Is It Legal to Do Business as a DAO?  by@xdao
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Is It Legal to Do Business as a DAO?

October 6th 2022
9 min
by @xdao 497 reads
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There is a simple legal rule: “everything that is not prohibited by law is Allowed”. While creating a DAO by itself is usually legal, but one would run into many troubles trying to engage into any meaningful economic activity with his DAO. Here are 3 options how to make a DAO legal: Directly register a DAO, create a legal entity and merge it with a DAO, make a DAO as a partnership. There are pros and cons for each approach. To determine the most suitable form one should talk with legal advisor.

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There is a simple legal rule: “everything that is not prohibited by law is Allowed”. While creating a DAO by itself is usually legal, one would run into many troubles trying to engage in any meaningful economic activity with his DAO.

Taxes are the first set of conundrums that is particularly hot for US citizens. If you earned any profits with a DAO, you would generally become liable to report the gains, assess, and pay the tax. Otherwise, you may be fined or even put in jail. The payment by itself might not be such trouble. The main issue comes at the tax calculation stage. The rules on crypto-gains and especially on DAO participation are desperately lagging behind emerging business activities.

In many cases, the rules become obsolete right at the date of their adoption. It goes on to such a degree that sometimes tax agencies completely give up on precision and humbly ask people just to pay “reasonable taxes”. It tends to get especially complicated when your DAO issues its own tokens and distributes them under various terms.

Lack of DAO legal subjectivity is the next issue, which is closely interlinked with the first one. Almost all jurisdictions do not recognize the DAO as a subject of law. The DAO can not make contracts or own property. It can not file a claim or defend its rights.

Most countries would treat the DAO as a “general partnership” (including for tax purposes). This brings on the following consequences:

  • DAO members shall calculate and pay their taxes as persons and as personal gains (sometimes the taxes might be surprisingly high);

  • DAO members would bear unlimited personal liability to counterparts with whom they made contracts, even while acting as a representative of the DAO.

Currently, very few jurisdictions have an actual legal framework for the DAO. Only Marshal islands, the US Delaware and Wyoming state, and to some extent Swiss — have clear DAO incorporation procedures and treat them as actual subjects of law. Other countries are still the Wild west from a legal standpoint. Lawmakers worldwide are slowly probing their way into DAO regulation, and major jurisdictions are yet to find their own solutions that would fit legacy infrastructure.

All right, you are willing to engage in business via your DAO. What should you do?

First off, Yes, you can use your DAO for a meaningful economic activity in most countries. You just have to take some preparatory steps:

Take legal advice

Consult a lawyer for the current legal landscape of your country regarding DAO and crypto gains that are likely to occur in your business. Do not rely just on Internet articles — their authors do not bear legal responsibility; the data can be obsolete and there is a good chance that you can just misinterpret a correct article because all people are prone to believe what they want to believe. Doing background research is a good idea, but for the sake of reason, consult a lawyer with relevant experience.

It is important to understand for what activities you are going to use your DAO because it determines whether you need additional licenses or permissions. In most countries, you must get a license if you:

  • keep crypto-funds of others;

  • manage and invest crypto-funds of others;

  • exchange crypto to other crypto and especially to fiat money;

  • issue and sell your own tokens;

  • deal with security tokens.

Generally, you do not need additional licenses as long as you use your DAO as a treasury to make payments and receive rewards under usual contracts with a legally capable entity.

Be aware that some countries do not allow crypto as a reward under contracts. Do some research on that matter and avoid those jurisdiction-specific problems as a set-up platform.

To obtain some crypto-licenses, governments often demand significant corporate capital, hire residential compliance officers, or rent an office. You shall also expect to pay lawyers for the set-up and accountants to form and submit the reports.

The choice of jurisdiction is an important step, and you should consider:

  1. the set-up costs (drafting company by-laws, registration, and legal fees);

  2. maintenance costs (salaries, office rent, taxes);

  3. list of regulated and restricted activities;

  4. licenses you need to get and the cost of such an endeavor;

  5. personal risks in the case of breaching the law.

In practice, it takes some form of legal research to choose an appropriate jurisdiction that would fit your budget and desired activities.

There are three solutions that you are likely to stick with after taking legal advice:

  • Register a DAO in a jurisdiction that directly allows that action (the Marshall Islands, Delaware, or Wyoming in the USA);

  • Register a classic legal entity in a crypto-friendly jurisdiction and use your DAO as a multi-signature wallet (BVI, Caymans, Swiss, Singapore);

  • Form a partnership with other persons via a DAO.

Let us dive into these options.

Direct DAO registration

The fancy procedure of a direct DAO registration, which is boasted by a few jurisdictions, does not actually add much to your business flow. It does cut some corners at the set-up stage, but afterward, you essentially manage your DAO almost like a classic legal entity. You file an application to register your DAO and then you file the same tax reports — all as usual. The only difference you will have is that, from the very beginning, a state would recognize blockchain deals made by your DAO as legally valid.

The trick is that you can achieve the same result in many other jurisdictions with a classic legal entity. And the prize can be huge because other jurisdictions can offer more attractive options when it comes to taxation or regulated activities. For example, the Marshall Islands would not allow you to use a DAO for for-profit activities. On the other hand, the USA might require you to pay quite high corporate taxes and compliance costs can be severe since US lawyers are among the most highly paid in the profession.

Legal entity merged with DAO

The second option for doing business as a DAO is to register a classic legal entity in a crypto-friendly jurisdiction and use your DAO as a multi-signature wallet and a voting tool. The idea is that your DAO would not be a subject of law by itself, but it would rather be a tool of your company and will mirror the processes going on within it. Many countries allow paying in crypto and using sophisticated technical tools as an equivalent of a handwritten signature.

It means that you can:

  1. draft an Article of association of your company;
  2. specify in it personal blockchain accounts of shareholders and directors;
  3. specify DAO treasury account;
  4. describe the procedure of blockchain voting and decision-making;
  5. create a DAO that mirrors the power structure of your company.

As a result, you get a DAO that acts as the hand of your company. A director can sign a paper contract but the payment would be sent to the DAO account and directors would pass a blockchain vote in order to collectively manage DAO funds. The DAO voting process shall be tuned to mirror the governance procedures of your company when every owner and manager has a white-listed account with appropriate powers. It is a merger of the existing corporate legal framework with blockchain technology.

Blockchain vote for corporate resolutions

To push it even further, you might look for solutions to hold corporate meetings and pass company motions and resolutions via blockchain DAO votes. It eliminates the necessity of holding a slow and expensive live meeting and empowers to manage your company completely on a blockchain.

There are a few solutions that allow one to attach a blockchain signature to a document made in a natural language. Imagine that you propose a motion to “Appoint Smith a director of “Goldfish LLC”. You draft a .pdf file with the full text of the resolution and then put it to the DAO vote. When a DAO member supports the vote, he applies his private key to sign that .pdf file and when the quorum is reached, the resolution deems to be effective.

A skilled lawyer can draft an Articles of association that would make legally binding such a blockchain resolution vote for your company and its members.

Partnership via DAO

This is probably the cheapest and fastest solution. From a legal standpoint, the partnership is not a legal entity but a collective of individuals that jointly do business. A partnership is an ancient and common legal device and it is acknowledged by a majority of jurisdictions and it is usually regulated by a similar set of rules. So, it would not be a problem if a partnership is formed between people of different citizenships — they are likely to receive similar treatment at home.

The major advantage of a partnership is that it usually does not require registration. Partners just draft Articles of association which govern their relationship, responsibilities, decision-making process, and profits distribution. Partners from different countries can wet-sign the Articles of association by exchanging copies sent via post and that is it.

There is only one-layer taxation for partnerships, i.e., the partnership itself does not pay taxes (since it is not a subject of law). Each partner pays taxes individually in his home jurisdiction, and his tax decisions do not affect other partners. The partnership essentially shifts a significant part of the compliance burden to its members, and each member can individually choose a risk-efficient approach.

You can combine the partnership with blockchain voting (see above) and link the blockchain accounts of each partner to their personality and thus launching a legally capable DAO that acts as a forum and a treasury of your partnership.

Each partner can make contracts with third parties. The partner can (and shall!) disclose that he acts on behalf of the partnership, but the contractor would have a legal claim not to the whole partnership but only to the contracting partner as an individual who will bear the whole responsibility under the contract. To mitigate that risk, the Articles of association can specify the joint liability of all partners for the deals made by each of them within their powers. Risks to fair partners caused by the reckless or malicious deals of others can be shielded via a detailed description of the contractual powers of the partners.

There are plenty of legal devices to protect fair partners from the bad deals of others, like:

  • designate only a specific partner to make contracts with third parties;

  • specify the necessity of getting the approval of other partners before making a deal;

  • specify a value limit for contracts that can be made without the approval of other partners;

  • specify categories of deals that require approval of other partners (like an IP assignment);

Deals made by a partner beyond his contractual powers will not affect other partners.

It would take a skilled lawyer to carefully draft the Articles of association of your partnership, which would take into consideration the specifics of personal relationships between partners, their risk appetite, specifics of their DAO activity, rules on loss and profit share, etc.

However, you should be aware of the following downsides of the partnership:

— Unlimited liability: partners are liable as individuals with their whole personal wealth, and a bad deal can bankrupt all partners;

— Licensed activities: you are still required to obtain licenses for regulated activities and to bear the respected compliance costs. It is common for governments to not grant most of the licenses to a partnership, requiring them to register a corporation for that. The penalties for breaking the rules on regulated activities will also be borne by partners as individuals.

Conclusion

Business as a DAO is still in its infancy, and many solutions that work on paper are yet to be probed and tested. One should be particularly mindful while choosing a jurisdiction and a legal form for a DAO business and the tasks that such a regulated DAO is intended to solve. There is no universal “one-size-fits-all” solution. Each case shall be considered individually according to its budget and business specifics.


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