On 16 November 2022, the Law Commission announced that it will begin work on a scoping study into Decentralised Autonomous Organisations (“DAOs”). The review will shed light on how DAOs are to be treated under UK law, which is part of the UK’s greater drive to become a global cryptoasset technology hub.
DAOs are a strange (relatively) new entity, whose legal status is currently something of a mystery. Their structure does not quite fit within any current model of legal entity. They are projects that operate almost exclusively over the internet, whose participants make decisions collectively without anyone directly in charge. DAOs have been used in an array of areas in the crypto-sphere, for instance as investment groups, to fundraise for new projects, and as software development and social clubs.
For those without a foothold in the crypto sphere, DAOs have sprung seemingly out of nowhere. In the past year alone, DAO treasuries reported surging from $400 million of crypto funds at the start of 2021, to an estimated $12.5 billion in January 2023. DAOs are a particularly popular model for new crypto and metaverse ventures and are seen by crypto enthusiasts as the tonic to the concentrated power of Big Tech for their democratic and decentralised structures. As such, they are deeply embedded in the culture and ethics underpinning web-3.
New types of organisations are rare, and it often takes a long time for the law to catch up. In the meantime, there will inevitably be uncertainty whenever disputes arise involving a DAO. In particular, it is difficult to determine who can bring a claim on the DAO’s behalf or, in the event that the DAO itself has committed a wrongful act, serve as a Defendant. The huge market share gained by DAOs in the past year suggests we are destined to see many more disputes, which all begs the question: What are DAOs? And can they be parties to a claim?
What even is a DAO?
That’s a good question. DAOs are the crypto sphere’s version of a joint enterprise. The simplest definition is that they are a group making decisions towards a common goal without a centralised command structure. Instead, decisions are made by a consensus of the members of the DAO. They are, in many ways, a company with voting buttons instead of a board of directors.
What a DAO looks like in reality can be a little more complicated. Most DAOs’ decision-making is built into their structure through a complex web of smart contracts. Voting rights may be conferred by crypto-coin ownership: the more you own, the greater your say in the future direction of the DAO. All of the voting mechanisms are pre-determined by the smart contract, which acts as the DAO’s version of a constitution. Most follow an open-source set of smart contracts on the Ethereum blockchain, which are then modified to fit with the specific needs of the DAO. In this respect, coin holders look somewhat like shareholders: they often own a proportional share of the DAO and have a corresponding voting power.
However, unlike a company, there is usually minimal or no delegation of decision-making to an executive board. Whilst some have committees to carry out various functions, these usually do not exercise high degrees of autonomy and usually only execute on the decisions of the majority. Voting can cover a vast array of areas, which will vary from DAO to DAO. Tokens can give voting rights over wide issues, such as the governance or economic trajectory of the DAO, or more narrow issues such as whether to hire a contractor for a specific task or to implement a new feature into their products.
This is not to say that every DAO is structured in the same way: some DAOs are much more like an online members’ club whose decision-making is made through a specific forum or social media channel. However, DAOs of this type tend to have crude voting systems, which usually indicate they are less sophisticated and economically active than DAOs governed through smart contracts, thereby reducing the likelihood that they will become involved in disputes.
Can a DAO be party to a claim?
First thing’s first, a comment on why this is important. Disputes involving crypto and metaverse companies are becoming increasingly common, particularly in relation to intellectual property. The culture and ethos behind Web3 is particularly recalcitrant to commercial monopolies and intellectual property is designed to protect just that. We have seen an explosion of parodies of famous trade marks, including the widely reported MetaBirkin case and even a parody of McDonald’s involving metaverse Pigeon McNugget shoes (our previous Law Now on this bizarre venture is available here). Irreverence and hype often translate into significant boosts in sales, which has significantly fuelled (often deliberate) trade mark infringement in a digital context. Metaverse organisations, including DAOs, also have a significant interest in figuring out how to protect their intellectual property in a digital setting. The damage that can be caused by copycat products and fake coin scams in particular can be extremely damaging to a metaverse brand, particularly as trust and transparency are considered key in the industry.
With the growing interest and money being poured into the metaverse, particularly by tech giants such as Meta, Alphabet and Amazon, we expect many cases of patent, trade mark, copyright and design infringement to follow. If you are considering expanding your business into the crypto space, it is becoming increasingly inevitable that you will eventually have dealings with a DAO. As part of that process, your due diligence should include assessing how you might recover your losses if things go wrong. On the other side of the coin, the number of new start-ups electing to operate as DAOs is growing rapidly. Those enterprises will need to know exactly how they can bring legal proceedings should their valuable IP be misappropriated.
Bringing a claim on behalf of or against a DAO could be tricky. Understanding your DAO’s structure and how you might bring a claim is important at the outset, otherwise you run the risk that service may not be valid. On the other hand, the main issue around pursuing a DAO is figuring out who to take action against. If voting rights are established by the ownership of a publicly traded coin, tracking down and serving on all of the owners is logistically difficult, if not impossible: the speed at which crypto transactions occur means that, between postage and receipt, the ownership may have changed hands numerous times. However, if you serve on the DAO itself (presuming that you find a suitable postage address), you run the risk that the service is not valid and that your claim fails at the first hurdle. Recently, we have seen service by NFT arise as one solution to this problem. However, it nonetheless requires a proper understanding of how the DAO operates, to ensure that the correct token holders are served.
From a legal standpoint, figuring out exactly what a DAO is appears to be a tricky question and there currently is no clear answer. The characteristic part of a DAO is how it makes decisions, not what it does or how it is structured. This makes DAOs a broad church of ventures and activities and no single rule is likely to apply in all cases. Whilst the precise nature of DAOs will be a matter for the courts or Law Commission, there are a few questions which can be helpful to consider in practice:
- Is the DAO actually a company? Generally speaking, no, a DAO is unlikely to be a company. The limited constitutions and decentralised structure mean they are not compliant with the UK’s Companies Act and therefore they are unable to register in the UK. However, some states in the US allow certain DAOs to register as limited liability companies. Whilst take-up within the sector has been poor as it is seen as going against the grain of web-3’s decentralised ethos, this is nonetheless worth investigating in the first instance. Furthermore, a company may have some features or connections which operate as a DAO, whilst nonetheless being incorporated. For instance, the Bored Ape Yacht Club (“BAYC”) has an associated DAO governed by ownership of ApeCoin, which makes decisions about the future direction of the NFT, ownership perks and other key points of economics and governance. However, BAYC’s creator, Yuga Labs, is a company incorporated in Delaware. Whilst the DAO makes decisions to which Yuga Labs then usually complies, it is nonetheless a company which has elected that a portion of its decision-making should be made through a DAO. Therefore, whilst the general rule is that DAOs are not companies, there may be a company associated behind a DAO which could be a valid party to proceedings.
- Is the DAO a partnership? Under UK law, a partnership involves two or more people coming together with a view to making a profit. One current legal uncertainty is whether coin ownership can amount to an intention ‘to make a profit’. This will in part be a matter of context, which will depend on the structure and purpose of the DAO. For DAO investment clubs, the activity itself may make a strong case that they are acting as a partnership. Where DAOs confer voting rights without ownership rights, then those structures seem less likely to be partnerships: the decisions are being made by people who have no stake in any potential profit. However, even if collective ownership is conferred with voting rights, it is still necessary to show that there is an intention to make a profit. Many DAO projects have broad social aims, such as developing new technologies, increasing access to decentralised banking or solving inflationary pressure. Whilst some coin owners will have bought their coins speculatively, hoping that they will appreciate in value, many others will be invested in the projects for non-financial purposes. Figuring out motive in an anonymous, decentralised system is particularly problematic and it is not clear how the courts would go about doing so. It will remain a point of uncertainty until someone is brave enough to test the issue in court or until the outcome of the Law Commission’s study. If a DAO is a partnership, then the individual partners are jointly and severally liable: in other words, the claimant can pursue any one of the participants for the entirety of their loss, and it is for that person to seek a contribution from the others. This is particularly helpful or concerning where there are members with deep pockets, such as founders or institutional investors, depending on which side of the table you are sitting on.
- Is the DAO an unincorporated association? An unincorporated association is a fancy term for something we are all familiar with: a group of people brought together for an activity, such as a sports club. They are unincorporated, meaning that they do not have their own legal personality: they cannot own property, register for loans or have standing in court. This means that they cannot bring a claim against any party, but also that parties cannot bring claims against them. If a DAO is an unincorporated association, that could prove to be a major headache for any rightsholder seeking to enforce their intellectual property rights: there will be no legal entity encompassing the ‘DAO’, instead the individual members will be responsible for their own actions. How this would work in the context of a dispute with a DAO is unclear. It may mean that all of those who participated in a vote which led to infringement are liable. It may be possible to claim that they are jointly and severally liable, as with a partnership, but this is a complex legal argument which will depend on demonstrating that the individual participants voted in a fashion that led to the infringement. As discussed earlier, identifying who was involved in a vote and tracking them down could be logistically difficult where there are large numbers of participants. In fact, the complications surrounding the service of a DAO were a central issue in a recent case before a Californian court bought by a regulator against Ooki DAO. By implicating the DAO in regulatory action, the court considered whether the regulator would have to serve on all of the members in order to be valid under the laws of California. It held that it was sufficient to serve on the founders of the DAO as identifiable coin owners in the US, although it is unclear whether the reasoning behind the decision would also apply in the UK if the DAO was not a partnership. Overall, from a litigation standpoint, treating DAOs as unincorporated associations is problematic and makes legal action difficult, whether the DAO is the subject or the instigator of a claim.
- Does it have a ‘wrapper’? Where a DAO has sought legal advice, they will often have a ‘wrapper’. Wrappers are legal entities associated with a DAO, which act as tools for the DAO to carry out functions it would otherwise not be able to do. These functions include hiring employees, registering and paying tax and registering with regulators in key industries. One of the most important functions of a wrapper is to own property, including intellectual property. For instance, Maker DAO operated through a wrapper called the Maker Foundation. Maker DAO is a highly successful crypto venture operating in fintech which created DAI, a stablecoin pegged to the dollar which currently has a market cap of nearly $6 billion dollars. Maker Foundation owned all trade marks for Maker DAO, allowing Maker DAO to protect and grow its brand. Wrappers can take many forms, but most DAO wrappers are companies or non-profits incorporated in the US or Switzerland. Wrappers are useful from a litigation standpoint: if a DAO has a wrapper, then it is a good candidate to be a party to litigation. It will also hold most of the assets for the company, meaning that you know it should have the funds to meet your claim in the event you are bringing a claim against a DAO.
Whilst the legal status of DAOs is uncertain, context is the key to any dispute involving a DAO. Members of DAOs should consider carefully how they wish to structure their organisations, as ease/speed of initiating proceedings can often be critical in instances of egregious and/or fraudulent infringement of intellectual property rights.
As to bringing a claim against a DAO, a thorough investigation into how the DAO operates, and whether it has relationships with companies or with a wrapper, should always be your first pre-action step. Thankfully, the transparent nature of web-3 means much of this information is readily available online. Knowing what to look for is therefore crucial, meaning it is particularly helpful to get legal advice early on in your dispute. Another approach when contracting with a DAO is to leverage the smart contract in your favour: if your transaction will auto-execute with the DAO paying, you can insist on all of the payment being paid upfront, to avoid the risk of a payment dispute.
The uncertainty around the legal status of DAOs is likely to continue. It may be resolved by a brave party taking the issue of partnership to court. Alternatively, it may be established by the Law Commission’s study or by future legislation giving them their own legal personality. Whichever way DAOs develop, CMS will continue to keep you updated.
This article was co-authored by Oliver Roberts, Trainee Solicitor at CMS.