Syed Rahman explains what they are, their legal status and the issues that need to be addressed
When it comes to digital governance and asset holding, decentralised autonomous organisations (DAOs) can be viewed as a new frontier.
They go beyond what cryptocurrencies offer. DAOs are run on smart contracts and can hold and manage a wide range of digital assets. Essentially, a DAO is like a digital community or organisation that runs on a blockchain. Decisions are made collectively by its members through a voting system. The rules regarding how it operates are encoded in smart contracts (self-executing code) on the blockchain.
Members of a DAO can propose and vote on different actions, such as how to use funds, what projects to work on, or even changes to the rules themselves. Once a decision is made, the code automatically enforces it, ensuring everyone follows what has been agreed on. This means that the DAO can run without a central authority. It has no need for any form of CEO or government, as everything is automated and controlled by the code.
Key Features of DAOs
While DAOs do have similarities to certain other parts of the digital landscape, their range of characteristics sets them apart from anything else.
These features include:
Decision making: As mentioned earlier, decisions in a DAO are made collectively by its members through a voting system. Every member has a say, and votes are usually proportional to the number of tokens or shares they hold in the DAO.
No central authority: There is, as explained previously, no single leader or central authority in a DAO. Everything is automated and controlled by computer code written on a blockchain, with no specific person in charge.
Transparency and automation: Rules and decisions are written in smart contracts on the blockchain, which are like self-executing agreements. This ensures transparency and that decisions are followed automatically.
Global and borderless: DAOs can involve people from all over the world, and they are not bound by any specific country's laws or regulations.
The Legal Status of DAOs
DAOs control billions of dollars of assets and have already been the subject of litigation in the United States. Yet, so far at least, the term DAO does not refer to any one type of arrangement. They come in various forms. This raises the real possibility of them facing different arguments regarding their legal status and varying legal challenges to them.
In July 2024, the Law Commission published a scoping paper on DAOs. The paper highlighted a number of issues in relation to DAOs; including legal characterisation, liability of participants, the ability to enter contracts and hold property, assessment for tax purposes, and jurisdictional / territorial issues.
All of these issues will slowly be addressed through litigation in England and Wales and will give rise to various points of contention and uncertainty until they are resolved. But for now at least, there is much to be clarified in relation to DAOs and the law.
The Law Commission paper identified three main areas that could be considered to be DAOs:
Pure DAOs: These are decentralised and, according to the Law Commission, “sit[s] at the more decentralised and autonomous end of our spectrum: they are decentralised and reject dependence on law and legal institutions for their existence”. These may include a general partnership or unincorporated association or involve a collection of legally-enforceable contracts between participants.
Hybrid arrangements: These combine smart contract-based coordination with other legal forms or entities, which are often referred to as a “wrapper”. Adoption of a legal wrapper can improve a DAO’s ability to protect its members from liability and enable interaction with the off-chain world. What will be important (from a legal point of view) will be what type of legal entity or entities are used and in which jurisdiction. While it is very early days in terms of the law, Wyoming already has a specific law for DAOs.
Digital Legal Entities: The Law Commission classes these as an incorporated legal entity which “makes use of technology such as Distributed Ledger Technology and smart contracts in its formal governance and/or operational arrangements.” The Commission states that these types of entities are still “largely theoretical in this and most jurisdictions due to statutory restrictions on the form of, for example, shareholdings and fund interests”.
Implications
How legal issues relating to a DAO - such as jurisdictional challenges, whether it is a legal entity and who is liable for its actions - will be addressed will depend on where it sits on the spectrum, from pure DAO through to digital legal entity.
If claimants are seeking to recover assets held or misappropriated by a DAO, they could face the following challenges:
- The difficulty in identifying defendants to any claim. This may be far from straightforward – it could involve the wrapper (the associated legal entity), the developers and creators, the token holders or the service providers.
- The lack of clarity regarding service issues under Civil Procedure Rules.
- The need to establish the appropriate jurisdiction.
- Problems determining liability if the DAO is truly autonomous.
DAOs can hold and interact with numerous types of digital assets simultaneously: governance tokens, native utility tokens, stablecoins, NFTs and other DeFi instruments. They may also stake or lend assets across other protocols, creating multiple on-chain footprints that complicate tracing exercises.
As these assets are controlled by smart contracts and can move without human interference, any asset tracing exercise will not only require locating the digital assets but also predicting any future movements based on their programming. This makes it far more difficult than tracing a static asset such as crypto, which is not autonomous. There is also the problem of identifying who or what should be the subject of a court order in any attempt to have assets transferred back to the rightful owner. There is even the question of whether a smart contract itself can be compelled to comply with a judgment or whether this would require all token holders to vote in a certain way.
Approaches
Despite such difficulties, there are some approaches that can be of use in DAO-related litigation. These include the use of what has been called on-chain arbitration. This term covers a range of procedures, such as Oracles.
There is also the possibility of litigators identifying token holders if the DAO operated within a regulated DeFi or real-world market that had Know Your Customer and anti-money laundering controls. This could make it easier to seek disclosure or freezing orders against individuals and to argue that the DAO operates more like a traditional partnership or association. And if the DAO is linked to a legal wrapper, this would make it possible for it to sue or be sued in the real world.
At this stage, there is much that still needs to be addressed regarding DAOs. This area will be subject to a lot of litigation in the future, which may well go some way to providing clarity. Lines will need to be drawn regarding whether a DAO is a partnership, who is responsible for it, and the duties of developers.
