February 3, 2023

Response to the Law Commission of England and Wales' DAOs Call for Evidence

Andrew W. Balthazor | Andrew N. Choi | Daniel J. Barsky | Phillip Euell

"The 2022 implosion of many centralized virtual asset service providers and hedge funds — the consequences of which continue to ripple throughout the interconnected digital asset ecosystem — has accelerated investor and consumer interest in decentralized services. In the United States, this increasing DAO-related economic activity has resulted in regulatory scrutiny, including enforcement actions, and a number of private party disputes. These actions have highlighted the legal uncertainties surrounding DAOs."

The above was included in the introduction of Holland & Knight's response on Jan. 25, 2023, to the Law Commission of England and Wales' Decentralized Autonomous Organizations (DAOs) Call for Evidence. Through this inquiry, the Law Commission seeks to better understand the legal implications of DAOs, and to inform its assessment of how to reform the law in the United Kingdom to address these novel entities in light of substantial recent legal uncertainty.

One of Holland & Knight's guiding principles is to help our clients embrace innovative, efficiency-enhancing new digital technologies — while providing indispensable legal and regulatory guidance necessary to foresee potential issues that are invariably present at the early stages of technology adoption. DAOs represent an innovation in human organization, yielding new ways of cooperating toward the advancement of common goals with novel ways of attributing and sharing of risk.

Holland & Knight's response to the Law Commission embodies a prudent and practical approach to DAOs that considers the risks and benefits of DAO organizational structure and functionality:

  • The abstract individual descriptors of a DAO (decentralized, autonomous and organization) — while useful as a starting point for understanding the functioning of these novel entities — cannot convey the variety and complexity present in real-world DAOs.
  • Unincorporated DAOs and DAOs operating without agreements place stakeholders at risk of uncertain liability and accountability for actions attributed to the DAO — leaving it to courts to determine the extent of liability of DAO participants, including founders, promoters, governance token holders and software developers.
  • DAOs and their stakeholders will greatly benefit from the increased certainty and risk management inherent when organizing using established legal forms.

Key Points and Excerpts from Holland & Knight's Response

  • "In theory, a DAO's operations should be entirely on-chain and self-executing based on DAO's coded rules. Moreover, one school of thought by DAO proponents seeking autonomy holds that the self-executing nature of the DAO renders it unaccountable to regulatory oversight. This view is grounded in either an ideal (a DAO is technology outside the purview of any regulator); or the practical (DAOs are not entities and thus cannot be served with legal process or held liable). These views are unsustainable, however; sovereign entities will find ways to bring the operations of DAOs under regulatory umbrellas and within reach of courts."
  • "Some DAOs may merely be seeking to avoid the costs and burdens of structuring operations within a legal form. But DAOs do this at the risk of uncertainty to all DAO stakeholders regarding their personal liability for DAO activities. Indeed, certain DAOs may be deliberately seeking shelter in the uncertainty their lack of legal formality creates, in an attempt to avoid or delay regulatory accountability and liability for DAO operations. In our view, the uncertainty of operating DAOs outside of a legal structure is risky and outweighed by the benefits of organising DAOs within appropriate legal forms."
  • "Without responsibilities defined by either contracts or a legal form in which persons have known roles and expectations, DAO stakeholders are exposed to enormous uncertainties: who owes what duties to whom? Who is liable in the event something goes wrong — such as the code operating in an unintended fashion, or a majority stakeholder embezzling from the DAO's treasury?"
  • "DAO founders, promoters, stakeholders, and software developers may be exposing themselves to immense and uncertain liability because they are leaving it to the courts to determine to what extent they may have duties to others in the DAO context — or whether any warranties apply to the DAO's services — absent contracts between the parties or operating the DAO within a legal form. It is likewise important for DAO customers — leaving courts to determine whether a DAO or DOA stakeholder is liable to customers for customer harm is risky."

Holland & Knight's Virtual Currency, Digital Assets and Blockchain Technology Team has the technical know-how and regulatory and compliance knowledge to assist in any matters involving DAOs and decentralized finance (DeFi) services. Our attorneys are available to discuss your needs.

READ: Holland & Knight's Full Response

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