A Legal Framework for Decentralized Autonomous Organizations This analysis was written by David Kerr (Principal, Cowrie LLC) and Miles Jenni...

A Legal Framework for Decentralized Autonomous Organizations

A Legal Framework for Decentralized Autonomous Organizations

This analysis was written by David Kerr (Principal, Cowrie LLC) and Miles Jennings (General Counsel, Crypto, Andreessen Horowitz). Special thanks to Marc Boiron, Aaron Wright, Molly McQueen and Connor Spelliscy for their contributions and insights. David Kerr is a recipient of a research grant from the DAO Research Collective.

Introduction The United States regulatory environment surrounding digital assets presents an extraordinary challenge for blockchain and smart contract-based protocols. In the absence of comprehensive legislation addressing the complexities of this developing technology, individual regulatory agencies have been forced to provide their interpretations of how regulations should be applied to situations and technologies, well beyond what was considered when the current laws and regulations were enacted. Although it is universally agreed that comprehensive reform and new legislation is a necessity, the reality exists that the developers and users of blockchain technology have been left to navigate a patchwork regulatory environment insufficient to address relatively simple issues related to digital assets, let alone the additional complexity accompanying the decentralized alternatives to traditional financial service offerings available through smart contract-based protocols. The vast majority of blockchain networks and smart contract-based protocols are organized as, or intend to implement, DAOs, which are member controlled organizational structures that operate absent a centralized authority. 3 While blockchain networks utilize a number of different consensus mechanisms, DAOs of smart contract-based protocols are typically facilitated by a set of governance-related smart contracts that have specified control rights with respect to the smart contracts making up the underlying protocol, all of which are built on distributed ledger technology, most commonly the Ethereum blockchain. These governance smart contracts disintermediate transactions between counterparties by automating the decision-making and administrative processes typically performed by traditional management structures. Decentralization of a given protocol occurs when control (e.g., governance) of the non-immutable aspects of a protocol’s smart contracts is passed from the developers to the members of a DAO via the activation of governance smart contracts. Decentralized Finance (“DeFi”) protocols are one example of smart contract-based protocols. DeFi protocols provide alternative mechanisms to perform many traditional financial services that are, often times, highly regulated themselves (i.e., payments, swaps and derivative transactions, insurance, asset trading, lending and investing). As the functionality of many DeFi protocols deviates significantly from traditional financial services, significant interpretive obstacles exist in determining the manner and extent that existing statutory authority is applicable. Although the SEC, CFTC, FinCEN, OFAC, IRS, Department of Treasury and state regulators have issued guidance and interpretations concerning digital assets, the issues highlighted in that guidance and the concentration of accompanying enforcement actions has resulted in a prioritization of the following: (i) identifying the applicability of SEC and CFTC registration requirements, (ii) taxation of virtual currency as property and the need for taxpayers to include virtual currency activities on their tax returns and (iii) the implementation of BSA compliant Anti-Money Laundering (“AML”) and Know Your Customer (“KYC”) programs.

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