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Law Commission examines decentralised autonomous organisations

Blockchain-related technology: 'huge amounts of value flow through, are created, used and sometimes lost by DAOs,' the Law Commission states | Credit: Reto Scheiwiller; Pixabay

The legal status of decentralised autonomous organisations (DAOs) is being examined by the Law Commission of England and Wales.

The body has opened a 10-week call for evidence asking how DAOs, which are increasingly significant in the context of crypto-assets and decentralised finance (‘DeFi’), can be characterised and how the law might accommodate them ‘now and in the future’.

DAOs are a collective organisational structure involving multiple participants online that operate via blockchain technology, smart contracts (self-executing contracts that have terms of agreement between buyer and seller directly written into lines of code) or other software-based systems. But there no ‘unified understanding or definition’, the Law Commission states.

Examples include organisations involving multiple participants set up for investment purposes – including to invest in or trade crypto-tokens and non-fungible tokens (NFTs –  ‘one-of-a-kind’ digital assets that exist on a blockchain), as well as for fundraising or charitable purposes. Many DAOs are also involved in software engineering — developing, modifying and maintaining open-source software infrastructure.

‘Many thousands of DAOs exist today, but few appear to be structured using the law of England and Wales,’ the Law Commission notes in its announcement of the government-commissioned review. ‘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 the rules and regulations that apply to them’.

DAO questions to answer

As legal uncertainty swirls, the Law Commission’s 96-page ‘Decentralised autonomous organisations (DAOs): call for evidence’ document seeks views on questions including: how DAOs structure their governance and decision-making processes; when a DAO would choose to include an incorporated entity into its structure; how money laundering, corporate reporting and other regulatory concepts apply to DAOs (and who is liable for taxes if the DAO makes a profit); and which jurisdictions are currently attractive for DAOs and why.

On the latter question, the document notes that some jurisdictions have set up additional corporate forms specifically to encourage DAOs to use that specific incorporation element within their organisational structuring — and therefore, it states ‘(partially) to structure their organisation within that jurisdiction’.

The US state of Wyoming, for example, enacted a supplementary act in 2021 to enable DAOs to register as a ‘DAO LLC’ (limited liability company); another US state – Tennessee – earlier this year amended its corporation code to include provision for ‘decentralised organisations’; and, also earlier this year, the Marshall Islands passed an amendment to its Non-Profit Entities Act to enable a DAO to register as a non-profit LLC.

The Law Commission notes that such legislation has been ‘heralded by some’ but that the concept of a DAO-specific corporation and legislative implementations to date has ‘found its critics’.

‘We understand that DAO-specific incorporations may not be attractive to all DAOs for practical, legal or ideological reasons, especially those that wish to maintain or increase their degree of decentralisation,’ the call for evidence states. ‘However, we also understand that other stakeholders might find a use for these entities: for instance, if they wish to set up a simple DAO and immediately benefit from limited liability; or if they wish to incorporate a limited liability sub-DAO as part of a more complex DAO organisational structure.’

‘Legal and regulatory status unclear’

“DAOs are said to offer multiple benefits to market participants, incentivising cooperation and innovation, levelling playing fields, reducing the scope for human error, lowering costs and increasing transparency. Yet their legal and regulatory status is unclear,” said Law Commissioner for Commercial and Common Law Professor Sarah Green. “Our work will aim to build consensus on the best ways of describing the constituent elements of DAOs and to highlight ways in which the law of England and Wales might foster their development.” 

The call for evidence will close on 25 January 2023, after which the Law Commission intends to produce a ‘scoping report’.

This project is sponsored by the Department for Business, Energy and Industrial Strategy (BEIS), given its responsibility for company law and the corporate forms within that legal framework. HM Treasury also has an interest given its focus on crypto from both a private law and regulatory perspective.

The Law Commission has undertaken a number of projects focused on fintech-related matters in the past couple of years.

For example, it is currently examining responses to a consultation on proposed legal reform related to digital assets that will inform recommendations to be published next year. In a separate review, in March this year the body published recommendations to allow for the legal recognition of electronic versions of trade documents with the resultant Electronic Trade Documents Bill introduced to Parliament last month. In November last year it completed a review of smart contracts, concluding that the current legal framework in England and Wales is ‘clearly able’ to facilitate and support their use.

FURTHER READING

‘Law Commission publishes digital assets reform proposals’ – our news story (9 August 2022) on proposals for legal reform relating to digital assets, including the suggestion that they are recognised as a new distinct form of property called ‘data objects