Guide to DAO Legal Wrappers: Best Practices, Frameworks & Jurisdictions
Ultimate guide to DAO legal wrappers: governance models, legal frameworks, forms and jurisdictions, international legal & regulatory compliance. Five must-knows about creating DAO legal wrappers.
Exploring the DAO legal wrapper options for your organization? Want to understand how a legal wrapper can make the DAO work better and follow regulations? Continue reading this article by DAObox to learn everything you need to know before creating a legal wrapper for your DAO or Web3 collective.
Decentralized Autonomous Organizations (DAOs) have emerged as powerful structures for collective decision-making and management in the blockchain space. However, the legal landscape for DAOs remains complex and often challenging to navigate. This article delves into the world of DAO legal wrappers, exploring the frameworks, considerations, and key insights necessary for creating effective legal structures.
We designed this article as an educational guide for anyone looking to establish a DAO legal wrapper or structure a Web3 organization, and for those interested in understanding the essential concepts. In this material, we explain the major forms of legal wrappers and their features, share our top five things to know before creating a DAO legal wrapper, and provide practical tips for designing them.
Understanding DAO Legal Wrappers
A DAO legal wrapper is a legal entity that a DAO employs to operate within existing legal systems, gaining separate legal personality, limited liability, and tax protection. A well-designed wrapper essentially provides a legal framework for a DAO to interact with traditional financial and legal systems while maintaining their decentralized nature.
Key Rationale to Wrap the DAO
In 2024, the main reasons why a DAO would want to become legally structured and establish a legal wrapper are:
Limited Liability: The No1 reason for having a legal wrapper is to exclude DAO members’ and core contributors’ personal unlimited liability for the obligations of the DAO.
Separate Legal Personality: This provides the DAO with legal recognition, allowing it to enter into contracts, own property and IP, open fiat payment accounts, manage infrastructure, grants, sue or be sued as a distinct legal entity.
Tax Optimisation: A properly structured legal wrapper allows for tax optimisation, potentially reducing the overall tax burden and mitigating personal tax risks for the DAO members and contributors.
Step into Light: People “in the know”, such as large VCs, auditors and vendors, tend to engage less with unstructured DAOs due to regulatory considerations and potential legal risks involved. Ultimately, this means that, at some point, any developing DAO would want to become legally wrapped.
DAOs Categorization
For the purposes of legal wrapping, DAOs can be categorized based on several essential parameters. Understanding these categories is crucial for selecting the most appropriate wrapper for your DAO.
Depending on the Legal Structure
Unstructured (Entityless): These DAOs operate on-chain, without a formal structure or legal wrappers. While this may preserve the 'decentralized ethos' of the DAO, it often presents challenges in gaining legal recognition and protecting members and core contributors against liabilities.
Partially Wrapped: In a ‘partially wrapped’ DAO, only certain siloed activities are wrapped, while the larger organization itself remains not wrapped and continues to exist largely as is. An example of this would be wrapping a grants program initiated by the DAO or setting up a separate grants sub-DAO wrapper.
Fully Wrapped: The whole DAO, together with its members, is wrapped and the legal wrapper essentially ‘absorbs’ the DAO, fully or partially. In a fully wrapped DAO, the members of the DAO become members of the legal wrapper.
Depending on the Profit Distribution
Non-Profit DAOs: These organizations do not distribute profits among DAO members and, in return, can often exist in essentially tax-free environment.
For-Profit DAOs: In a for-profit DAO, the members of the DAO can receive distributions, and the organization is often required to pay and account for taxes.
Depending on Governance Model
Member-Managed DAOs: In member-managed DAOs, governance is exercised by members through voting mechanisms. Smart contracts and venues like Snapshot facilitate the voting processes, ensuring that decisions reflect the collective will of the members.
Algorithmically-Managed DAOs: Algorithmically-managed DAOs are governed by smart contracts with pre-set rules, reducing the need for human intervention and enhancing automation. Members of algorithmically-managed DAO normally do not exercise governance via voting.
Five Must-Knows About DAO Legal Wrappers
Before a DAO approaches the legal wrapper design stage, it is crucial that their key contributors understand and are aware of the five important considerations outlined in this section. This awareness will enable them to better grasp the opportunities for legal wrapper structuring on an international scale and see the 'bigger picture'.
DAOs Can Have Multiple Wrappers
Since this is not obvious to many, let’s put it straight: a DAO can have multiple legal wrappers that coexist, each responsible for different activities or development directions. A DAO can combine several partial wrappers or even a full wrapper with one or several partial wrappers (types discussed below).
Wrappers Don’t Protect by Default
Another important consideration is that legal wrappers do not protect the DAO by default and in all respects. To benefit from limited liability and an additional level of protection, the DAO must engage in relevant activities specifically through the wrapper. In other words, the legal wrapper protects the DAO from liability only in transactions where the wrapper is the counterparty or actor.
Don’t Forget About Compliance
The Web3 regulatory landscape is constantly evolving and changing across the globe, becoming more comprehensive and complex. One of the mistakes a DAO could make in the legal design is incorporating in a jurisdiction where anticipated activities of the wrapper would trigger undesired compliance burden, for example, under the VASP laws or local financial, securities or economic substance regulations.
Therefore, it is important to account for the purposes of the anticipated wrapper and its planned activities to ensure compliance and avoid any unnecessary or undesirable regulatory implications.
Distributions Among DAO Members
Since some forms of legal wrappers do not allow for making distributions among members and stakeholders, it is important to understand whether the DAO makes or intends to make distributions to its members, and whether the anticipated legal wrapper will be used to make or process such distributions.
Distribution restrictions normally apply to legal wrappers which are non-profit entities, for example, some of the foundations. Other forms may allow for choosing between for-profit and non-profit status, therefore, permitting the wrapper to distribute assets among its members but requiring to pay taxes instead.
UBO Reporting Applies
A legal wrapper, like any other corporate body, is subject to certain legal and regulatory requirements depending on the laws of its jurisdiction. One such requirement includes the reporting of ultimate beneficial owners (UBOs). Although this varies by jurisdiction, UBOs typically refer to individuals with 20% or more voting power in the DAO or those exercising control through other means.
DAOs must identify and disclose UBOs to registered agents and, in some cases, government authorities. At least one UBO must be reported, typically managers (directors, supervisors, protectors) if no other controlling person exists. UBOs must disclose their identity and undergo KYC (Know Your Customer) checks.
This requirement can be challenging for DAOs and Web3 organizations, as key contributors often prefer anonymity to avoid legal exposure. For those facing this challenge, DAObox offers its signature wrapper management service, where DAObox assumes the role of a director (or similar position) of the wrapper, undergoing necessary checks and screenings itself. This allows DAO contributors to maintain their anonymity and avoid additional exposure. For more details on the service, please refer to the link above.
DAO Legal Wrapper Major Forms and Types
Not all legal entity forms are suitable for use as DAO legal wrappers. The ones that are can be divided into two main categories, depending on whether these wrappers can "wrap" the entire DAO or only specific siloed functions or activities.
Partial Wrappers
Partial wrappers are not suitable for wrapping the entire decentralized organization, but they can be employed for wrapping its specific functions, activities, or property. Regardless of the number of partial wrappers a DAO may have, the DAO, as it exists on-chain, will co-exist with these wrappers from a legal standpoint.
A partial legal wrapper does not "absorb" the DAO. The members of the DAO do not become members of the legal wrapper and can only obtain limited governance rights with respect to the wrapper.
Partial legal wrappers include:
- Foundation
Overview: Ownerless foundation is an orphan legal entity without shareholders that combines features of corporations and trusts. Created for specific predetermined purposes, this entity can outlive the founding team and core contributors of the project, potentially lasting indefinitely — as long as it can finance its operations and has objectives to pursue.
Jurisdictions: Switzerland, Cayman Islands, Panama, Seychelles, Nevis, Cook Islands, Liechtenstein, and others.
- Association
Overview: A membership-based entity that offers a certain degree of flexibility in governance and operations. Normally, associations are required to have members who must undergo regular onboarding procedures, making it impossible to admit all DAO members as association members based on token holding.
Jurisdictions: Switzerland, Luxembourg, Liechtenstein, and others.
- Trust
Overview: In our context, a trust refers to a contractual arrangement for managing specific property attributable to the DAO. A trust does not imply the formation of a separate legal entity, but allows the trustee (manager) to hold and manage the property entrusted by the DAO for certain purposes, separately from the trustee’s own estate.
Jurisdictions: Guernsey and others.
- Company limited by guarantee
Overview: Depending on the circumstances, this entity can have no shareholders and be non-profit, with the board owing fiduciary duties to the purposes of the company rather than to the interests of shareholders. Proper structuring is required to ensure that members have limited authority and no ownership or distribution rights.
Jurisdictions: Singapore, BVI, Hong Kong, and others.
Full Wrappers
Unlike partial wrappers, a full DAO wrapper is designed to wrap the entire organization and its core activities. In a full wrapper, the members of the DAO are typically recognized as members of the legal wrapper itself, meaning that the legal wrapper effectively "absorbs" the decentralized organization, merging the DAO governance with that of the legal wrapper.
Full wrappers include:
- DAO LLC
Overview: Unlike traditional LLCs, a DAO LLC can admit as members all persons holding the DAO’s governance tokens, without having them to undergo onboarding, KYC and other legal formalities, granting the token holders direct governance rights and limited liability by default.
Jurisdictions: Marshall Islands, Wyoming (USA), Utah (USA), and others.
- DLT Foundation
Overview: DLT Foundation is a special form of foundation that can be established in ADGM (UAE), designed specifically for blockchain-based organizations. Can be used to engage in DAO-related activities and even issue a token, which, however, must be in compliance with fairly strict regulatory requirements.
Jurisdiction: ADGM (UAE).
Designing DAO Legal Wrapper
Now, when we understand the concept of DAO legal wrappers, their main types, available structuring opportunities and frameworks, let’s discuss several major considerations for DAO legal structuring and legal wrapper design.
DAO Governance vs. Corporate Management
Central to any DAO legal structuring, governance presents both a major challenge and a matter of critical importance: properly integrating the traditional corporate governance of the legal wrapper with the DAO’s on-chain voting procedures is essential for effective management and compliance.
The most important element of governance design is the legal wrapper’s recognition of DAO resolutions and token holders’ on-chain voting. This setup serves as a cornerstone for proper governance and control mechanisms within the legal wrapper. Without such integration, aligning the DAO’s on-chain governance with the wrapper’s corporate management procedures would be close to impossible.
When we design legal wrappers, our goal is to achieve a balance where the management of the legal wrapper has enough authority and discretion to effectively manage its operations. At the same time, this management must remain subordinate to the DAO, with the DAO consent being necessary for dealing with material and significant matters. This ensures that the DAO retains ultimate control, preserving its decentralized decision-making process while allowing the legal wrapper to function effectively within existing legal and regulatory frameworks.
Checks and Balances
A well-designed system of checks and balances ensures that the directors and managers of the legal wrapper do not usurp power or act in bad faith, and if they do, they will face consequences, and any damages to the DAO will be prevented.
Designing a system of checks and balances can be challenging, especially when integrating them with DAO governance. Depending on the circumstances, these mechanisms could include basic recognition of the DAO’s will, procedures for appointing and removing management, fiduciary duties aligned with the organization’s purposes, a list of reserved matters requiring the DAO’s consent, a list of excluded activities, emergency procedures, and more.
Centralization
Centralization is always one of the primary concerns when structuring a DAO, not only because it aligns with the 'decentralized ethos' of Web3 organizations, but also because sufficient decentralization is often crucial from a compliance standpoint and is required to achieve the project’s strategic regulatory objectives.
Depending on how the wrapper is structured, it could either create a point of centralization or facilitate decentralization. For example, a point of centralization could emerge when the initial founders of the project assume majority of board seats within the legal wrapper, which is not adequately subordinated to the DAO vote. This results in a closely connected (centralized) group of people gaining control over the wrapper and its assets.
Balancing decentralization with the legal wrapper’s corporate governance and applicable legal requirements is essential. While the wrapper provides necessary protections and recognition, it’s important to avoid excessive centralization that could undermine the DAO’s governance, regulatory strategy, or put its property at risk.
Creating DAO Legal Wrapper
While the formal procedure for establishing DAO legal wrapper would depend on the type of the legal wrapper chosen and its jurisdiction, the general structuring roadmap would normally look as the one described here.
DAObox is a full-service company for designing, creating and managing DAO legal wrappers. We work with all major forms and types of legal wrappers currently available, and all key jurisdictions where such wrappers can be created. DAObox delivers only ready-made legal wrappers, tailored to the specific needs and purposes of a DAO, focusing on:
Educating the DAO members and key contributors;
Identifying the most suitable legal wrapper form and jurisdiction;
Designing the legal wrapper, properly integrating it into the DAO ecosystem;
Establishing proper control, safety and emergency procedures;
Addressing regulatory and compliance implications;
Ensuring sufficient decentralization, while preserving the DAO’s control.
Design and Formation Stage
Based on our experience and current market practices, from a DAO’s perspective, the legal wrapper creation procedure would normally include the following steps:
Initiation of Discussion: The process begins with discussions within the DAO, typically on its forum or Discord channel.
Gauging Support: If the DAO shows support through a signaling vote or other means, key contributors commence the preparation phase. During this phase, they communicate with potential vendors and discuss suggested structuring approaches.
Vendor Presentations: The potential vendor, such as DAObox, presents its offer to the DAO regarding the design and formation of the legal wrapper, which must include timeline, costs and deliverables.
AMA Sessions: The DAO can hold an AMA session or a similar event, inviting the potential vendor to educate the DAO about the legal wrapping procedure and discuss associated matters.
Discussion and Decision: The DAO discusses the proposals and options suggested by the vendors and decides which ones to put to a vote. Once the vote passes, the design and formation phases commence.
Post-Formation Stage
The story does not end with the creation of the legal wrapper; it only begins there. Like any other legal entity, a legal wrapper comes with associated corporate and legal responsibilities, including managing paperwork, personnel, and property; executing legal documents; facilitating corporate reporting and annual continuations; opening and managing fiat payment accounts; and more.
Proper management and administration are crucial once the legal wrapper's operations commence. The DAO must appoint management and other personnel required to administer the legal wrapper, allocate resources necessary to finance its operations and costs, and oversee the legal wrapper’s management.
For organizations that prefer to focus on growth and development rather than legal and compliance matters, DAObox offers its signature legal wrapper administration service. As administrator, DAObox assumes the necessary managerial positions within the legal wrapper and takes responsibility for administering day-to-day operations, managing personnel and contributors, handling infrastructure, dealing with paperwork, corporate continuations, compliance, reporting, and more.
Conclusion
Navigating the complex landscape of DAO legal wrappers requires a thorough understanding of various legal structures, jurisdictional differences, and practical considerations. By carefully selecting and designing a legal wrapper, DAOs can achieve operational efficiency, legal compliance, and enhanced protection for their members.
If you’re considering establishing a DAO or hiring professional manager, or looking to optimize your existing structure, reach out to DAObox for a free consultation with our experts to explore the best options for your DAO’s specific needs and objectives.
Last updated