Introduction
In a previous article,1 I looked at how prevailing jurisprudence is grappling with personal property rights applying to digital assets (such as cryptocurrencies and non-fungible tokens (NFTs)). This investigation is necessary as both regulators and users alike are looking for greater certainty and legal recognition of such assets.
The investigation started with a simple question: Can digital assets be considered personal property? In response, the Law Commission of England and Wales (LCEW) had to revisit a preliminary question: What is personal property? After several hundred pages of meticulous research, the LCEW reached a conclusion: We need a novel form of property right that the LCEW called a "Digital Object".2
Here, I consider another frontier of jurisprudence that is rapidly taking shape with the potential to create entirely new fields of law, this time in relation to legal personhood. Distributed Ledger Technologies (DLT) such as Ethereum, Avalanche and other smart contract platforms have brought about new forms of organisation and identity that are purely digital in nature. As with property rights, users and regulators are revisiting a foundational question: What is a person, at law?
The concepts of Decentralised Autonomous Organisations (DAOs), Soulbound Tokens and the latest attempts to theorise, adjudicate and legislate in this field will be discussed.
What is a DAO?
Defining DAOs has been subject of much debate, typically reflecting the political leanings and legal training of those defining the term.
At one extreme, US practitioners such as Gabriel Shapiro have stated that the term has been applied in so many different ways and widely differing circumstances that it has become close to meaningless. Nonetheless, Shapiro offers one version representing libertarian and cypherpunk concerns:
"DAO" in its purest form refers to an unincorporated association of persons (an "organisation") utilising censorship-resistant technologies to permissionlessly ("autonomously") engage in non-hierarchical, widely distributed ("decentralised") governance of shared resources and goals.3
At the other end of the spectrum and reflecting a willingness to have DAOs recognised by the legal system with their own separate legal personality, the Coalition of Automated Legal Applications (COALA) has defined DAOs in its draft of a Model Law for DAOs (Model Law) as follows:
"Decentralized Autonomous Organization" (DAO) refers to smart contracts (ie, blockchain-based software) deployed on a public Permissionless Blockchain which implements specific decision-making or governance rules enabling a multiplicity of actors to coordinate themselves in a decentralised fashion. These governance rules must be technically, although not necessarily operationally, decentralised.4
Setting aside the wide range of legal definitions possible, DAOs typically have several common features:
- an online forum (sometimes using third party apps such as Discord or Telegram) for discussion of various proposals relating to the configuration of the DAO's software as well as the DAO's interactions with the "real world"
- a web-based voting portal that records the cryptographically secured and immutable votes on such proposals, often using the DAO's own governance token to represent voting power
- a process by which such proposals are implemented, either through changes to the smart contract software or approved actions to be taken by DAO contributors and ecosystem participants
- the smart contract software that facilitates and records these choices in a decentralised fashion.
This begs the obvious questions of how should a DAO be recognised at law and how should the law view a DAO's founders, token holders and contributors. Are DAOs corporations, partnerships or some other form of unincorporated association?
As DAOs often include pseudonymous actors who create multiple identities and wallets (either to obfuscate their voting behaviour or gain financial advantage), a preliminary question for any system of legal recognition will be identifying the relevant participants. One possible solution is that offered by what has been referred to as "Soulbound Tokens".
What are Soulbound Tokens?
In a 2022 blog post,5 Ethereum founder Vitalik Buterin set out to address one of his longstanding concerns with the current state of pseudonymous, trustless systems employed by blockchain solutions and Web3. Primary among those concerns is that social reputation and voting power can easily be purchased and transferred. This leads to commoditisation and concentration of voting power and abuse of governance. These issues are becoming increasingly problematic because many blockchain solutions and DAOs are governed by votes reflecting the distribution of tokens staked within the protocol or delegated to a proxy. And as with real-world voting, non-compulsory voting has resulted in voter apathy, further concentrating voting power.
Setting aside the unfortunate use of the word "soul" that opens up a range of complex philosophical, religious and human rights debates, the essential premise of the solution presented by Buterin is that each person's commitments, credentials and affiliations could be verified by what he called "Soulbound Tokens", initially comprising non-transferable tokens and NFTs held in each person's wallet on the blockchain. These tokens would be issued by institutions, authorities and communities and effectively operate like a resume, with a key difference being that each element of this "resume" has been attested to by the issuer of the Soulbound Token and cannot be forged, replicated or transferred.
Such Soulbound Tokens permit software to replicate the trust networks of the real world in order to establish provenance and reputation.6 This opens up use-cases which are currently not possible in the purely digital realm, especially in relation to public goods, because Soulbound Tokens can be used to enable verifiable voting systems reliant on equal representation and permit more efficient interactions between citizens and the public services and spaces they engage with. Soulbound Tokens would facilitate lending and other financial products analogous to those offered in traditional finance, including under-collateralised loans, as Soulbound Tokens can be designed to store reputation and creditworthiness.
Soulbound Tokens would also allow for community-based and non-custodial recovery of digital keys and passwords as the Soulbound Token can be used to independently verify that a user actually owns a specific wallet and authorise a "social recovery" of that wallet.7 This will become increasingly relevant as one of the roadblocks to wider adoption of digital assets has been the reliance on a user's capacity to securely store and recover their digital wallets, often requiring a daunting knowledge of cryptographic key management and security. It is estimated that nearly 20 per cent of all Bitcoin has been lost forever and there are countless stories of users losing access to their wallets.8 The characteristics of Soulbound Tokens would therefore simplify recovery of wallets in situations where the owner of a wallet has lost their keys, is incapacitated or has died.
Not surprisingly, privacy advocates both within and outside the blockchain industry have raised concerns with a system that captures one's reputation, creditworthiness, health records and other sensitive data. In a subsequent paper, Buterin and his co-authors anticipated these criticisms, recognising that privacy will be a central challenge to maintaining systems that utilise or store Soulbound Tokens and encouraged software developers to investigate programmable privacy and zero-knowledge proofs as a core element of any Soulbound Token system. This would restore and even increase a user's control over their personal information in the digital realm.
AI acceleration – from org to cyborg . . .
In May 2023, former Professor of Computer Science at Cornell University Emin Gün Sirer introduced yet another innovation in this space that he termed "Coin-Operated Agents" or COAs.9 These would theoretically operate as fully independent networks or DAOs powered by nothing more than large language models and AI tools such as ChatGPT.
A distinguishing feature of this concept is that while a COA would share many of the benefits of a DAO in terms of output and decision-making, no human participants would be involved. Unlike DAOs with human founders and members, a COA would have no members, voting systems or proposal discussions – the AI tools would be able to take instructions and complex operations in plain language (a simple contract for example) and process those transactions and rules without the need to develop any software or smart contracts. The COA could also maintain its own software, learning from known vulnerabilities and anticipating others.
This and other innovations will test existing frameworks for determining legal personhood.
How has Australia responded to these developments?
Law reform initiatives into legal recognition of DAOs are well underway around the world. In Australia, the position is less clear. The federal government has yet to reveal its plans with respect to the recommendations of the bipartisan Select Committee on Australia as a Technology and Financial Centre that reported on cryptocurrencies and digital assets in October 2021.10
Of the 12 recommendations published in the report (one of which included an investigation into legal recognition of DAOs), the government has only taken up one in relation to a token mapping exercise.11 The government argued that this task was a necessary first step to scope out a broader set of regulatory responses but it was not clear why parallel initiatives could not be undertaken or their view on the other recommendations, so it remains to be seen how the identification of token categories will proceed.
Why do we need a new form of legal personhood in Australia?
Some have argued that current legal uncertainty in relation to DAOs can be detrimental to development and utilisation,12 although this has not stopped thousands of DAOs being created worldwide with more than $115 billion in value managed by them at the time of writing. However, the common refrain from the crypto industry has been that lack of regulatory clarity is a hindrance to growth.
In response to this uncertainty, the industry has sought out novel and often untested legal solutions.
It is not uncommon for software developers and contributors to DAOs to seek legal protection through not-for profit foundation companies, special purpose vehicles and operating entities in jurisdictions as far-flung as the Cayman Islands, British Virgin Islands and Dubai.
These jurisdictions actively market company structures that claim to offer anonymity for directors and members, limited liability and minimal reporting. Some entity structures can operate without members, and using a single, non-executive, nominee director. These entities are used to raise capital, open bank accounts and transact with suppliers, and present a highly attractive package for start-ups and teams with anonymous stakeholders and developers.
Other projects have attempted to structure their operations around even more creative solutions including Delaware's Series LLC structure that requires no identity verification and little more than a crypto wallet to establish the entity.13 Questions remain regarding the effectiveness of such models in practice and whether they genuinely offer limited liability or vicarious liability for developers, token holders and others supporting DAO operations. Even within the US, not all states recognise series LLC entities and concerns regarding their efficacy grow stronger once participants start operating outside the US.
In short, these and other band-aid solutions are sub-optimal risk mitigation strategies and fail to provide a foundation for investment and growth of the sector.
How have the courts, regulators and lawmakers responded?
As mentioned earlier, the Senate Select Committee issued 12 recommendations, including one that the government establish a new DAO company structure designed for Australia's specific corporate frameworks. The recommendation also encouraged the government to conduct an examination of the COALA model and other international examples.
Although the government has yet to respond to this recommendation, there is merit in considering the approach taken by courts, regulators and lawmakers around the world as this provides useful insight on how Australia might ultimately respond.
The courts
The biggest headline for DAO-watchers has been the recent lawsuit in the District Court for the Northern District of California, brought by the US Commodity Futures Trading Commission (CFTC) against Ooki DAO,14 alleging that Ooki DAO was operating an unregistered futures trading facility.
This lawsuit came to global attention because the DAO has no entity, no office and no employees. The CFTC, therefore, sought court permission to serve the entire DAO at once by posting the lawsuit on the DAO's public forum and through the DAO's chatbot.
As the DAO had no legal representatives, several amici briefs were filed by technology venture funds and leading practitioners in the industry arguing that Ooki DAO was not a legal person and could not be served. In response, the Court held that:
- contrary to the amici claims that a DAO is software and cannot be subject to service, let alone the proceedings brought by the CFTC, Ooki DAO was, in fact, an unincorporated association for the purpose of establishing proper service
- the CFTC could sue Ooki DAO as an entity separate from the individual governance token holders.
Subsequent to the interlocutory order on the alternative service requested by the CFTC, the Court then awarded default judgment in favour of the CFTC requiring Ooki DAO to permanently shut down and pay a civil monetary penalty of 643,542).
As this is a decision of a single judge in a non-appellate court with an unrepresented defendant, it is unlikely that the courts will view this case as setting a precedent. That said, District Judge William Orrick's reasoning was nuanced and displayed a sophisticated understanding of DAOs so it may well be persuasive in future cases.
The regulators
In another landmark event that had an immediate chilling effect on the crypto market, the US Office of Foreign Assets Control (OFAC) sanctioned virtual currency mixer Tornado Cash and included, as the "persons" the subject of the sanctions, a list of Ethereum wallet addresses15 making this the first time in history that a software application has been added to a sanctions list.
Sometimes referred to as a "mixer" or "tumbler", Tornado Cash and similar platforms allow one to maintain privacy of transactions by allowing deposits to, and withdrawals from, a common pool of funds, thereby obfuscating the source of funds for the ultimate recipient. According to the sanction published by the OFAC, Tornado Cash had been used to launder more than 1 trillion market in money laundering conducted through the existing banking system, illicit transfers of physical cash and international trade.16
Of interest in the context of this discussion is OFAC's broad reading of their sanction powers which can only be sought against "persons".17 As OFAC did not provide grounds for how the sanctions could be brought against a software platform such as Tornado Cash, industry groups have accused OFAC of regulatory overreach. As occurred in the Ooki DAO case where there was no entity or other person to oppose the regulator, the industry groups filed amici curiae in opposition.18 It remains to be seen if the courts will uphold the sanctions.
Aside from the tentative steps taken by the courts and regulators, there has been considerable work done by law reform advocates and legislators. We will look at these next.
The minimalists and BORGs
Under a model proposed by Delphi Labs,19 DAOs would remain unincorporated, loosely structured groupings of users that exist purely as software on a public blockchain. DAOs should not, according to Delphi Labs, be recognised at law. They argue that such recognition will result in complex, non-compliant businesses that expose participants to legal jeopardy.
The alternative, they argue, is for DAOs to incorporate separate operating entities (or "BORGs", as in cyBernetic Orgs) using widely recognised entities such as foundations, trusts and limited liability companies that augment the DAO and facilitate real-world interactions. The BORG would be bound by its constitution and supporting contracts to act in accordance with the stated objectives of the DAO members. No law reform would be required in this instance; however, it remains open to debate whether such a model will provide adequate protection of DAO token holders who would be viewed as neither shareholders nor directors of the BORG, especially in light of the Ooki DAO case.
The incrementalists – Wyoming, Tennessee and Vermont
In July of 2018, Vermont became the first US state to enact LLC legislation tailored to blockchain-based companies. While not explicitly referring to DAOs, the legislation allows registration of a new form of entity called a Blockchain-Based LLC that permits the LLC to use blockchain solutions in place of traditional forms of governance, record-keeping and other procedures typically required for operating an LLC.
In 2021, Wyoming became the first US state to recognise DAOs as a distinct form of limited liability company. It did so by permitting DAOs to incorporate and obtain LLC status under the existing Wyoming Limited Liability Company Act. Wyoming further amended the legislation to allow DAOs to set their own quorum requirements and largely dispense with fiduciary duties except where the organisational documents state otherwise.
Tennessee followed suit with a similar approach to Wyoming in April 2022.20
A common feature of the above approaches is the reliance on existing regulatory frameworks to support DAOs. While this has the benefit of clarity regarding rights and duties, there has nonetheless been a general backlash to this approach by industry specialists. The primary concern is that many of these laws are founded on misunderstandings regarding the nature of smart contracts and DAOs and the technology underpinning them. This could lead to situations where, for example, failure by the DAO to satisfy one of the technical or operational requirements mandated by the regulations could lead to deemed dissolution or defects in eligibility. This would lead to the loss of any limited liability protections and the corporate veil, exposing members, employees and office holders to personal liability.
A new breed of COALAs
The Model Law drafted by COALA rests on the proposition that DAOs should be afforded separate legal personality from their members. The Model Law includes DAO-specific provisions to respond to software updates and failure events. It calls for shares or tokens recorded on a blockchain-based system to be regarded as valid titles to a share, transferable via a blockchain-based registry. The Model Law does not mandate the types of registers and reporting typically kept by traditional companies but attempts to find functional equivalents that are blockchain-native.
Several jurisdictions have already introduced or implemented some form of legal recognition based on the Model Law including New Hampshire, Utah and Marshall Islands. This approach differs from that taken by Wyoming and the other incrementalists in that it creates an entirely separate framework for the incorporation of DAOs and avoids many of the Wyoming law's definitional pitfalls, minimising the risks of hair-trigger dissolutions and eligibility defects. Given their infancy, it remains to be seen how the Model Law will operate in practice.
Conclusion
In recent years, there have been significant shifts in the recognition of legal personhood and the relationship between legal persons and human persons. The approach by nation-states towards the concept of legal personhood has transitioned over time from relative non-interference into fields as diverse as disability and environment law, where legal capacity and rights have been granted to vulnerable persons and even natural objects such as rivers.21
Australia has had no difficulty in adopting new corporate structures, such as no-liability mining companies and collective corporate investment vehicles. In that sense, DAOs are an example of investment and collaboration tool that make an ideal candidate for recognition. By doing so in an appropriate way, Australia would place itself at the forefront of global law reform initiatives and open the door to international investment that is, despite market conditions, continuing apace. ■
By Paul Imseih.
Paul is the founder and principal of Daimon Legal and a board member of the Dai Foundation, the entity that oversees operations and intellectual property for Maker DAO. He is an internationally recognised legal theorist working at the cutting edge of fintech, emerging technologies and law, supporting international clients in the DeFi, NFT, AI, cryptocurrency and blockchain industries.