CryptoLaw101 - Legal Wrappers
The very nature of a decentralised organisation is to be neither State-sponsored nor incorporated by law. However, in order to mitigate some of the peculiar risks faced by participants of DOAs and multisigs (as outlined in our last piece) many DAOs that wish to exist in compliance with the law eventually ask the question of whether that DAO should utilise a traditional legal form. To do so is often described as a using a “legal wrapper”.
At present legal wrappers are mostly used by DAOs that engage in some activity that the partcipants recognise as being or potentially becoming the subject of regulation or prosecution. By doing so they hope to avoid the punitive treatment reserved for outlaw DAOs through a form of self-regulation. The logic of these DAOs is straightforward. As discussed in our previous piece, some of the most serious risks to DAO participants flow from the non-separation of the legal personality of the DAO and its constituents and the consequent lack of limitation on the liability of those members so it stands to reason that one of the most effective ways for a DAO to mitigate risk is to “wrap” itself or any of its components and make use of the organisational forms that can afford it the traditional legal protections granted by the State.
The cypherpunk in most of you will about now be frothing at the notion of bowing to the fear, uncertainty and doubt created by certain State-sponsored agencies and regulators by fleeing to the safety of their established regimes. There may some truth to this irony but I would be quick to note that outside of those who engage in cynical branding tactics and blatant mischaracterisation of non-DAOs, it is hard to conceive of why a DAO in the truest sense would sacrifice it’s natural state of disincorporation and opt to use a legal wrapper except out of pragmatism to protect its participants.
On the other hand, depending on a DAO’s activities and makeup, the use of wrappers to segment and silo DAO operations can also make plain commercial sense. Even if at its core the concept of a legal wrapper is a band-aid approach attempting to fit a self-sovereign square peg into a regulatory round hole,so stick with me, Anon, and keep an open mind to the ways in which a legal wrapper might benefit your DAO. Later we’ll examine some of the legal wrapper’s downsides which are not just idealistic as mentioned but also sometimes of a practical nature. But before we get ahead of ourselves, let’s take a step back and answer some basic questions that will be fundamental to any DAO’s approach to risk mitigation:
What does it mean to incorporate? Basically, incorporation refers to the creation of a formal entity such as a limited liability corporation, limited company or some modern forms of partnerships. The previous piece in this series outlined some of the numerous risks that DAOs and their participants face merely by “failing” to incorporate.
What is separate legal personality? This, one of the greatest examples of collective mental gymnastics our race has conjured and a concept that has fuelled the explosive proliferation of corporates that defines the modern era, is the idea of incorporated entities or other legal forms of organisation being recognised as legal persons distinct from their members. Another long-established legal construction known as the “corporate veil” prevents the law from recognising the entity’s underlying members as collectively constituting the organisation, thereby limiting their liability.
What does it mean to have limited liability? Essentially this means one participant cannot be wholly liable for the actions and liabilities of an entity and the other participants in that entity. This was covered in detail in our previous article so please do go back and read that if you haven’t already.
Armed with this knowledge, we can turn to some of the benefits of using a legal wrapper. Generally, they can enable better and less risky coordination among the participants of an organisation and the ability to better engage with other legal entities:
Wrapped DAOs can agree and enter contracts, engage service providers like lawyers and accountants, and in their own right as separate legal persons incur liabilities, gain rights, and own property;
The entity’s members and management will not themselves be liable, in the ordinary course of business (i.e. absent fraud or other exceptional circumstances), for the organisation’s obligations outside of their own capital contributions and responsibilities within the organisation;
The entities themselves will not be seen as tied to individual participants and will not be targeted for the personal liabilities of any of its members, again with some exceptions.
However as touched on there are downsides to the use of legal wrappers, a statement which may be obvious to an audience concerned with decentralisation. For example, a decentralised autonomous organisation is arguably no longer autonomous once it cedes its authority to exist in its chosen form to the requirements of the State which permits and facilitates its existence. Even outside of the ideals of decentralisation, there are also practical considerations that may make incorporation undesirable for your DAO. These include:
Costs of participation and non-inclusivity: There are administrative costs associated with incorporation and administration. The additional costs around even some very basic activities and formalities might be such that your DAO may no longer function in the same way it would have in its straight up decentralised form;
Anonymity: most forms of entity, even organisations which do not require formal incorporation like a traditional partnership, will require some sort of registration with a regulator by those holding interests in those entities.
So you should by now have some idea of what a legal wrapper is and why or why not your DAO would want to use one. In future pieces we’ll discuss the particulars of some of the different types of State-sanctioned entities that a DAO might be or become, focusing on the most common, those closest in form to a true DAO, and even the limited examples of more recently introduced entity types that have been designed specifically for DAOs.
Thanks as always for reading.