DAO Politics is a series of podcasts from Forklog, in which we, together with invited experts, understand how decentralized autonomous organizations work, talk about their conceptual and technological foundations. In this issue, we continue to discuss the legal aspects of the DAO with lawyers Baseley&Partners Eliza-Tatyana Vasilyeva and Bogdan Popovchenko. Check out the first part of the podcast Here.
1. A DAO without elaborate rules is a child’s toy. Contractual relations in a decentralized system are as variable as in a centralized one: both here and there, you need to carefully work out the rules. Creating an object in the DAO without thoughtful rules means that we are at the stage of an infant who does not yet know how to find a common language with other people.
Frequently used smart contracts are highly simplified and do not take into account all aspects. They should be more complex and provide for very different turns of events. Or they need to be combined with paper and electronic contracts, which should include all unaccounted aspects.
2. Lawyers are working on creating a common standard for the DAO, which would satisfy any claims of regulators. The Howey test was developed by the US Supreme Court in 1946 to determine which assets are securities and which are not. In 2019, the SEC developed guidance on how to use it to classify virtual assets. It applies the basic rules: the buyer can count on a share of the profits, freely transfer and sell the asset, the purchase is considered an investment. The European Union has a similar test, enshrined in the MiFID II directive. It has its own criteria: the crypto asset must belong to the class of securities, be the subject of trading on the capital markets, and must not be used as a payment instrument.
Regulators are trying to apply these tests to decentralized autonomous organizations. Many DAO projects make investment promises but are not businesses and may fall under the classification of securities. This creates legal chaos.
We, as lawyers, form a matrix of regulatory claims and look at what configuration and how DAOs were classified. Apply a suitable regulatory wrapper to each configuration. We define what is an investment platform, a fund, and what is a truly decentralized project that can respond to any possible claims from regulators. Now we are mathematically refining this matrix in order to present it to the community as a standard for such organizations.
3. DAO is not taken out of thin air; the legacy of philosophy, psychology, and law should be taken into account. It is absurd to think that you have to abandon all the old concepts and create everything from scratch. Yes, we need to rethink a lot. However, we will not create a new decentralized philosophy from a vacuum.
For small DAO projects, we recommend:
- create a minimum legal infrastructure;
- bring the tokenomics and positioning of the project in line with legal requirements;
- prepare for a serious fight, remember those who promote disloyal regulation, file deliberately unfair lawsuits against projects.
The future is decentralization. In the generation of children who are now seven or eight years old, communication takes place to a greater extent in the virtual space. This will promote decentralization with public regulation, agreements through tokens, high-quality smart contracts, artificial intelligence capable of resolving disputes automatically.
4. But relying entirely on AI is dangerous, so the DAO needs moderators. The role of intermediaries in a decentralized world will be just as important as in a centralized one. Improving smart contracts will make it possible to solve all deadlocks in an automated manner, but there will remain questions that cannot be solved without a person.
AI may not be suitable where people are able to sit down at the negotiating table. It is important that in such situations there are moderators who will help regulate the decisions of artificial intelligence in terms of universal human values, principles of justice and balance.
5. If you determine the share of each participant, it is much easier to regulate the DAO. Action Tip: Don’t confuse regulatory responsibility with ownership issues. Assets are one thing, activities are another.
In classical corporations, there are two main models of ownership:
- the principle of work for hire – everything that we have created belongs to the company, because it distributes the salary;
- contract mechanics – what was asked to be developed for the company belongs to it.
In DAO, the following model is possible: the participant makes a contribution, the community decides what part this work is from the total, then a certain percentage is fixed. The main thing is to draw up contractual relations correctly: smart contracts, electronic documents, monetization of property.
6. Anonymity is maintained until taxes are paid. In the DAO, the identification of the right holder is carried out by unique tokens. This allows you to remain anonymous, but exactly until the moment when it comes time to fulfill tax obligations. If a participant has earned on a contribution to the DAO, the question of declaring income arises. Oversight bodies will, of course, want to deanonymize all members of the organization. The situation is similar with marketplaces in Europe, which are required to provide tax information about those who earn on them.
Of course, this is disastrous for the blockchain. A TAAR-compliant corporate structure can reduce the tax burden in some cases (don’t take this as a fact, each case should be discussed with consultants in the jurisdictions involved).
7. When a fragment is confiscated NFTs you can get compensation. Let’s consider a particular situation. A criminal case is opened against a DAO participant, his property is confiscated, including a fragment in the NFT. As a result, the token loses its value. This will not deprive other participants of the opportunity to exhibit the picture in the virtual gallery, however, instead of the missing fragment, a black spot is formed. Distribution may also be blocked, or the funds from it will be received not by the participant, but by the state body that confiscated the property.
In the event that an NFT fragment is seized within one jurisdiction, citizens of other states will have the opportunity to return it. The regulator does not care that the work will lose value.
The only thing a participant can do is to apply for compensation. The following logic may apply here. For example, when container ships are opened during searches, the value of their contents is lost because the storage technology has been violated. The state structure that organized the inspection is obliged to compensate for the lost profit. A full refund is unlikely, but a partial refund is possible.