Originally published: Metaverse, 14th of February , 2022
The purpose of this research is to provide a wide view on how DAOs should be viewed from a legal perspective. This is a paper that has been completed with input provided by multiple legal and professional opinions, and reflects views on actual legal instruments that international jurisdictions offer. It’s not intended as a definitive or sure opinion, considering that as the technology evolves, so too do the laws of the states. The reference material which informed the development of this article is enclosed below.
An introduction to DAOs
Organization theory has abundant literature on several kinds of decentralized organizations, dating back to 1962. However, the first references to actual Decentralized Autonomous Organizations (DAOs) only emerged in the 1990s to describe multi-agent systems in an internet-of-things (IoT) environment. What is referred to nowadays when discussing DAOs can be traced back to the earlier concept of a Decentralized Autonomous Corporation (DAC), a term coined a few years after the appearance of Bitcoin (2008) and used mostly informally on online forums and in discussions by early cryptocurrency enthusiasts, using both “decentralized” and “distributed” autonomous corporations interchangeably. Later on, in 2013, the term became more widely adopted, and publicly discussed, in particular by the cofounder of Bitcoin Magazine, Vitalik Buterin.
Within the crypto-vernacular, DACs have been an established corporate governance form for the longest period; using tokenized, tradable shares as a means of providing dividends to shareholders. Such corporations were described as “incorruptible”, running “without any human involvement” and with “publicly auditable” bylaws as “open source software distributed across the computers of their stakeholders'': anyone could become a stakeholder in a DAC by simply “buying stock in the company or being paid in that stock to provide services for the company”, with the owners of a DAC stock being entitled to “a share of its profits, participation in its growth, and/or a say in how it is run”.
Similarly to DACs, the emergence of DAOs brought about an evolution from the current vertical and centralized management of companies to a horizontal and widespread one typified by direct involvement of the community, achievable through the use of smart contracts operating on a blockchain platform which guarantee investors direct and real-time control over decisions regarding the investments to be undertaken. While some argue that Bitcoin is effectively the first DAO, the term today refers to “organizations deployed as smart contracts on top of an existing blockchain network”.
There have been several attempts at instantiating a DAO on the Ethereum blockchain. The first DAO that attracted widespread attention is a 2016 venture capital fund confusingly called “TheDAO”, which later inspired a variety of new DAOs (e.g., MolochDAO, MetaCartel) and platforms aimed at facilitating DAO deployment, as Aragon, DAOstack, Colony or DAOhaus. The concept enabled other derived terms: Decentralized Collaborative Organization (DCO), which is typically referred as a DAO with strengthened collaborative aspects; and Distributed Cooperative Organization (DisCO), which highlights its co-op and democratic nature.
A DAO stands as a direct expression of an idea of community-driven governance, in which some traditional corporate governance principles are challenged, starting with the strict separation of company management and shareholders. This is clear when considering both the descriptions used in the literature and in practical use within the technology industry:
Buterin, in the Ethereum white paper (Ethereum, 2013, p. 23), defines a DAO as a “virtual entity that has a certain set of members or shareholders which [...] have the right to spend the entity's funds and modify its code”. That is, the aim is to replicate “the legal trappings of a traditional company or nonprofit but using only cryptographic blockchain technology for enforcement” (ibid).
Some of the most popular DAO platforms, such as DAOstack and Aragon define a DAO similarly as “a network of stakeholders with no central governing body” (https://daostack.io), “which is regulated by a set of automatically enforceable rules on a public blockchain” (https://aragon.org/dao). Conversely, other DAO platforms have opted to use a different terminology as a proxy to a DAO, such as the “colonies” of Colony (https://colony.io) or DAOhaus’ “magic internet communities” (http://daohaus.club).
The DAO governance should remain independent from central control: three main features are thus self-governance, self-organization, and peer-to-peer democratic control. In addition to this, since DAOs rely on a blockchain, they inherit some of its properties, such as transparency, cryptographic security, and decentralization.
Participants can directly discuss the management - and the organization itself - of the company, and also directly put forward proposals through smart contracts (that operate as computer programmes which are deployed on a blockchain, so that they are non-repudiable and verifiable). By engineering more complex smart contracts, organizations can be established, where the rules of governance are defined in code on a blockchain. With the rules of governance being transparent, and distributed to all nodes (or participants) in the network, DAOs do not have any single "owner" who can directly force them to act in a certain way. DAOs therefore enable a form of non-hierarchical governance, where decision-making power is spread across the network's nodes rather than being deferred to a centralized body.
A DAO's duty is to abide by its specific programmatic set of rules, being tailored to any purpose or objective (both specific and deterministic, or more sophisticated where people or machines interact to achieve a specific purpose). In other words, the way a DAO operates ultimately depends on its degree of automation: at the lower end of said spectrum, a DAO may act as a platform, where members interact according to a self-enforcing, open source protocol. Tokens give voting rights to members, who can then vote on proposals put forward by other DAO members (for instance, to undertake a new project). It is in the interests of all DAO token holders that only beneficial proposals that will optimize the value of the DAO are approved. If the proposal is approved, it will be recorded in the blockchain.
In terms of executing proposals (which requires some degree of human input or ‘work’), remuneration will typically be codified in a smart contract, such that compensation will only be rewarded once proposers (or those who have been allocated the work) deliver on their promise. DAOs with this architecture have the potential to retain a strong human element, as “DAO members” (humans or machines) still vote on decisions, and put forward their own proposals. Importantly, with governance rules codified in smart contracts, relevant governance decisions are automatically executed without manual intervention, circumventing the need for a central decision-making entity.
At the higher end of the organizational spectrum (i.e. highly autonomous) are DAOs which incorporate artificial intelligence to run entirely independently on a blockchain with minimal human input. Activities of this type of DAO are fully determined by a blockchain's protocol and the DAO's smart contract code. A DAO of this type can use tokens to trigger smart contracts independently. Ultimately, with a sufficient number of digital tokens to pay a blockchain network for the resources it needs, a DAO can operate indefinitely without human control (insofar as humans are not required to maintain the operation of the underlying blockchain network).
Humans may still contribute funds to the DAO in return for digital tokens (and a share in the DAO's profits), or interact with DAOs by paying for its service. These DAOs can be constructed embodying decision-making capabilities in the DAO's smart contract code. The underlying algorithm may interact with environmental inputs (including people’s needs and desires), but no person can exert direct influence over its operations. In this way, the DAO's underlying code comprises all requirements needed to complete a task. A DAO can also be constructed by the coordinated aggregation of multiple smart contracts, creating "a DAO whose capabilities are much greater than the sum of its parts". These more sophisticated DAOs benefit from the collective intelligence of a number of independent smart contracts which may purposefully or inadvertently contribute to achieving a common goal.
Thus, it brings a radically revolutionary perspective to the traditional corporate organizational structure, thanks to the horizontal openness facilitated by the employment of new technologies. Its scope, in fact, is significantly broader: a DAO can, for example, be used to create a virtual entity that operates as a crowd-funding platform, a ride-sharing platform, a fully automated company, or a fully automated decision-making apparatus. It is therefore important to understand that a DAO is not a particular type of business model or organization, but a concept that can be used to refer to a wide variety of things.
As the limitations of blockchain-based governance came into light, especially in the aftermath of the aforementioned TheDAO hack (DuPont, 2017; Reijers et al., 2018; Mehar et al., 2019), the public discourse around DAOs has shifted from describing DAOs as a technical solution; to a governance problem; to a discussion on how DAOs could change the nature of economic and political governance in general.
When DAOs are required
The growth of DAOs in general and the successes of some of the most innovative ones inevitably results in the perception that the route to growth and robust network participation requires a DAO structure.
DAOs work best when the governance burden related to care, safety, and risk can be reduced faster than the natural increase in coordination costs that accompany the need to have members involved in voting on every decision made.
The areas of governance that are common to all DAOs are:
Collective ownership and management of tokens. DAO treasuries and budgets should function as decentralized corporations with considerations of tokens and liabilities, liquidity, income, and where to allocate financial resources.
Risk management for tokens. Volatility, price, and other market conditions require continuous monitoring.
Asset care. From collected artwork to loan collateral, all DAO tokensbenefit from goals and processes around care.
A DAO should only be formed when it is clear that all of these areas of governance are required by a community. It is important to note that while a DAO might focus on a subset of these activities; it should provide all three functions.
DAOs will need to add new collective skills and governance processes as their activities change, and successful DAOs will quickly recognize their own shortcomings to enable them to address emerging challenges and scale their solutions effectively.
DAOs will likely reach the point where their communities will require governance structures for all three key needs:
Risk management: because a DAO's balance sheet generally consists of high-risk tokens, managing a DAO's currency exposure to ensure that future operations can be funded becomes increasingly important. Tokensare intended to be used to fund development, providing insurance in the event that the underlying protocol fails, and for growth and user acquisition expenses. In order to meet these goals, DAOs need to manage treasuries to meet particular metrics or KPIs.
Asset care (curation and quality): the most natural place for asset curation are withNFT collection DAOs. NFT collection DAOs act as curators of art and culture. Users, through the DAO governance token, vote on adding or removing tokens from the collection. However, Decentralized Finance (DeFi) DAOs do address this issue as well, for example through certain mechanisms, anyone can create an exchange pool with a new asset. Asset quality can be measured via token distribution, liquidity/ease of price manipulation, and historical volumes – protecting quality is crucial for leveraged DeFi DAOs. Since many of these DAOs use their governance token as an implicit or explicit insurance fund to repay lenders in the event of adverse events, it is important for these DAOs to pay attention to what tokens they admit and how the parameters for these tokens are chosen. As the space evolves, it is likely that insurance products will help improve and reduce the amount of governance intervention required to care for tokens in DeFi.
Differences between DAOs and traditional audit bodies
The DAO was an organization that was designed to be automated and decentralized. It acted as a form of venture capital fund, based on open-source code and without a typical management structure or board of directors.
In other words, the governance of DAOs is based on community, while traditional companies’ governance is based on executives, the Board of Directors, etc. DAO’s operations are fully transparent and global whereastraditional companies’ operations are usually private –only the organization knows what is happening, and they are not always global.
Considering that a DAO, if properly conducted, can grow exponentially, it requires a juridical person or at least an entity to have the power to sign agreement, and bind the DAO in order to permit the DAO itself to conduct commercial activity.
Since the DAO is characterized by people working anonymously or through aliases, from all over the world, and the DAO interacts with physical and digital tokens through decentralized governance, it is necessary to find a legal entity that allows it to act and be legally recognized.
One solution could be to set up a registered company as an LLC / C-Corp, but this would reintroduce centralized governance and require a territorial structure and size limitations.
An alternative would be to create offshore entities in more favorable regimes, but this would be expensive and complicated from a tax liability perspective for employees.
Finally, an "Unincorporated Non-Profit Association" (UNA) could be established, but it cannot distribute profits to members and not all countries recognize UNAs, which leads to a less favorable view on them.
Many projects are set up through foundations, which are registered entities in a specified country, and which have boundaries that are given by the specific law of the state where they operate or they are registered.
A foundation (also a charitable foundation) is a category of nonprofit organization or charitable trust that typically provides funding and support for other charitable organizations through grants, but may also engage directly in charitable activities. Foundations include public charitable foundations, such as community foundations, and private foundations, which are typically endowed by an individual or family. However, the term "foundation" may also be used by organizations that are not involved in public grantmaking.
An understanding of a Trust, and how it works, is therefore key to understanding their viability as a means to managing a DAO.
As stated above, it is deemed important to do a deep dive into what a Trust is, and how it works, to understand its suitability for integration with a DAO.
A trust is a fiduciary relationship with respect to property in which one person (the trustee) holds the legal title to the trust property (the res), subject to enforceable equitable rights in another (the beneficiary). It is a tool whereby one or more persons manage the property for the benefit of others according to a valid trust purpose. The trustee ordinarily has legal title to the property, while the beneficiaries have equitable title. The testator or grantor who creates an express trust is the settlor, who must have had the intent to create the trust. Consideration is not required for the creation of a trust; in fact, trusts are usually created free of charge. As “property”, it can be intended as any kind of asset, being it material (a house) or immaterial (intellectual property, a trademark, or a wallet or smart contract).
What are digital tokens and how can they be transferred?
Digital tokens consist of anything that can be stored/saved in electronic form on a computer.
Even an item that is not initially classified as a digital asset can become one when converted into electronic form. There is a large number of digital tokens being licensed or sold by people on the Internet, worldwide. Executing these transactions through traditional contract execution channels is time-consuming; in contrast, smart contracts built on the blockchain can offer a more efficient method to transact. Since a smart contract works on a decentralized ledger system, it ensures transparency and builds trust between the parties to the transaction.
Utilizing smart contracts on the blockchain also solves the problem of confidentiality as each customer is provided with a unique hash for each transaction that is immutably added to the blockchain. Within the existing system (i.e. when not conducted on the blockchain), the transfer of ownership of an asset can take place without the delivery of the tokens; in which case ownership transfers with consent regardless of whether the asset has been physically delivered to the buyer.
In any case it is fundamental to understand when the property of an asset changes hands, not least to answer questions that may arise after the transfer itself. Depending on the case, the law intervenes to remedy the complications of transfers. Consider an example with intellectual property: it's fairly easy to transfer a physical copy of a creative work, such as a book or DVD. Courts recognize the legitimacy of such transfers under the doctrine of "first sale," which allows physical copies to be bought and sold despite the fact that the original author maintains the underlying copyright interest.
However, for digital copies, lines can get blurred because when a copy is "transferred", as a technical matter this usually means that a new copy is made on the recipient's device, with the first copy remaining on the transferor's device until it is deleted. In other words, technically the subsequent copy is not the same file. For this reason, courts have been reluctant to apply the first sale doctrine to digital copies, and as a result many transfers of digital works are not permitted, or are treated as licenses rather than true sales or assignments so that the restrictions can be applied to downstream transfers.
From this, it can be inferred that the transfer of documents and information representing ownership of all or part of an underlying asset also occurs in the digital mode. This is where the blockchain steps in with several possible solutions.
First, the blockchain can be used to record transactions in which ownership of the underlying content is transferred, or use of the content is licensed.
Second, the blockchain can be used to generate digital "tokens" that actually represent some or all of the underlying tokens; these are sometimes called "asset-backed" tokens. Such a digital asset token would be encrypted and require the owner's private key to be transferred. These tokens act as an IOU (I Owe You).
Digital tokens can also be sold with built-in restrictions, and since these restrictions would travel with the digital token, they could easily be enforced downstream.
An example of a digital property transferring using smart contracts from a Trust.
The owner uploads the digital content on a file server where it will be stored. The customer can view and download the digital content from the server by executing a smart contract. For this, the customer must pay an agreed amount in a chosen asset and also provide collateral, kept as a security, that would showcase his honesty and willingness to enter into a contract. The file server shall also provide collateral to the customer.
A token, valid only for a limited time period, would then be provided to the customer to download the content. Once the customer downloads the content, the file server shall send a confirmation to the smart contract. The customer then also needs to send his confirmation to settle the payment. Once executed, the collaterals are released and payment is made to the owner. This method shall also resolve the issue of confidentiality as each customer is provided with a unique token number. In light of this, we can conclude that digital tokens can be transferred, even within a trust. Although the transfer is in the "metaverse", today the value of digital tokens among people is recognized, so much so that there are contracts that provide for the transfer of digital tokens against payment of a price. In fact, the transfer of digital tokens is also recognized at the legislative level, as in the various states there are specific taxes on digital tokens and digital tokens transfers.
The Origin of Trusts
In the case of a given DAO managed via a Trust, the creation of such a structure would be viable due to the fact that common law did not present any suitable remedy to protect the legal status of the subject who had transferred tokens to a trustee to manage them in the interest of a third party. In the event that a trustee, after having gained the trust of the settlor, had then taken advantage of the tokens of which he had come into possession to enjoy them for his own exclusive benefit, neither the party constituting the trust nor the beneficiary could have resorted to the courts of common law.
In fact, the common law did not attach any effectiveness to the trust agreement entered into between the settlor and the trustee, and considered the latter as the owner of the tokens transferred in trust as a consequence of the asset transfer. This meant that the trustee's obligation to deal with these tokens in the interest of the beneficiary and not for his own benefit was a moral obligation rather than a legal one.
This situation led to an unfair miscarriage of justice and, as a result, trust matters were devolved to the jurisdiction of equity. The solution chosen to overcome these problems was to acknowledge that the trustee had legal ownership over the trust property while the beneficiary had equitable ownership.
Historical background on the Trust
Henry VIII wanted to get and earn money, and decided to earn some money by prosecuting with a vengeance his ancient feudal rights as the man at the top of the feudal pyramid. He even had a special court set up, the Court of Wards, to help him do so. Because by this time feudalism was essentially anachronistic, his efforts were branded as “fiscal feudalism”. Vexed at being deprived of the feudal revenues he would otherwise have received but for the employment of uses by his noble tenants, in 1535, he managed to get Parliament to pass the Statute of Uses.
This statute ‘executed the uses’: a conveyance from A to X, Y, and Z to the use of B was, after the Act, treated as a conveyance from A to B directly. The title passed from A to X, Y, and Z, and then to B as the use was automatically ‘executed’, cutting out X, Y, and Z. Following the statute, then, the typical use in which A conveyed land to X, Y, and Z to hold to his (i.e. A’s) use did nothing at all. A would remain the legal owner of the land.
It was henceforth impossible for someone holding the legal title to be bound to benefit another, since there was no longer any use by which he could be bound.
How the trust arose in the next century and a half to replicate the use in all but name is an interesting bit of history, but not, alas, one to be explored in detail here. But it is to be noted that the statute did not execute all uses-roughly, it only executed those uses in which the feoffees to use held the “paper title” for a cestui que use who continued to possess the land as before the transfer. The statute did not execute ‘active’ uses, in which the feoffees to use had to carry out genuine positive duties. An example of an active use would be a use for the benefit of an order of Franciscan monks, who were unable to own property. The feoffees to use did not merely hold the paper title, but actively participated in the management of the land. This provided one loophole in the statute, and others were soon found by industrious lawyers.
Furthermore, in the next century or so, the political climate changed; the king no longer relied primarily on his feudal rights for revenue, and so there was no political consequence if the Court of Chancery gave effect to uses which managed to evade the statute. Suffice to say that, by the turn of the eighteenth century, where someone, now called the ‘settlor’, transferred a legal title to X to hold for the benefit of B, now rendered as ‘in trust for B’ rather than ‘to the use of Bl Chancery would require X to hold the land for the benefit of B, just as if he had formerly held it to Bt use. B was consequently renamed the ‘cestui que trust’, and is now generally called the ‘beneficiary” and X is now called the ‘trustee’.
Since the incidents of feudalism are now abolished, you might ask why anyone would want to give a ‘structured gift’ today. Why do people set up trusts? For most private trusts, the basic reason is the same as in medieval times: to provide for loved ones in a way one cannot do, or it would be unwise to do, simply by transferring legal title.
One cannot give minors land, so if one wants a minor to have Blackacre (‘Blackacre’ is the name commonly given by lawyers to represent a hypothetical piece of land – e.g., Whiteacre, Greenacre, and so on), it must be held in trust for him by someone else.
One may be worried that one’s son is a spendthrift, and so they decide to give money for his living expenses to a trustee to dispense, on condition that the benefit will pass to someone else if that son goes bankrupt. One may want someone, like your surviving spouse, to have the dividends, i.e. the income, from shares for the rest of their life, and someone else, say your children, to have the capital, title to the shares themselves, once your spouse has passed on. One cannot fragment the legal title to shares to accomplish that.
In certain circumstances, the law of taxation also favors giving property by way of trust when one is alive over leaving property to others in one’s will, so many trusts are essentially tax-avoidance devices.
Note that the structured gift and tax-avoidance functions of the use/trust work in essentially opposite ways. To the extent that the use/trust avoids feudal incidents or taxes, it frees property from restrictions that reduce its value to an owner. On the other hand, the structured gift burdens property, and the structure of benefits under a trust can be very complicated indeed. If the feudal use worked to free land from the institution of feudalism, its modern counterpart, the trust, also ties up property with bonds quite tightly to different social institutions, such as the family, or the workplace as in the case of pension fund trusts.
From this historical excursus, we can clearly note how the trust is one of the most characteristic (and successful) legal forms in Anglo-Saxon law and worldwide. It has been deeply rooted for centuries in the common law countries, and subsequently known in the civil law countries thanks to the development of comparative studies.
Common law and the Trust
As stated, the trust is a well established and used product of English common law, and, more specifically, of when the British Empire began to establish colonies overseas, from the seventeenth century onwards, the colonists brought their own law with them, and the trust was part of it. This is why the common law legal system, and the trust as part of that system, is now available in many countries around the world, where trusts can be tailored to the most diverse uses as needed.
Civil law and the Trust
Despite the presence in Roman law of a range of institutions designed to meet the same needs as the trust, no legal institution has emerged in modern civil law systems to rival it. The trust was regarded as an essential legal entity by about half the world, but totally unknown to the other half.
In recent years, however, a number of civil law systems have created individual trust-like institutions through special legislation.
An example of a legal system influenced by civil law but with many typical common law features is that of Jersey.
With the other Channel Islands, namely Guernsey, Alderney and Sark, this small island is part of what remains of the Norman legacy of the ancient Dukes of Normandy, who later became Kings of England in 1066. Its customary law is the old law of the Duchy of Normandy.
Since Norman law largely survived untouched until 1789, the connections between Jersey and the mother country France were important, despite the different political sovereignty. Certainly, over the past hundred years, Jersey law has been much more influenced by English law than by French law.
Trusts, however, have become a fundamental part of Jersey law, at least since the nineteenth century, when Jersey became the preferred place for Englishmen to settle outside England. Brits brought their own legal culture with them and wanted to use the same institutions they used in England.
In the 1980s, fears that the trust, not being an originally Norman institution, might not stand up in the courts against conceptual attacks prompted the legislature to enact the Jersey Trust Act. This law has undergone many amendments since then, the most recent being Amendment Number 6 of 2013.
The 1984 Act, as amended, establishes a detailed Regulatory Framework in which trusts may continue to exist in Jersey law. The trust that has continued to exist from 1984 to the present is primarily the English style trust, placed in an offshore setting.
To the extent that there are gaps in the text of the law, they are filled primarily by references to English case law. It is only where there is no English precedent that lawyers take it a step further. The lawmakers have introduced some important innovations, such as so-called 'noncharitable purpose trusts'.
Everything that can be achieved with an English trust can also be achieved with a Jersey trust. Furthermore, some aspects can be performed with a Jersey trust that cannot be performed with an English one: the 'purpose trust' is one of them.
Jersey law is more malleable for trusts, and its structure is such that it provides – from our perspective – better protection to the tokens and management of the trust itself.
While trusts have been established in Jersey for many years their operation is now governed by a modern, comprehensive statute entitled The Trusts (Jersey) Law 1984 (the ‘Trusts Law’). The Trusts Law provides that a trust exists, and will be enforced by the Jersey Courts, where a trustee holds or has vested in him tokens for the benefit of a beneficiary, whether or not yet ascertained or in existence, or for a specified purpose.
Article 54 of the Trusts Law confirms that the trust tokens constitute a separate fund and do not form any part of the personal property of a trustee. The Trusts Law also imposes fiduciary duties on trustees, regulates the administration of trusts and provides rights of beneficiaries. For example, any beneficiary has a legal right to force a trustee to act in accordance with the terms of the trust instrument and the Trusts Law. Unlike the position in certain other offshore jurisdictions, a Jersey trust can be of unlimited duration.
Jersey is a party to the International Hague Convention on the Law Applicable to Trusts and on their Recognition.
The Royal Court of Jersey has an acknowledged proficiency in the law of trusts and the senior British judges who sit on the Court of Appeal in Jersey provide added assurance to settlors and beneficiaries that litigation, while unwelcome, will be decided upon justly, fairly and with an expertise that may be lacking in less sophisticated jurisdictions.
There is no register of trust documents under Jersey law and trust arrangements are not open to public view.
The Hague Convention on the Law Applicable to Trusts and on their Recognition has given further impetus to the expansion of trust services on the Island. Under this convention trusts which have been duly constituted under the laws of Jersey must be recognised by the signatories to the convention. At present these include the following jurisdictions: the United Kingdom, France, Italy, Netherlands, Luxembourg, United States of America, Canada, Cyprus, Switzerland, Hong Kong, and Australia.
Requirements of a trust
The requirements of a trust are as follows:
A Settlor, equipped with the capacity and present intent to create a Trust. A trust can be created by word or conduct, and the settlor can be an individual as well as a legal entity.
A Trustee, who can also be the settlor. Trustee must have duties. An inter vivos trust (i.e. signed and set among living parties) will fail without a trustee because there can be no valid delivery and transfer of trust property.
Trust Property (Res): property may be of any type, including future interests or virtual tokens.
Beneficiaries: must be capable of taking and holding title to property and must be definite.
A valid trust purpose.
The rules of the trust are established by the settlor (in the deed of trust or in the unilateral declaration or in the will): the settlor establishes, for example, the duration, the beneficiaries, the powers of the trustee, the powers of the guardian/protector, the replacement of the trustee, the criteria for the administration of the tokens, the use of the income, the final destination of the tokens.
The general regulatory framework is given by the law that knows and regulates the establishment of the trust chosen by the settlor (in our case Jersey law).
A constant element is segregation: the tokens cannot be detached from the purpose of the trust; the personal events of the trustee (spousal ties, debts, bankruptcy, death) have no effect on the tokens in trust. When a trustee ceases to hold office, the trust tokens are transferred to his successor. The time frame of a trust depends on its governing law: it may even be eternal, as discussed below.
The Role of the Trustee
The main feature of the Trust is therefore the role of the trustee, whose main task is to manage the tokens in accordance with the provisions of the deed of trust.
The trustee is an individual or a legal entity that owns the trust tokens: the trustee becomes the owner of these tokens for all purposes and vis-à-vis anyone, including the settlor; however, he is subject to the obligation to manage or dispose of these tokens according to the purposes laid down by the settlor.
In English law, this result has been reached through the theorization of the so-called dual ownership, resulting from the operation of the trust on the equity level and not on the common law level, and from the correlated distinction between equitable ownership (which would pertain to the beneficiary of the trust) and legal ownership (which, instead, belongs to the trustee). Hence a long debate, still in progress in many respects, on the legal nature - actual or personal - of the beneficiary's right, which recently has seen the prevailing supporters of the mandatory nature of this right.
Additional debate arises in the light of cases such as the trust of purpose and discretionary trust, where objectively any real right of a beneficiary cannot be can not be configured on specific tokens. In any case, the legal ownership of the trustee is characterized by peculiar features, which mark its essence by limiting the content of the owner's powers effective towards third parties.
In the event of the performance of acts contrary to the terms of the trust, beneficiaries can recover the tokens from the third party purchaser (who is not a bona fide purchaser for value without notice), and the tokens in trust are not part of the estate of the trustee, nor can claims be brought on the same by the trustee's spouse, as well as by the trustee's creditors. In those jurisdictions that do not recognize equity, the conceptualisation of the trust has instead been based on the configuration of trust property as autonomous or separate tokens.
The trustee must therefore exercise all powers and duties in relation to the trust property as it actually belongs to him; he is personally liable for this to an unlimited extent. Therefore, since the tokens in trust belong to the trustee, he is entitled to perform any act which pertains to their owner.
The trustee is vested with the power and charged with the obligation, for which he is accountable, to manage, run or handle the tokens as stipulated in the trust. However, the tokens in trust remain immune to the personal affairs of the trustee.
The trustee does not normally engage in acts of management or powers of disposition unless she is certain that he can do so; but he also runs the risk of incurring liability if he is overly cautious and therefore misinterprets the extent of his powers in a restrictive sense.
The trust deed can certainly steer the exercise of the trustee's powers, but some limits cannot be overstepped on pain of rendering the trust void.
This office can be held by a natural person as well as by an entity : it can be a Private Trust Company (i.e. a corporation whose purpose is to act as trustee) or a Fiduciary Company that has extended its corporate purpose to encompass this management activity. It depends on the jurisdiction which adopts the trust.
The role of the Guardian/Protector
The guardian is vested with fiduciary powers and may express his opinion to the Trustee on any matter relating to the Trust, even if not requested to do so (by the Trustee). He has the right to take legal action to enforce the Trust and in the event of breach of obligations or violation of the law governing the Trust.
The guardian can perform three distinct types of functions:
Directly exercising dispositive or managerial powers: in which case he exercises the powers that the settlor might reserve for himself in the deed of trust or that he might assign to the trustee or a third party. Some laws consider the powers of revocation and appointment of trustees to be typically inherent in the duties of the guardian.
Voting power: in this case, the guardian gives or withholds consent to decisions made by the trustee and limits the trustee's discretion in both dispositive and managerial matters; the guardian therefore paralyzes the exercise of the trustee's powers if consent is not given.
Issue instructions or directives to the trustee regarding the performance of specific acts: in this case, the trustee is obligated to follow the guardian's directives in the matters within the scope of the guardian's powers. The deed of trust removes the trustee's discretion in such cases. If the issues taken away from the trustee are over and above a quantitative limit, the guardian then becomes a de facto trustee.
The first protector is usually appointed by the settlor, while subsequent protectors may be appointed by others, depending on the rules. Therefore, the guardian is not anyone's agent, but is responsible to those in whose favor the trust powers have been granted. In beneficiary trusts, for example, it is the beneficiaries who can act against the protector.
The guardian is not liable for loss to the trust fund or damage to a beneficiary as a result of his acts or omissions, unless the loss to the trust fund or damage to the beneficiary resulted from his or her "actual fraud" or "willful misconduct" or "gross neglect".
The Role of Beneficiaries
It is possible to have "income beneficiaries", i.e. persons destined to obtain the benefits that can be drawn from the tokens in trust (collecting a sum, using an asset, living in a house, etc.) and "final beneficiaries", i.e. persons to whom the tokens subject to trust will be transferred upon termination of the trust.
The beneficiaries can be identified in the deed of trust or even later.
The identification can be made directly by the settlor or by a third party appointed for this purpose (the so-called protector); moreover, they can be identified either by name or as belonging to a certain category of subjects (for example, all the descendants of a certain ancestor; graduates of the University of Turin in the year 2022; employees of a specific company with at least 10 years of seniority).
The beneficiaries have a claim against the Trustee for the preservation of the economic value that will accrue to them in the future, or to claim the benefit to which they are currently or will be entitled in the future, or to claim the reinstatement of any diminution in value by which they are affected.
It is necessary that both the definition of the category and its termination at the end of the trust term are assured by means of mechanisms which offer the utmost certainty. This is because in any trust the trustee must always be able to know which parties belong to the category and also because certain types of beneficiary positions generate particular effects when all their holders have been determined in accordance with the definition provided and others cannot occur, so that the category is "closed"; finally, because the termination of a category, when it becomes empty, can lead to the takeover of another category's components.
Any uncertainty in this matter can produce outcomes contrary to the intent of the settlor.
Valid Trust Purposes
Trust or its provisions must not be illegal, impossible to achieve, contrary to public policy or based on illegal consideration.
“purpose” means any purpose whatsoever, whether or not –
(a) involving the conferral of any benefit on any person; or
(b) consuming or capable of consuming the income or capital of the trust,
including without limitation the acquisition, holding, ownership, management or disposal of property and the exercise of functions;
A common impermissible purpose is a trust created to defraud creditors. In this type of scheme, a settlor will transfer property to a trust for the purpose of hiding it from creditors. If the fraud is discovered, the trust is nullified, thereby allowing the creditors to reach the tokens in the trust.
Other types of prohibited purposes often involve trusts created that are against public policy. For example, trusts that unreasonably restrain marriage by a beneficiary are invalid. Reasonableness is gauged by how long the restraint lasts and by the relationship between the settlor and the beneficiary. In addition, trusts that encourage someone to get a divorce are also invalid. In contrast, to support public policy that favors marriage, courts have upheld conditions requiring that a beneficiary not divorce a spouse.
As in the case of a court striking a provision that violates the Rule Against Perpetuities or not allowing the trust to fail for lack of a trustee by appointing another trustee, the consequences for a trust with an impermissible purpose are usually not that the whole trust is negated. Instead, the court will delete the illegal purpose or condition and enforce the trust without it, as long as this action does not thwart the settlor’s overall purpose for establishing the trust.
Letter of Wishes
Especially in discretionary trusts and special purpose trusts, the settlor perceives the need to provide the trustee with criteria for identifying beneficiaries or specific ways of achieving the purpose, which can rarely be included in the trust deed. These considerations are mostly confidential and practical, rather than technical or legal.
The letter of wishes is bound up with the fiduciary element that underpins the whole trust structure.
It can also be written by the trustee and provided to the settlor to ensure that she understands its purposes. Alternatively, it can be submitted by a beneficiary to the trustee to express the way she would like discretion to be applied.
The trustee may have regard to that letter or memorandum of wishes in exercising any functions conferred upon him by the terms of the trust but the trustee shall not be bound to have regard to that letter of wishes and shall not be accountable in any way for his refusal to have regard to that letter. If the settlor wants some of her instructions to be binding on the trustee, she must include them in the trust deed. However, even if practice calls for trustees to follow the letter of wishes scrupulously, no fiduciary duty or obligation shall be imposed on a trustee merely by addressing the letter of intent to him.
Thus, the letter of wishes contains extra instructions or information for the trustees to use as a guide. The settlor can tell the trustee how to manage the trust and make more explicit how the trust works without it being published in the trust deed (for example, the letter of wishes can be used to explain in detail how a DAO voting system works without it being made public). In fact, the letter of wishes is primarily used because it is easy to change and will remain private between the settlor and the trustee.
Additional Types of Trusts 1. Purpose Trusts
A trust is defined as a special purpose trust when it is set up for a definite purpose without any beneficiary being designated or intended.
A special purpose trust is therefore characterized by the fact that the tokens conferred are not intended for specific beneficiaries, but are only intended to achieve a specific purpose.
For example, under laws which expressly provide for special purpose trusts, the purpose must be charitable such as: assistance to the poor, advancement of the arts, culture, science, education, amateur sports, development of religion and health, promotion of human or animal rights, etc.
In other foreign jurisdictions, purposes are not only charitable and trusts for non-charitable purposes are often used for commercial and financial transactions instead of companies.
Any type of asset can be placed in the Trust: wallet, crypto tokens, movable, immovable, money, etc. A separate asset will be created and managed for the fulfillment of a specific purpose, which will therefore be protected as an unassailable asset.
The Purpose Trust hence benefits an undefined plurality of subjects; to the extent that in this case the guardian of the trust, whose presence is indeed required, acts against the trustee.
2. Charitable Trusts
A subcategory of purpose trusts is the one of charitable trusts.
This type of trust must be in favor of a reasonably large number of unidentifiable beneficiaries and the purpose must benefit the public. For example, a person can create a charitable trust to disburse funds for scholarships or medical expenses for the needy. It is a useful structure if the charity’s primary purpose is to hold, invest and disburse funds.
The structural characteristic of charitable trusts is that the trustee is required to use the trust tokens for a charitable purpose, and that this is the sole purpose of the trust.
This neither means that the purpose is necessarily one of public benefit or public interest, nor that the existence of this latter requirement is enough to endow a trust with the charitable characteristic, thus saving it from the voidability which is generally imposed on charitable trusts.
One of the special features of charitable trusts is that they are exempt from the rules on duration and against perpetual trusts, thus they can last forever. The uncertainties about the matter, which would result in a declaration of voidness in an ordinary trust can be bridged by the judge. This is where the so-called “cyprès” theory comes in: when the purpose indicated by the settlor cannot be achieved, the judge identifies a scope as close as possible to that designated by the settlor and ex officio adjusts the deed of establishing the trust.
When a specific charitable purpose can no longer be accomplished and the settlor's intended purpose is impracticable, unlawful, or wasteful, a Court can substitute in a new charitable purpose. Doing so requires that the settlor had general charitable intent and was not simply interested in the named charity. The result is that a Court will select another purpose as near as possible.
3. Discretionary Trusts
As an alternative to the settlor determining the beneficiaries and the equitable position to be given to each of them, the trust deed may defer this determination to the trustee or protector. The trustee can also be referred to the decision as to whether to distribute the entire income (or only a part of it, or even nothing at all) among the beneficiaries.
Conversely, those trusts that identify one or more beneficiaries as having the right to receive the income or principal are called “fixed.”
The beneficiaries of a discretionary trust are characterized by belonging to a category or simply by being included in a list drawn up by the settlor or a person to whom the settlor has granted the relevant power.
The deed of trust must therefore make it possible to determine with certainty whether or not any individual is a member of the class.
The trustee is never required to explain how he has exercised his discretion (e.g., in allocating income to one beneficiary and not to another one).
4. Mixed Trusts: “Purpose and Beneficiary Trusts”
The mixed “purpose and beneficiary” trust is generally designed first to satisfy a purpose and second to satisfy the interests of a set of beneficiaries. This is a variation of the so-called “trust with succeeding interests”, where a list of purposes and beneficiaries is defined, so that the beneficiary or the purpose in successive order can be satisfied only after the complete satisfaction of the preceding beneficiary or purpose.
Also, a trust can be both “for beneficiaries”, in a first phase, and “for purposes”, in a second phase.
PROS (and CONS)
a) The tokens of the trust constitute a separate property, and cannot be attacked either by the trustee’s creditors or by the settlor’s creditors; basically, its peculiarity lies in the fact that the tokens of the trust are neither the property of the trustee, nor of the settlor, nor even of the beneficiary; in fact, the tokens of the trust cannot be attacked even by the beneficiary’s creditors, in case the beneficiary is unspecified, as they respond only to the obligations contracted by the trustee in the interest of the trust.
b) The distinctive effect of the trust lies in the splitting of ownership: ownership of the trust property and of the related rights is attributed to the trustee, but the intended tokens remain segregated in the trust and, as already mentioned, are alien to the personal tokens of both the settlor and the trustee. The trust, in fact, is managed by the trustee solely in the interests of the beneficiaries identified by the settlor or for the pursuit of the purposes indicated by the settlor.
c) Income can be distributed at the trustee’s discretion to beneficiaries with the lowest marginal tax rates to minimize the aggregate tax beneficiaries pay.
d) The trust’s beneficiaries pay tax on income they receive at their own marginal rate.
e) The trustee can distribute income at their discretion.
f) The trust model provides more privacy than a company.
g) The beneficiaries do not own the trust tokens, so there is scope for protection from a beneficiary’s third-party creditors.
Trusts as the most appropriate solution for DAOs
The Trust structure is the most suitable solution for the DAO given that the trust is a complex system, but its multi-faceted structure can be tailored to perfectly suit the settlor. It also is a tool that can be flexibly adapted to suit the specific needs of the settlor thanks to its structural pliability: (i) it can be shaped by the settlor according to her needs; (ii) it allows a streamlined management and, finally, (iii) the segregation of the fund in trust, which is not affected by any personal or financial affairs of the trustee.
The trust is also generally accepted in almost all legal systems and allows the applicable law to be chosen, thus leaving much freedom to the settlor as stated above.
Finally, there are many trusts which allow the settlor to choose the one that is closest and most suitable to the situation she wishes to protect.
As analyzed above, in a “DAO TRUST” it is permitted to have the DAO holders to enforce through an immediate and user-friendly voting system the governance of the trust.
The trustee is in fact bound by the proposals submitted by the users on the forum and the vote taken, and receives irrevocable instructions that it must comply with. There is always room for improvement, such as bringing more features of this agreement up the chain or establishing a more direct link between DAO holders/users and the trustee. But prior to this, value must be demonstrated to show service providers that this is a worthwhile investment of their time and effort to achieve this goal.
Given the real-world impact that a DAO can achieve, having a robust legal foundation and sufficient resources must be the primary goal in order to connect the crypto world with the real one.
Example Trust Structure
The below discussion introduces an indicative example of how a DAO Trust could be structured.
ALFA TRUST is the settlor of BETA DAO TRUST.
GAMMA DAO trust receives a platform via the smart contract containing the “GAMMA DAO” application and subsequently develops a user voting system.
Upon receipt of the platform, this Trust, through the Trustee, shall develop and make the Platform grow in order to receive more applications on, and to make the user base grow, with the assistance of external consultants.
Finally, the Trust, after receiving the platform and after tailoring it to the needs of the community/users, shall manage the GAMMA DAO voting system and make it work in accordance with the legal principles and the blockchain system.
The ultimate purpose is indeed to find the best voting system and to make sure that the future of the GAMMA DAO platform, both in terms of growth and goals, is determined by the user community.
The voting system, which can be embedded in the letter of wishes or in the scope of the Trust, is in fact a decentralized voting system and the Trustee is in charge of applying the results obtained through the voting system, thus respecting the will of the entire community and user base.
The voting system can also be flexible, allowing the calculation of voting power for each vote.
For instance, should the trust be as decentralized as possible, before each vote, the proposal can be discussed on the forum, which will be conferred hereto by the Settlor.
If we take as an example Ethereum’s Snapshot voting system, the Settlor can confer the forum and the keys to access it, and the “Space” on “Snapshot”, and the relative “GAMMADAO.ETH” ENS Domain necessary to access Snapshot.
For the beginning, the GAMMA DAO Platform will use the “Snapshot” voting system through the use of the blockchain.
The Trustee will be “Controller” of the Space, therefore will be able to change the settings of the space, including administrators.
As the GAMMA DAO system is based on the “$GAMMA” cryptocurrency, it is confirmed hereto that all the holders of the $GAMMA, $wsGAMMA and $sGAMMA will be able to vote for any modification to the Platform itself.
It is also confirmed that each user can then make a new proposal on the Forum, by going to the Forum itself and linking their Discord user.
While the forum proposal is published and well accepted or rejected by the users, the Trustee must fill in the title and the proposal summary, select the type of vote, the start date and the end date of the proposal, leaving enough time for voting.
The Trustee must then choose the block number where the total number of voters will be counted and finally publish the proposal on the Space after it has been discussed on the forum.
In order to vote on the given proposal, the user will need to have a sufficient amount of tokens at the time when the block was created. Depending on the Space settings, everyone with a sufficient amount of tokens can vote.
Each vote is calculated by the amount of voting power held by each voter/user. The voting power for each voter is calculated using a strategy selected in the proposal.
Depending on the type of vote, the voting power for each voter can be distributed over several choices. There are different types of voting such as single choice voting, approval voting (Each voter may select ("approve") any number of choices, each selected choice will receive equal voting power), or ranked choice voting or weighted voting, a proxy vote, a weighted vote, an NFT vote. The Trustee may also allow only certain members to vote using the whitelist strategy or calculate voting power from multiple chains with multichain strategy.
Each vote is signed by the voter in an easily verifiable way online.
The user making proposals on the forum and later on the Space through the support of the Trustee platform can follow different strategies to calculate the result of a proposal and each proposal can also have multiple strategies. They can also create their own strategy from scratch or add a plugin to a proposal. Most of the time a plugin creates a new block in the proposal page with extra information or action buttons.
The voting process used by the platform is flexible and easy to use. It is also carried out outside of the blockchain and therefore does not cost a gas fee, as is the case with e.g. Ethereum or Polygon.
The result of the votes cast through the voting system is almost certain and therefore very difficult to dispute; the system designed by Gamma DAO is user-friendly and allows for easy voting and verification from all users who wish to participate.
Once a discussion has taken place and a ballot has been cast, the Trustee must act according to the parameters that have emerged and ensure that the wishes of the voters are respected.
The Trustee shall always act in consultation with the Guardian and with the ultimate aim of spreading the Gamma DAO ideal throughout the world.
In this respect, the Trust intends to operate in a sustainable and transparent manner towards both the community, in particular the voters, and the environment.
Trustee of the BETA DAO TRUST will be a community trusted person who will be – through the rules of the trust, given by the scope or the letter of wishes – bound by irrevocably accepting all the decisions coming from the voting system, therefore bound by the will of the user community.
The trustee cannot act without the affirmative vote of Gamma DAO, which is verified by the Protector on the blockchain.
The trust is therefore formed with the smart contract/app platform, the various conferment of cryptocurrencies, the know-how, the NFT (such as the ENS domain) and the keys for accessing to the wallets and the space for voting.
The instruction, being irrevocable, makes the most appropriate, decentralized structure for a DAO, in the opinion of this paper.
Following this, another example regarding the development of a Trust that can enable the auxiliary activities of a DAO to be implemented by so-called ‘contributors’.
The below discussion introduces an indicative example of how a DAO Trust could be structured.
A designated settlor can establish a Trust, namely “Contributors Trust” for the purpose of (i) protecting Gamma DAO contributors, (ii) helping gamma DAO to accrue more users and pursue its scope in the best way, and also to (iii) protect our environment by tempering the impacts of climate change and reducing the speed and rate of change.
The Contributors Trust aims to reward Beneficiaries who perform consulting activities in the strategic, IT and legal fields for the implementation of climate and environmental policies and in particular, but not limited to: (i) those whose work helps to disseminate develop and produce innovative high-tech services for environmental screening, (ii) those whose work assists in finding solutions in the strategic field to minimize the negative impact of climate change in the world, and (iii) those whose professional expertise is made available to find smart, appropriate and efficient solutions to protect the Trust and the Beneficiaries and to develop (and later adopt) innovative and effective practices to protect and preserve the environment as well as to improve the quality of people' lives and health.
For having a more streamlined process, on a monthly basis, after consultation with the Protector, the Trustee identifies the contributors who perform their work for the benefit of the Trust and then allocates sums/parts of the Trust to them.
As far as contributors are concerned, the Contributors Trust is the most efficient solution for their protection, while maintaining a decentralized structure.
In this case, the trust in fund will be the conferment from other trusts or other cryptocurrencies, or again the know-how and all the projects that are developed from the contributors themselves.
Depending on how the settlor would like to give the instruction to the trustee and the protector, a system of voting can be agreed on as well as a management system within this trust.
Disclaimer: the legal information is not advice and should not be treated as such. The legal information is provided without any representations or warranties, express or implied. Without limiting the scope of the above, we do not warrant or represent that the legal information in this article will be constantly available, or available at all; or is true, accurate, complete. No lawyer-client, solicitor-client or attorney-client relationship shall be created through this article. You must not rely on the legal information presented here as an alternative to legal advice from your lawyer or other professional legal services provider. If you have any specific questions about any legal matter, you should consult your lawyer or other professional legal services provider.
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