Law Commission Reports on Decentralised Autonomous Organisations

What kind of legal organisation or entity is a group of people linked by a computer network? If they are using distributed ledger technology (DLT) and following a common set of rules, then they could be described as a decentralised autonomous organisation (DAO). A challenge for English law is how to classify and align any particular DAO with existing corporate and non-corporate legal forms and determine the allocation of rights and responsibilities between participants, on the one hand, and the entity/organisation and the outside world, on the other hand. It is relevant to matters ranging from contract law and corporate governance to criminal responsibility for activities undertaken using the network.

The Law Commission was tasked by the Department for Business, Energy and Industrial Strategy (BEIS) to look into this issue in 2022. It has now produced a Scoping Paper, taking account of input received on its 2023 call for evidence. The Scoping Paper describes the Commission's review of English and foreign law structures, including unincorporated associations and special-purpose foundations. Although it was not asked to make recommendations, the Commission does point to areas where further work would be beneficial. In this note, we briefly summarise the paper and proposals.

DAO Classification Challenges

The creation of loose networks of people for various purposes is not novel. Groups frequently come together to raise funds for charities, organise sporting events, and work for political goals without formalising their relationships. English law generally does not impose organisational forms or governance responsibilities on the members of such groups (loosely referred to as unincorporated associations); preferring to deal with them as a collection of individuals. In that capacity, members may assume legally-significant roles as agents or trustees, but it is rare for general members to become liable for obligations of the group or the acts of other members.

The lack of form as a legal entity means that the corresponding rights and obligations of corporate shareholders or partners are not available to participants. The group cannot hold funds or property in its own right. Claimants in litigation have to make their case out against the relevant individuals, rather than the group. Regulators cannot authorise the group to perform restricted activities, given that it lacks legal personality. HMRC will look to individual members, rather than the wider group, to assess tax liabilities.

These considerations may be advantageous or disadvantageous for the members; and they might wish to consider formalising their relationship through contract or by creating a business organisation with limited liability, such as a corporation. For some DAOs involved in activities using cryptoassets, that has utility; for others, it sounds anathema. The very reason for creating some DAOs is to avoid the legal and other burdens of setting up and running a company. There might also be international links between participants, which mean that it is difficult to determine the relevant jurisdiction for any arrangement. The participants might not know each other or even be able to find out the names of other group members easily (eg, where anonymisation or pseudonymisation techniques have been used).

These choices can become very important. Legal personality – eg, in the form of a limited liability company – confers many of the rights and obligations of a natural person. It also regulates the relationships between different members in consistent ways. If the existing forms of business organisation are not adopted, then the law is forced to adapt – which can result in unexpected outcomes for participants and society at large.

The Law Commission's Considerations and Recommendations

• The Legal Nature of a DAO

The Law Commission notes that DAOs can be constituted in different ways and for a range of purposes. They consider that, along a spectrum ranging from the most to the least decentralised arrangements, three main categories can be identified:

"(1) “pure” DAOs: arrangements implemented through smart contracts with very limited off-chain activity, no incorporated legal structure and, often, a rejection (deliberately or otherwise) of dependence on law and legal institutions for their existence (although they may well still attract legal and regulatory consequences);

"(2) hybrid arrangements: arrangements combining smart contract-based coordination with deliberate use of one or more legal forms or separate legal entities; and

"(3) digital legal entities: arrangements where an incorporated legal entity adopts digitalisation through the use of smart contracts or DLT in its operations or governance."

The Law Commission concludes that England does not need a new form of company organisation specifically for DAOs, but they recommend keeping the matter under review. A forthcoming review of trust law by the Commission will provide an opportunity to consider the impact of DAOs alongside new trust structures. Nevertheless, the Commission suggests that a "limited liability not-for-profit association with flexible governance options" ought to be considered further. In the case of "digital legal entities" – which are essentially companies making use of DLT infrastructure for governance purposes – the Commission recommends further review of the Companies Act 2006 to assess whether changes are required.

• Money Laundering and Financial Crime

The Commission suggests that alternative approaches to money-laundering regulations ought to be added to take account of DAO arrangements. The Commission also notes that, given the potentially global nature of DAOs, the extra-territorial reach of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 could be extended.

• The Responsibilities of Developers

The Law Commission highlights the recent case of Tulip Trading, in which several developers of the Bitcoin network were sued with the aim of forcing them to make changes to the code of Bitcoin in favour of a user. The case was discontinued, so the question remains open whether developers are responsible to participants of DAOs on a fiduciary basis.

• Collective Investment Schemes

Some DAOs have features similar to collective investment schemes. Noting this, the Commission suggests looking to clarify the boundaries between them.

• Regulated Activities

The Commission proposes that the status of DAOs should be considered as part of the review of the regulated activities framework for cryptoassets. In particular, they are interested in how tokens are used within a governance framework.

• Taxation

Finally, the Commission suggests that the taxation of DAOs should be considered on an international basis.

Conclusion

With its Scoping Paper, the Law Commission has elaborated on many of the issues that are key to understanding the legal status and possibilities of DAOs. The most important take-away, for the organisers of DAOs, is that English law can accommodate many potential arrangements. The Law Commission was not dazzled by the technology; nor was it convinced by libertarian arguments that DAOs are "everywhere and nowhere" at the same time. There is still work to be done to find a place for informal networks that use DLT to connect participants; but, when they are a means for conducting business, then English law has the flexibility to support many models.