DLT-Foundation (DAO) and Regulation

Decentralized Autonomous Organizations (DAOs) have gained popularity in recent years, and many entrepreneurs and investors are looking to set up DAO foundations in various jurisdictions worldwide. DAO stands for “Decentralized Autonomous Organization”, a type of organization that operates through smart contracts and distributed ledgers, without a centralized authority or hierarchy. To regulate such DAO by a centralized regulatory body sounds like a paradox. However, there are legal challenges in establishing a DAO foundation as many legal questions remain unanswered. And after the FTX disaster regulation of DAOs, blockchain and cryptos are heavily discussed. DAOs enable networked collaboration, open participation, and transparent decision-making, but also raise various legal and regulatory challenges, such as jurisdictional issues, liability attribution, and governance accountability.

Legal Issues Overview

First, it is important to understand what a DAO is. A DAO is a type of organization that operates and executes decisions through blockchain technology, without the need for a central authority. It is governed by smart contracts and the will of its members, who “own” and manage its operations. DAOs have become very popular in the cryptocurrency industry, where they are used to fund and manage different projects or initiatives. The regulatory body of Abu Dhabi Global Markets (ADGM) recently published a consultation paper introducing the draft legal framework for DLT Foundations based in ADGM, i.e., DAOs. On one hand, the legal framework for cryptocurrencies and blockchain-based businesses is still developing. On the other hand, ADGM has embraced digital technologies and proposed a very comprehensive and specific regulatory framework for DAOs:

https://www.adgm.com/documents/legal-framework/public-consultations/2023/consultation-paper-no-3/annex-a-distributed-ledger-technology-foundations-regulations-2023.pdf

It is very likely that the law will be effective in the second half of 2023. This does not mean, however, that creating a DLT Foundation in ADGM will be easy and without addressing some legal challenges. One of the biggest challenges is the legal status of DAOs in ADGM. Currently, there is no specific legal framework for a DLT Foundation recognized as a DAO under ADGM laws. Therefore, the existing wealth foundation under the Foundation Law of 2017 was used to create a DAO with some success. In the future a DLT Foundation will be regulated separately and will be granted a legal personality recognized in ADGM. The object of the DLT Foundation can in principle be very broad unless it is not unlawful. However, such entity must comply with very complex regulations and obligations. Thereby, ADGM defines under “obligations” the following in abstract terms:

“Each DLT Foundation shall ensure compliance with all applicable laws, requirements, rules and regulations, including, without limitation, any requirements set forth by the United Arab Emirates, the Emirate of Abu Dhabi (to the extent applicable to the relevant activities in the ADGM) and ADGM with respect to anti-money laundering, anti-bribery, sanctions and export controls (including, where applicable, in the area of virtual assets), consumer protection, data protection, data security and prevention of cyber-crime.”

For instance, to ensure the compliance with the anti-money laundering and anti-terrorism financing regulations will be a big challenge for the Councillors of the DLT Foundation or any other liable so-called “Relevant Person” (cf. the above-mentioned draft ADGM DLT Foundation law, page 18 et seq.). Blockchain technology enables anonymity, which makes it attractive to criminals for money laundering or financing terrorism. ADGM will impose strict AML regulations on DLT Foundations, including Know Your Customer (KYC) and customer due diligence (CDD) requirements. The most important document for a DLT Foundation subject to approval of ADGM is the Charter. The draft law defines the minimum content of the Foundation Charter as follows:

“A DLT Foundation shall have a Charter that complies with the provisions of these Regulations. Any provisions, duties, powers, functions and rights set forth in a Charter shall not replace or limit the processes, restrictions, oversight or other terms set forth in these Regulations.”

Summary and Experiences

In conclusion, setting up a DAO (DLT Foundation) in ADGM involves navigating legal challenges related to the lack of practical experience with the upcoming specific regulations. These challenges require careful consideration and planning to ensure compliance with applicable regulations and laws. Despite these challenges, ADGM offers a supportive and innovative environment for blockchain and cryptocurrency startups, which makes it an attractive destination for DLT Foundations. However, ADGM is not and will not be a place for “crypto desperados” who quickly want to get the branding of a regulated DLT Foundation and are not willing to accept the regulatory responsibilities coming with it. Sponsors and initiators who are willing to implement (i.e., invest in) a regulatory setup will find a Crypto/FinTech friendly environment. After more than 20 years in the regulatory law business and according to own experience as a founder of an early stage ADGM foundation, however, one must say that it is not the biggest task to get a regulatory license. It is more challenging to maintain such licence and to allow the business side to be successful.