December 5, 2022
The Law Commission of England and Wales (Law Commission) has been commissioned by the UK Government to launch a public call for evidence about how decentralised autonomous organisations (DAOs) should be characterised, and how the law of England and Wales could accommodate DAOs both now and in the future.
While many thousands of DAOs exist today, very few appear to be structured under the laws of England and Wales. Is it because the laws of England and Wales are not currently appropriate or adapted to facilitate and encourage DAOs?
Huge amounts of value flow through, are created, used and sometimes lost by DAOs. This raises questions about their legal status, the liabilities of those who participate in them, and what role the law should play in creating and regulating the rules and regulations that apply to them.
What is a DAO?
A DAO is a new type of organisational structure involving multiple participants whose functions rely to varying degrees on blockchain systems, smart contract or other software-based protocols.
DAOs are a revolutionary decentralised approach to organisational structure. DAOs are increasingly important in the context of crypto-token (cryptocurrency) and decentralised finance protocols, as crypto project proponents also want to take a decentralised approach to its governance structures.
DAOs are often contrasted with traditional organisations (think private companies, partnerships or co-operatives) that function privately, have less transparency and deliberately centralised governance structures. DAOs typically have certain characteristics and elements that distinguish them from traditional organisations:
- Decentralised. A DAO is not controlled by a single individual or group, but instead operates based on the ‘democratic’ collective decisions of its members using a set of rules encoded into smart contracts on the blockchain protocol governing the DAO.
- Autonomous. A DAO’s activities, functions and decisions can operate without needing human intervention. This is possible because the rules that govern the DAO are encoded into smart contracts on a blockchain, and the DAO can automatically execute these rules without the potential for human error (or, importantly, human discretion).
- Transparent. Members and third parties can see and verify any on-chain transactions. This inherently transparent and efficient mechanism builds trust amongst members in place of a traditionally centralised and private process.
How or why are DAOs used today?
While still a very new concept, thousands of DAOs (or entities employing DAO concepts) exist today. Examples include social structures or organisations involving multiple participants set up for investment purposes, such as to invest in or trade crypto-tokens and non-fungible tokens (NFTs), as well as fundraising or charitable purposes. The vast majority of DAOs today are in DeFi, accounting for 83% of all DAO treasury value and 33% of all DAOs by count.
DAOs are also used in software engineering, with many popular software protocols choosing a DAO structure to govern developing, modifying and maintaining open-source software infrastructure for its underlying blockchain systems or decentralised finance applications.
A DAO is rarely fully decentralised or autonomous. Rather, DAOs exist on a spectrum, with some decentralising or autonomising only a few components or limiting its application to control a single purpose entity or a single fund. Decision-making within DAOs typically remains highly concentrated amongst governance tokenholders, which raises questions around whether this contradicts true decentralisation principles. Completely autonomising a sophisticated entity’s entire operations also dramatically increases the technical complexity required to achieve full decentralisation or automation, as well as opening further the scope for exploits or mischief.
How is a DAO recognised currently?
The UK Government has asked the Law Commission to investigate how DAOs can operate and be recognised under the existing law of England and Wales, and identify any areas of law or regulation needing further consideration or potential reform. To achieve this the Law Commission’s call for evidence paper seeks views on the characteristics and elements of DAOs and how they relate to each other.
As discussed in our previous article, in the UK under current laws a DAO is likely to be considered as either a partnership or an unincorporated association. It’s possible that this structure is sufficient in certain scenarios, for example, an incorporated association structure might align with a community DAO without a for-profit purpose. However, for many looking to use a DAO structure in the UK, the lack of separate legal personhood and unlimited liability for participants is a non-starter, and is a likely contributor to the dearth of DAOs founded in the UK.
By comparison, other jurisdictions offer and recognise other entity structures that align better with the ownerless decentralised control structures of DAOs, or are looking at how existing structures can be applied to recognise DAO principles. Proponents looking to establish a DAO in a particular jurisdiction will of course take into account a number of factors in addition to straight up legal treatment of the DAO entity, such as potential tax liability, sovereign risks, setup ease and costs, and the existence of a broader virtual asset regulatory regime.
The call for evidence is open for 10 weeks until 25 January 2023 and will contribute towards the Law Commission’s scoping report.
To read the Law Commission’s press release in full and for a link to the call for evidence, click here.
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