Wrapping the DAO: Decentralised Autonomous Organisations under English Law

As technologies in the Web3 space continue to evolve, one concept that’s frequently utilised by blockchain-based projects is some form of Decentralised Autonomous Organisation or “DAO”. In broad terms, DAOs are typically some form of community governance framework facilitated by a blockchain protocol.

So for example in DeFi, Uniswap is a decentralised crypto currency exchange platform, with no single decision making authority. Choices are voted on by UNI token holders as part of the DAO. In the Wed3 space more generally, another example might be the ENS DAO; a DAO that governs the “Ethereum Naming Service” protocol which facilitates the registration and management of ENS names, similar to domain names for Web 2.0.

In this article, we take a look at some of the key takeaways from the Law Commission’s recent Scoping Paper on DAOs and explore current trends in the legal structures some of these DAOs are starting to adopt.

The Law Commission Scoping Paper

Despite the fact that DAOs are fairly nebulous arrangements, they will have some legal implications under English law and this is something the Law Commission wanted to try and address by:

• identifying (in a technologically neutral manner) the legal status and liabilities of DAO participants; and 
• considering whether any further work should or could be undertaken to put these arrangements on their own legal footing or to give more certainty to market participants. 

Consequently back in 2022, following its work on digital assets, the Law Commission launched a Call for Evidence asking users and other experts for information about how DAOs can be characterised, and how the law of England and Wales might accommodate them now and in the future. 

The end result was the Scoping Paper on Decentralised Autonomous Organisations published by the Law Commission in July 2024 setting out its preliminary considerations on these issues.

Legal Categorisation? 

As commented on in the report, DAOs to some extent grew out of a desire to operate outside traditional, highly regulated, state-controlled environments. Some argue that DAOs are merely code operating autonomously on a blockchain, rather than a business being operated by token holders. However, the Law Commission found that in reality, most “DAOs” do not operate in a fully autonomous or decentralised manner. Many have dealings with the off-chain environment; entering contracts and holding both on-chain and real-world (off-chain) assets. 

The Law Commission noted that “Particularly in these circumstances, it is not possible to “opt out” of national and international laws merely by setting up a novel form of organisation or because of the technology used in their arrangement.”

For those that want some further reading, the Law Commission uses the Scoping Paper to explore in detail the various different ways what it calls a “Pure DAO” (discussed below) could be characterised under English law; ranging from a collection of legally binding contracts to a general partnership, unincorporated association or to some form of trust structure – however it found perhaps unsurprisingly, that most DAOs don’t fit neatly into any of these boxes.

For example, in the case of what the Law Commission has called a “Pure DAO” it concludes that to say this is a general partnership “may put a strain on the general conception of such organisations”; namely that they must carry on a single business in common. The notion that all participants are operating for a single purpose is not necessarily true for the full spectrum of node operators, miners, validators, token holders, founders and developers that might be involved. Software developers or founders of the project arguably have more control (but not all developers would necessarily be involved in the decisions of the business). 

“Wrapping the DAO”

One key finding highlighted by the Law Commission was its assessment that as DAOs have developed over the past few years, more or perhaps most DAOs are proactively adopting legal entities with separate legal personality. This process is sometimes known as “wrapping” the DAO. 

The Law Commission recognised that incorporating some form of legal entity will aid the project’s ability to transact in the real world (for example, by opening bank accounts and entering into contracts), as well as allowing DAO participants to benefit from the separate legal personality and limited liability most corporate structures afford.

This is also perhaps preferable to their exposure to uncertain legal characterisation which (as can be seen in some US litigation) could then result in a greater potential liability of participants than if the DAO voluntarily adopted a more considered legal structure. Although some respondents to the Law Commission’s call for evidence queried the effectiveness of this in practice, since for example the legal wrapper does not apply to all aspects of the DAO.

With this “wrapping” in mind, the Law Commission assessed that most DAO’s tend to fall somewhere along a spectrum; from: 

• a “pure DAO”, with no intentional legal structure; to
• hybrid arrangements; still using smart contract based coordination and governance but with one or more legal forms or separate legal entities; to
• “Digital Legal Entities”; where an incorporated legal entity also adopts DLT or smart contract in its operations or governance (such tokenised securities or on-chain shareholder resolutions).

Few DAOs are choosing to incorporate in the UK

Despite the prevalence of some form of legal structure somewhere within, or adjacent to the DAO, few DAOs are choosing to incorporate in England and Wales. The Law Commission noted that several consultees said that existing legal structures available in England and Wales were inconsistent with or unsuited to the operations and objectives of DAOs. This included difficulties around:  

• Filing and transparency requirements; namely that company incorporation and record-keeping requirements are inconsistent with the anonymity that some DAO participants seek; and
• Difficulties Complying with company law requirements, in particular the requirements: (i) to have a physical address; (ii) that all directors must be registered at Companies House; (iv) for publicly available annual statutory accounts; and (v) compliance with anti-money laundering and KYC requirements where it is a challenge to preserve members’ privacy as well as the fluidity of DAO membership. 

Where else are DAO entities incorporated?

As part of its assessment of the attractiveness of the UK as the jurisdiction of choice for DAO incorporation, the Law Commission sought to understand from consultees which jurisdictions may be preferable to the UK and the other forms of legal structures available.

Interestingly it found that a few American states have enacted legislation providing for amendments to their general forms of LLC in order to accommodate DAOs. Wyoming, for example, has the concept of a “DAO LLC”: which is an LLC that can be “algorithmically” or “smart contract-managed”. However some respondents queried the utility of these kinds of structures in practice, often due to restrictive nature of their structural requirements or certain administrative burdens. 

The Law Commission also found that, under Californian law, another popular option for non-profit DAOs is an unincorporated non-profit association which it understood: 

• can be set up without any form of state registration; 
• will be covered automatically by the statutory framework that amounts to separate legal personality and significant limited liability for members (unlike unincorporated associations in the UK which do not have separate legal personality); and
• members need not declare their identities and may remain pseudonymous. 

Finally, one of the most popular options the Law Commission highlighted, largely because of the flexibility in their rules and structuring was offshore foundations; in particular the Cayman Foundation Company and the Panama Private Interest Foundation. The Law Commission found that, like UK limited companies, Cayman foundation companies can be formed for any lawful purpose, have separate legal personality, and provide limited liability to members. But, they also have the capacity for its constitution to distribute governance powers to almost any person for any purpose. The Law Commission noted that this includes the possibility of most major decisions being subject to a vote of DAO token holders (which do not need to be members of the foundation). It also provides much greater anonymity than an English company and can be registered with the name of one supervisor and one director. 

What reforms might be needed in the UK? 

Notwithstanding the attractiveness jurisdictions such as the Cayman Islands and the Cayman Foundations, the Law Commission concluded that: 

1. At this stage that there is no current need to develop a DAO-specific legal entity for England and Wales, however, the Government should keep this matter under review. It also felt that challenges around filing, transparency and company law compliance for DAOs are not unique to England and Wales:
   
   “From a broader policy perspective, the case for offering DAOs different, and potentially less burdensome legal or regulatory treatment (such as reduced disclosures or greater flexibility in managerial control) […] has not (yet) been made out. […] We do not see a case for exempting DAOs from any or all of these requirements and restrictions, given their role in the overall integrity of the system and the need to protect third parties.”
   
   
2. In its view, the most significant “gap” is in the legal options available to not-for-profit DAOs in England and Wales, and in particular the unavailability of an unincorporated non-profit association with limited liability and separate legal personality (as is the case and is a popular structure for DAOs in the US).
   
   
3. A review of company law would be helpful to identify reforms to make it easier for organisations to leverage distributed ledger technology (DLT) at the governance level. For example to resolve: (i) Any potential difficulties around physical copies or addresses for recordkeeping and filing and with certificated securities; and (ii) to increase legal clarity on the ways in which smart contracts can be linked to legal governance processes. 
   
   
4. In general the Law Commission felt that the law of England and Wales does already provide significant flexibility to accommodate new technologies with little or no statutory intervention. For example, the Law Commission has previously confirmed, that smart contracts are capable of constituting legally enforceable contracts and that computer code could constitute “writing”. 

Conclusions

We’re over 3 years on from The Kalifa Review of UK Fintech which identified opportunities for Britain to build on its success as a leading global centre for fintech. Given the Government’s ambitions to retain the UK’s reputation as a world leading jurisdiction for fintech and innovation in financial services more generally, it will be interesting to see if the Law Commissions current conclusions around DAO specific entities impacts this reputation at all. 

Either way it seems that, English law remains a sound choice for contractual agreements in and around Web3 projects. As noted by the Law Commission, participation agreements and ‘constitutions’ of DAOs regularly refer to England and Wales as the governing law of these agreements. 

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