by way of action against the foundation company itself. Except as otherwise expressly provided by the constitution, rights under it are enforceable against the foundation company itself, not the directors. ⁴⁶⁹ “Supervisors”,⁴⁷⁰ similarly to offshore trust enforcers, can provide oversight of the directors to ensure alignment between the operations of the foundation company and its obligations to the DAO under the governing documents. “Interested Persons”, which may include DAO members under the governing documents, can also sue directors on the company’s behalf without being members.⁴⁷¹

4.143 Foundations do not typically “wrap” the DAO, but instead “act as an affiliate of the DAO, or even an independent entity, that is directed by the DAO’s token holders for a specific purpose”. ⁴⁷²While the foundation company will have limited liability, DAO token holders are often not members of the foundation as in the case of “full wrappers”: indeed, the foundation can be completely memberless if the originating member resigns. DAO members may merely stand to benefit from the objectives pursued by the foundation.⁴⁷³ A memberless arrangement is the preferable set-up for any for-profit DAOs, since profits cannot be distributed to members by the foundation.⁴⁷⁴ It is also the preferable set-up to retain anonymity: Foundations are still required to keep a register of members, directors and supervisors in the Cayman Islands. Foundations can sue and be sued in their own names in respect of assets they hold, avoiding the risk of trustee liability to counterparties that remain in trust structures.⁴⁷⁵

• 4.144    An important feature for DAOs is that while they remain managed by a board of directors, the Foundation company can be “ownerless”:⁴⁷⁶

[T]he Cayman foundation company, which is in substance a company limited by guarantee, requires an initial guarantee member to be created, but that guarantee member can subsequently resign such that is memberless. A Cayman Foundation provides much greater anonymity than an English company. It does not need to disclose its beneficiaries and can be registered with the name of one supervisor and one director. These can be the same person and can be corporate rather than natural persons.

• 4.145    DAOs using a foundation typically delegate to the foundation limited authority over assets transferred from the DAO (in much the same way as a trust). The foundation board/council is subject to fiduciary obligations owed to the company. But instead of owing fiduciary duties to the company for the benefit of shareholders, directors and managers have a more direct duty to act pursuant to the foundation company's governing documents and, where applicable, in pursuance of the foundation company’s objects.⁴⁷⁷

• 4.146    Perhaps the most appealing element of the Cayman foundation is the capacity for its constitution to distribute governance powers to almost any person for any purpose. This includes the possibility of most major decisions being subject to a vote of DAO token holders. The rights, powers or duties which can be specified in the constitution can relate to:⁴⁷⁸

• (1)    admitting, appointing or removing members, supervisors and directors;

• (2)    making and amending any bylaws;⁴⁷⁹

• (3)    the supervision of the foundation company's management and operations;

• (4)    enforcing duties;

• (5)    calling and attending at general meetings;

• (6)   voting on resolutions;

• (7)    altering the constitution; and

• (8)    winding up and disposing of surplus assets.

• 4.147    In short, the DAO can retain almost complete control over how the foundation’s assets are used, without being members or directors of the foundation company, so long as these rights are specified in the constitution of the foundation company.⁴⁸⁰

• 4.148    Another significant factor is tax advantages. A Cayman foundation company whose objects are to be carried out mainly outside the Cayman Islands is not subject to any corporation, income, withholding, or capital gains taxes.⁴⁸¹ What’s more, an exempted company is further entitled to apply for an undertaking that no Cayman Islands law enacted after the date of the undertaking imposing new tax obligations apply to the company or its operations.⁴⁸² Members or beneficiaries are also not subject to any income, withholding, or capital gains taxes in the Cayman Islands with respect to their interests. Both may, of course be subject to tax liabilities in other jurisdictions based upon their residence and/or activities, particularly in the issuance of tokens and off-chain operations.

• 4.149    Assuming it is a single entity performing typical DAO governance activities, it is likely that a Cayman Foundation will be designated a Virtual Asset Service Provider

(“VASP”) for regulatory purposes in the Cayman Islands.⁴⁸³ The VASP requirements extend to licensing, registration, notification and reporting obligations, including relating to anti-money laundering. The VASP legislation would clearly impact legal decentralisation that may have been reduced (although not eliminated) to a notable degree using the foundation company. On the other hand, the legislation - given its application to foundation companies - may be attractive to DAOs that have suggested an absence of regulatory certainty in England and Wales as being prohibitive to their use of entities provided in the jurisdiction. ⁴⁸⁴As Andersen LLP noted:

It is highly unusual to use such an entity incorporated in England & Wales due to the difficulty in registering it for AML purposes with the FCA in order to issue a token to fund the project.

Panama private interest foundations

• 4.150    Two consultees also mentioned the use of Panama private interest foundations (“PPIF”).⁴⁸⁵ These have been described as “a type of offshore private foundation, carefully designed by the Panamanian Government as an offshore asset protection solution”.⁴⁸⁶

• 4.151    A PPIF cannot engage directly in any business activity that is commercial in nature. Its main use is to hold and protect assets from creditors or regulators. As one adviser explains, “because the PPIF has no owners, the assets of the PPIF cannot be claimed if the founder, council members, protector or beneficiaries have unpaid debt”.⁴⁸⁷ Typically, PPIFs are used to hold investments and to collect royalties, manage trademarks and other passive activities.⁴⁸⁸

• 4.152    PPIFs may be used as part of more complex corporate structures. One adviser explains that the Cayman Islands have “approved the Panama Foundation to open accounts in its banks without any extra due diligence required”. ⁴⁸⁹This can make it attractive to structure a DAO using both Cayman Islands and Panama incorporated entities.⁴⁹⁰ While we have been told that tax is usually not the primary driver, the tax efficiencies offered by the Cayman Islands as a jurisdiction, such as an absence of corporation, capital gains and income taxes, are obviously relevant.