Table of Links Abstract and 1. Introduction Abstract and 1. Introduction Bitcoin and the Blockchain 2.1 The Origins 2.2 Bitcoin in a nutshell 2.3 Basic Concepts Crypto Exchanges Source of Value of crypto assets and Bootstrapping Initial Coin Offerings Airdrops Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.2 Smart Contracts 7.3 Tokens 7.4 Non-Fungible Tokens Decentralized Finance and 8.1 MakerDAO 8.2 Uniswap 8.3 Taxable events in DeFi ecosystem 8.4 Maximal Extractable Value (MEV) on Ethereum Decentralized Autonomous Organizations - DAOs 9.1 Legal Entity Status of DAOs 9.2 Taxation issues of DAOs International Cooperation and Exchange of Information 10.1 FATF Standards on VAs and VASPs 10.2 Crypto-Asset Reporting Framework 10.3 Need for Global Public Digital Infrastructure 10.4 The Challenge of Anonymity Enhancing Crypto Assets Conclusion and References Bitcoin and the Blockchain 2.1 The Origins 2.2 Bitcoin in a nutshell 2.3 Basic Concepts Bitcoin and the Blockchain 2.1 The Origins 2.1 The Origins 2.2 Bitcoin in a nutshell 2.2 Bitcoin in a nutshell 2.3 Basic Concepts 2.3 Basic Concepts Crypto Exchanges Crypto Exchanges Crypto Exchanges Source of Value of crypto assets and Bootstrapping Source of Value of crypto assets and Bootstrapping Source of Value of crypto assets and Bootstrapping Initial Coin Offerings Initial Coin Offerings Initial Coin Offerings Airdrops Airdrops Airdrops Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.2 Smart Contracts 7.3 Tokens 7.4 Non-Fungible Tokens Ethereum Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.2 Smart Contracts 7.2 Smart Contracts 7.3 Tokens 7.3 Tokens 7.4 Non-Fungible Tokens 7.4 Non-Fungible Tokens Decentralized Finance and 8.1 MakerDAO 8.2 Uniswap 8.3 Taxable events in DeFi ecosystem 8.4 Maximal Extractable Value (MEV) on Ethereum Decentralized Finance and 8.1 MakerDAO Decentralized Finance and 8.1 MakerDAO 8.2 Uniswap 8.2 Uniswap 8.3 Taxable events in DeFi ecosystem 8.3 Taxable events in DeFi ecosystem 8.4 Maximal Extractable Value (MEV) on Ethereum 8.4 Maximal Extractable Value (MEV) on Ethereum Decentralized Autonomous Organizations - DAOs 9.1 Legal Entity Status of DAOs 9.2 Taxation issues of DAOs Decentralized Autonomous Organizations - DAOs Decentralized Autonomous Organizations - DAOs 9.1 Legal Entity Status of DAOs 9.1 Legal Entity Status of DAOs 9.2 Taxation issues of DAOs 9.2 Taxation issues of DAOs International Cooperation and Exchange of Information 10.1 FATF Standards on VAs and VASPs 10.2 Crypto-Asset Reporting Framework 10.3 Need for Global Public Digital Infrastructure 10.4 The Challenge of Anonymity Enhancing Crypto Assets International Cooperation and Exchange of Information International Cooperation and Exchange of Information 10.1 FATF Standards on VAs and VASPs 10.1 FATF Standards on VAs and VASPs 10.2 Crypto-Asset Reporting Framework 10.2 Crypto-Asset Reporting Framework 10.3 Need for Global Public Digital Infrastructure 10.3 Need for Global Public Digital Infrastructure 10.4 The Challenge of Anonymity Enhancing Crypto Assets 10.4 The Challenge of Anonymity Enhancing Crypto Assets Conclusion and References Conclusion and References Conclusion and References 9.1 Legal Entity Status of DAOs DAOs can be defined as “organizational structures that use blockchains, digital assets and related technologies to allocate resources, coordinate activities and make decisions. [145] ” As discussed above, such organizations can commence their operations without any registration due to the pseudonymous nature of its members and permissionless nature of the public blockchains on which DAOs function. Although this might have advantages of enabling decentralized decision making without a management structure with clearly defined roles, it makes it difficult for DAOs to avail benefits of legal personhood like being able to sue as an entity, having a bank account and being able to enter into contracts, limited liability of its members, and simplified compliances. The legal entity status of a DAO has profound consequences related to applicability of tax laws, AML/CFT/CPF and other regulatory obligations of the DAO and its members. This makes the issue of a DAOs legal entity status crucial. Classification of DAOs as domestic or foreign general partnerships, unincorporated associations, domestic or foreign corporations, foundations, or limited liability corporations has bearing on various important issues like: organizational structures that use blockchains, digital assets and related technologies to allocate resources, coordinate activities and make decisions. ” A) Liability of the members for debts, judgements, obligations, and liabilities of the DAO B) Collection and filing of information relating to taxes and other regulations in multiple jurisdictions C) Determination of tax liability of the DAO and its members and identification of taxable events It is also possible that various sub organizations within the DAO may have different classifications as legal entities. For example, components of the DAO which manage the treasury and the component managing voting on the protocol might have different classifications. Many countries have enacted provisions to recognize DAOs as a legal entity. The Innovative Technology Arrangements and Services (ITAS) Act of Malta[146] enables DAOs to register by applying to the Malta Digital Innovation Authority. In Switzerland, DAOs can be structured as ownerless foundations and jurisdictions like Cayman Islands enable creation of an LLC structure that acts as realworld interface of the DAO[147]. Many states like Wyoming and Vermont in the US have also enabled DAOs to register as LLCs148 . However, many of these legal entities require filing of physical forms along with the relevant information or establishing and maintain a registered agent in the jurisdiction, which might be operationally difficult for truly decentralized DAOs and against their foundational principles. The following discussion about DAOs and their legal aspects is from the perspective of the laws in the US, other jurisdictions may have similar or different legal treatment and classification depending on their domestic law. 9.1.1 Unregistered DAOs 9.1.1 Unregistered DAOs One of the most important issues concerning the legal entity status of DAOs is the legal identity of an unregistered Decentralized Autonomous Organization which operates on the blockchain with pseudonymous members without registering with any State, government entity, or a regulator. As mentioned earlier, in an important case related to the Ooki DAO in the US, the US District Court for Northern District of California has adjudicated that Ooki DAO was an unincorporated association with token holders as its members, who joined it voluntarily. It was observed that Ooki DAO was a ‘person’ under the Commodity Exchange Act and it could be sued as it was an unincorporated association. The notice was served by Commodity Futures Trading Commission (CFTC) through the online community forum of the DAO, which was upheld by the court. A civil monetary penalty of $643,542 was levied and its operations were shut down. In California, an unincorporated association refers to a gathering of individuals united by a shared purpose or goal, but lacking formal incorporation status with the state. Despite this absence of incorporation, such associations maintain legal standing and can undertake activities such as contractual agreements, property ownership, and litigation. While possessing fewer formalities and regulatory obligations compared to corporations, they still hold recognition under the law. Examples encompass social clubs, community organizations, and informal business partnerships. There are no State filing requirements for unincorporated associations, however, if the association is operating a business, it may need to obtain relevant licenses or permits, which the Ooki DAO purportedly failed to obtain from the CFTC. This case is important as it highlighted that for unregistered DAOs, members of unincorporated association may have unlimited personal liability for the debts, obligations, and liabilities of the DAO. It may also be possible to classify many DAOs as general partnerships. General partnerships are a type of business structure where two or more individuals (or entities) come together to operate a business for profit. In a general partnership, each partner shares in the management, profits, and liabilities of the business. They may be formed through a written or oral agreement and the members have unlimited personal liability for the debts, obligations, and liabilities of the business. Thus, it might be possible that all members holding the governance tokens of DAOs which have not otherwise been incorporated as a legal entity form a general partnership inadvertently, as the intention to form a partnership is not a pre-requisite for forming a general partnership. However, the pseudonymity of the members of the general partnership and lack of the concept of a ‘principal office’ is a major roadblock in determination of the jurisdiction that governs the DAO as a general partnership. The classification as a general partnership might obligate a DAO to reporting requirements in jurisdictions like the US. Even if none of the members of the DAO happen to be US tax residents, but if the income of the DAO is attributable to the US, it might be required to report the same to the IRS. Partnerships may also be required to submit an information return, Form 1065, to the IRS, detailing the partnership's financial information. Additionally, each member receives a Schedule K-1, which outlines their share of income, deductions, and other tax items, to be reported on their personal tax returns. Due to pseudonymous nature of membership of the DAO, such information might be extremely difficult to gather and furnish. Also, considering the nature of DAOs operations it is not clear that who would have the power to act legally on behalf of the DAO to make such filings and how does the DAO confer such powers? As many of the DAOs may not be domestic i.e. ‘Organized in the US’ it would be possible to classify them as foreign partnerships. If the DAOs governance tokens are tradable on the secondary market, it may be classified as a Foreign Publicly Traded Partnership. Foreign partnerships that conduct certain activities within the US are subject to filing obligations with the IRS. This typically includes filing Form 1065, "U.S. Return of Partnership Income," if the partnership earns income effectively connected with a U.S. trade or business, or if it receives U.S. source income subject to withholding. Additionally, the partnership may need to issue Schedule K-1 to each partner to report their share of income, deductions, and other tax items 9.1.2 DAOs registered as a legal entity 9.1.2 DAOs registered as a legal entity Some DAOs are already registered in various jurisdictions under the existing legal frameworks. This provides the DAOs with the benefits of legal personhood, but might not eliminate the legal and regulatory uncertainty completely. DAOs choose multiple legal wrappers based on legal and regulatory considerations as well as tax implications. Some DAOs are constituted as foundations under the laws of jurisdictions like the Cayman Islands and Switzerland. Such structures have benefit of limited liability to identify members and beneficial owners, with limited liability of members of the foundation for its debts and other obligations. The LLC structure provides members of the DAO with benefit of limited liability and the flexibility to choose how it is taxed based on specific circumstances. Brunson (2022) argues that just like checkthe-box regulations led to more widespread adoption of LLCs as a legal entity, DAOs can also be given a choice to opt their entity status for tax purposes. However, as Decentralized Autonomous Organization live and operates on the blockchain and the Internet, and due to the pseudonymous nature of their members, DAOs registered as entities might find it technologically infeasible to collect and report information related to tax residency, beneficial ownership etc. of its members. Technological solutions that address the pseudonymity problem can help to resolve many legal, regulatory and tax related issues related to both registered and unregistered DAOs. 9.2 Taxation issues of DAOs One of the fundamental aspects related to taxation of DAOs and their members is the classification of the tokens of the DAO. Some tokens might be classified as securities on application of the Howey Test or any other similar test for securities in a jurisdiction. In such a scenario the tokens will be taxed as securities. However, the tokens might serve dual purpose as utility tokens of the DAO’s protocol/application. Unless jurisdictions prescribe specific tax treatment for such tokens, it is likely that actions like those taken by SEC in case of The DAO and by the CFTC in case of Ooki DAO may continue. The individuals or entities may undertake many transactions with the DAO which might be taxable. The members may either receive governance tokens of the DAO or NFTs in the form of airdrops or they may pay a consideration for buying the tokens. In case of airdrops, in most jurisdictions, an income tax is chargeable upon the receipt of the airdrop. However, in some jurisdictions the receipt of an airdrop is not taxed but is considered acquisition of a crypto asset with zero basis. Also, the subsequent sale, swap, spend or gift transactions are also subject to capital gains. However, in some jurisdictions, depending upon the domestic tax laws and guidance, gifts might not be taxed. In case the member pays a consideration for buying the governance tokens of a DAO which qualifies as a general partnership, in some jurisdictions like the US, no gain or loss would be recognizable (26 U.S. Code § 721[149]), making the initial contribution non-taxable. For DAOs which may be treated by default as general partnerships unless they register as any other entity, they might subject to passthrough taxation where the DAO does not pay taxes as a business entity and the individual partners pay taxes on their share of profits. The portfolios of the DAOs in the form of investments or NFTs etc. may appreciate and taxed when realized, DAOs might also have income from staking on DeFi platforms and the Ethereum Beacon Chain. DAO’s sale of governance tokens for other crypto assets or fiat currency for funding the treasury, software development or any other purpose might also be a taxable event. The individual partners of the DAO would have to account for profits from all the activities of the DAO to pay their due taxes, which might be a challenge. The partners in a jurisdiction might pay taxes in their jurisdiction of residence as well as taxes in foreign jurisdictions for the DAOs profits attributable to those jurisdictions. This multi-jurisdictional liability might make profit attributions and tax liability ascertainment extremely complex and possibly lead to double or no taxation. If the DAO is registered as a corporation or is treated as a corporation for tax purposes, its profits will be taxed at the level of corporation as well as at the time of distribution of profits. The distribution of profits by the DAOs or burning of governance tokens might be taxed as dividends or share buyback in some jurisdictions. DAOs also engage in the procurement of goods and services from multiple individuals and entities which would be taxable for the recipients of the consideration. These transactions might also give rise to VAT/GST liability and if the consideration paid is in the form of crypto assets it might be considered disposal for the purpose of capital gains. For example, a DAO may assign responsibility for some of their operations to a specialized entity or another DAO which might be subject to VAT/GST. DAOs that employ people might have obligations to pay employer taxes, social security contributions etc. Revenue sharing arrangements or royalty payments might also be subject to taxes. Many of the transactions and taxable events mentioned above might have withholding tax obligations. However, in the absence of tax residency information, DAOs might be have to withhold taxes at a higher rate. The mechanism for payment and seeking credit for withheld taxes is also a practical challenge. Author: (1) Arindam Misra. Author: Author: (1) Arindam Misra. This paper is available on arxiv under CC BY 4.0 DEED license. 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