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One of the most important elements in any investment proposal is the decision as to what the most appropriate and effective corporate structure will meet the business’ aspirations. The most common forms of vehicles traditionally used by individuals engaging in business in Australia include:

  1. partnerships;
  2. joint ventures;
  3. companies; and
  4. trusts.

However, this list is by no means fixed or exhaustive. For instance, in its 2021-2022 Federal Budget, the Australian Government announced that it will progress regulatory framework to introduce “corporate collective investment vehicles” into the Corporations Act 2001 (Cth) (Corporations Act).

Similarly, the emergence of, and demand for, cryptocurrencies, digital assets, and decentralised corporate vehicles has spurred Australian policymakers, regulators and governments to consider regulatory intervention and oversight, into what has previously been a largely unregulated industry.

setting the scene

The cryptocurrency and digital asset market surpassed US$3 trillion dollars globally at the end of 2021, up from around $750 billion at its peak in 2020. In response to this exponentially growing industry, the Australian Senate Select Committee on Financial Technology and Regulatory Technology (Committee) has now provided its final report, which contains a list of recommendations to address several issues affecting the competitiveness of Australia’s digital asset, technology and finance industries (Report).

The Report was based on more than 100 submissions, including notable entries from the Australian Taxation Office, Reserve Bank of Australia, the Australian Securities and Investments Commission and various other interested private and public bodies. The purpose of the Committee’s research (which included two previous reports released in September 2020 and April 2021), was to identify and drive opportunities for business innovation in Australia, whilst also balancing the need to protect consumers (among other things).

australian businesses considering alternative corporate structures

The Report noted the exponential interest in Australia and abroad in utilising alternative corporate structures to better align commercial vehicles with the aspirations of their members. Recommendation 4 of the Report endorsed the Australian Government to formally recognise DAOs as a legitimate corporate structure under Australian law. This recommendation was accepted in principle by the Government in December 2021. Nevertheless, it is unclear at this stage as to how DAOs will be formally introduced into the Australian legal landscape. It is also unclear as to what extent existing concepts under Australian law (such as those relating to managed investment schemes, digital currencies and digital currency exchanges) apply to DAOs.

what are DAO structures?

A DAO is an organisation that operates on decentralised blockchain infrastructure. In essence, this means that the organisation leverages the power of smart contracts and blockchain technology in order to bring about greater transparency, efficiency and decentralisation in the entity’s decision making, ability to transact and obtain member consensus. For instance, under the DAO structure, certain decision-making can be pre-determined by virtue of those decisions being coded into transparent smart contracts. The terms of these smart contracts can be viewed in open-source code by prospective investors and the market at large. Other DAO decisions, such as whether the DAO will engage in M&A activity, may require a threshold level of consensus from the DAO’s members. Where member consensus is required, the DAO’s leadership team can propose a vote to the DAOs members, who can each have their say as to whether the DAO engages in the voted upon activity.

DAOs: the opportunity

There are a number of ways in which DAOs may provide incentives to investors. One such way is for DAOs to provide incentives to the market to provide liquidity to liquidity pools (a liquidity pool can be thought of as a basket of crypto-assets, which can be utilised for loans and crypto-asset exchanges between parties). In exchange for a market participant providing liquidity to the liquidity pool, that investor may receive a share of trading fees and/or other rewards determined by the exchange upon which they ‘pool’ their tokens.

Alternatively, instead of relying on providing incentives to the market to provide liquidity to liquidity pools, the ‘protocol owned liquidity model’ instead utilises a “bonding” mechanism whereby the protocol sells tokens at a discount to buyers, who in exchange will provide another token (e.g., a coin which is pegged on a 1:1 ratio to the USD), which then forms part of the protocol’s treasury. The treasury can then be invested to generate returns for the DAO. As a result of this dynamic, the DAOs themselves can accumulate significant assets, which may be held in the DAO’s treasury and administered by the DAO’s governance documentation.

DAOs: the risk of legal uncertainty

DAOs are currently being used globally for purposes such as fundraising, charity, investment, borrowing and buying non-fungible tokens. According to data from DAO statistics platform DeepDAO, the total global assets under management for DAO treasuries listed on the platform increased from around US$380 million in January 2021 to a peak of US$16 billion in mid-September 2021.

At present, Australian law (such as the Corporations Act 2001 (Cth)) does not recognise DAOs with legal personality. Entities afforded legal personality under Australian law have the same rights as a natural person and can incur debt, sue and be sued. Entities which are not recognised under Australian law as having sufficient legal personality are at risk of having insufficient standing to enforce the entity’s rights. Similarly, other entities (i.e., individual or corporate investors) may be unable to bring proceedings against DAOs given their unrecognised legal status.

This uncertainty gives rise to a myriad of risks for both DAO leadership teams and its investors/members. For instance, consider the following tip of the ice-berg scenarios:

  1. Can a DAO’s leadership team be held liable for the debts of the DAO or are the DAO’s founders afforded some form of limited liability (similar to, for instance, a public company limited by shares)?
  2. If the pre-determined smart contracts which govern how certain decisions of the DAO are made are flawed, what recourse or protections are available to members of the DAO that are negatively affected by such decisions?
  3. Because DAOs may offer a variety of different types of incentives to investors, how are such incentives to be treated for taxation purposes (i.e., if a DAO incentivises early investors by providing those investors with additional tokens which have some ascribed value based on market sentiment (among other things), how is the provision of those additional tokens taxed in the hands of the investor)?
  4. What sanctions can be imposed on nefarious DAO leadership teams, which may reside in Australia and/or overseas who run off with investor funds or DAO treasuries (colloquially referred to in the crypto industry as a “rug pull”)?

Without further legislative clarity, such vehicles are destined to remain a high-risk commercial venture and investors and founders must do their own due diligence to work out whether such investments are worth the associated risks.

Tech advancements still bound by the law

As technologies advance, it is inevitable that investment, innovation and regulatory development will follow. The emergence of corporate and organisational structures leveraging the power and utility of blockchain infrastructure and other technological solutions brings about exciting new opportunities for businesses.

However, without further regulatory clarity, the jury is still out on whether the risks outweigh the opportunity.

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DAOs: a new frontier in australian corporate law?

25 February 2022
terry kokkinos oscar sach-haber

One of the most important elements in any investment proposal is the decision as to what the most appropriate and effective corporate structure will meet the business’ aspirations. The most common forms of vehicles traditionally used by individuals engaging in business in Australia include:

  1. partnerships;
  2. joint ventures;
  3. companies; and
  4. trusts.

However, this list is by no means fixed or exhaustive. For instance, in its 2021-2022 Federal Budget, the Australian Government announced that it will progress regulatory framework to introduce “corporate collective investment vehicles” into the Corporations Act 2001 (Cth) (Corporations Act).

Similarly, the emergence of, and demand for, cryptocurrencies, digital assets, and decentralised corporate vehicles has spurred Australian policymakers, regulators and governments to consider regulatory intervention and oversight, into what has previously been a largely unregulated industry.

setting the scene

The cryptocurrency and digital asset market surpassed US$3 trillion dollars globally at the end of 2021, up from around $750 billion at its peak in 2020. In response to this exponentially growing industry, the Australian Senate Select Committee on Financial Technology and Regulatory Technology (Committee) has now provided its final report, which contains a list of recommendations to address several issues affecting the competitiveness of Australia’s digital asset, technology and finance industries (Report).

The Report was based on more than 100 submissions, including notable entries from the Australian Taxation Office, Reserve Bank of Australia, the Australian Securities and Investments Commission and various other interested private and public bodies. The purpose of the Committee’s research (which included two previous reports released in September 2020 and April 2021), was to identify and drive opportunities for business innovation in Australia, whilst also balancing the need to protect consumers (among other things).

australian businesses considering alternative corporate structures

The Report noted the exponential interest in Australia and abroad in utilising alternative corporate structures to better align commercial vehicles with the aspirations of their members. Recommendation 4 of the Report endorsed the Australian Government to formally recognise DAOs as a legitimate corporate structure under Australian law. This recommendation was accepted in principle by the Government in December 2021. Nevertheless, it is unclear at this stage as to how DAOs will be formally introduced into the Australian legal landscape. It is also unclear as to what extent existing concepts under Australian law (such as those relating to managed investment schemes, digital currencies and digital currency exchanges) apply to DAOs.

what are DAO structures?

A DAO is an organisation that operates on decentralised blockchain infrastructure. In essence, this means that the organisation leverages the power of smart contracts and blockchain technology in order to bring about greater transparency, efficiency and decentralisation in the entity’s decision making, ability to transact and obtain member consensus. For instance, under the DAO structure, certain decision-making can be pre-determined by virtue of those decisions being coded into transparent smart contracts. The terms of these smart contracts can be viewed in open-source code by prospective investors and the market at large. Other DAO decisions, such as whether the DAO will engage in M&A activity, may require a threshold level of consensus from the DAO’s members. Where member consensus is required, the DAO’s leadership team can propose a vote to the DAOs members, who can each have their say as to whether the DAO engages in the voted upon activity.

DAOs: the opportunity

There are a number of ways in which DAOs may provide incentives to investors. One such way is for DAOs to provide incentives to the market to provide liquidity to liquidity pools (a liquidity pool can be thought of as a basket of crypto-assets, which can be utilised for loans and crypto-asset exchanges between parties). In exchange for a market participant providing liquidity to the liquidity pool, that investor may receive a share of trading fees and/or other rewards determined by the exchange upon which they ‘pool’ their tokens.

Alternatively, instead of relying on providing incentives to the market to provide liquidity to liquidity pools, the ‘protocol owned liquidity model’ instead utilises a “bonding” mechanism whereby the protocol sells tokens at a discount to buyers, who in exchange will provide another token (e.g., a coin which is pegged on a 1:1 ratio to the USD), which then forms part of the protocol’s treasury. The treasury can then be invested to generate returns for the DAO. As a result of this dynamic, the DAOs themselves can accumulate significant assets, which may be held in the DAO’s treasury and administered by the DAO’s governance documentation.

DAOs: the risk of legal uncertainty

DAOs are currently being used globally for purposes such as fundraising, charity, investment, borrowing and buying non-fungible tokens. According to data from DAO statistics platform DeepDAO, the total global assets under management for DAO treasuries listed on the platform increased from around US$380 million in January 2021 to a peak of US$16 billion in mid-September 2021.

At present, Australian law (such as the Corporations Act 2001 (Cth)) does not recognise DAOs with legal personality. Entities afforded legal personality under Australian law have the same rights as a natural person and can incur debt, sue and be sued. Entities which are not recognised under Australian law as having sufficient legal personality are at risk of having insufficient standing to enforce the entity’s rights. Similarly, other entities (i.e., individual or corporate investors) may be unable to bring proceedings against DAOs given their unrecognised legal status.

This uncertainty gives rise to a myriad of risks for both DAO leadership teams and its investors/members. For instance, consider the following tip of the ice-berg scenarios:

  1. Can a DAO’s leadership team be held liable for the debts of the DAO or are the DAO’s founders afforded some form of limited liability (similar to, for instance, a public company limited by shares)?
  2. If the pre-determined smart contracts which govern how certain decisions of the DAO are made are flawed, what recourse or protections are available to members of the DAO that are negatively affected by such decisions?
  3. Because DAOs may offer a variety of different types of incentives to investors, how are such incentives to be treated for taxation purposes (i.e., if a DAO incentivises early investors by providing those investors with additional tokens which have some ascribed value based on market sentiment (among other things), how is the provision of those additional tokens taxed in the hands of the investor)?
  4. What sanctions can be imposed on nefarious DAO leadership teams, which may reside in Australia and/or overseas who run off with investor funds or DAO treasuries (colloquially referred to in the crypto industry as a “rug pull”)?

Without further legislative clarity, such vehicles are destined to remain a high-risk commercial venture and investors and founders must do their own due diligence to work out whether such investments are worth the associated risks.

Tech advancements still bound by the law

As technologies advance, it is inevitable that investment, innovation and regulatory development will follow. The emergence of corporate and organisational structures leveraging the power and utility of blockchain infrastructure and other technological solutions brings about exciting new opportunities for businesses.

However, without further regulatory clarity, the jury is still out on whether the risks outweigh the opportunity.