A fully compliant global DAO
This concept paper describes how a global DAO may be implemented in a fully regulated manner.
A Decentralized Autonomous Organisation or a DAO is one of the holy grails of blockchain technology. It promises to unlock the full potential of Blockchain in a real world scenario. Here is an excerpt from the Ethereum whitepaper itself.
Decentralized Autonomous Organizations
The general concept of a “decentralized autonomous organization” is that of a virtual entity that has a certain set of members or shareholders which, perhaps with a 67% majority, have the right to spend the entity’s funds and modify its code. The members would collectively decide on how the organization should allocate its funds. Methods for allocating a DAO’s funds could range from bounties, salaries to even more exotic mechanisms such as an internal currency to reward work. This essentially replicates the legal trappings of a traditional company or nonprofit but using only cryptographic blockchain technology for enforcement. So far much of the talk around DAOs has been around the “capitalist” model of a “decentralized autonomous corporation” (DAC) with dividend-receiving shareholders and tradable shares; an alternative, perhaps described as a “decentralized autonomous community”, would have all members have an equal share in the decision making and require 67% of existing members to agree to add or remove a member. The requirement that one person can only have one membership would then need to be enforced collectively by the group.
A general outline for how to code a DAO is as follows. The simplest design is simply a piece of self-modifying code that changes if two thirds of members agree on a change. Although code is theoretically immutable, one can easily get around this and have de-facto mutability by having chunks of the code in separate contracts, and having the address of which contracts to call stored in the modifiable storage. In a simple implementation of such a DAO contract, there would be three transaction types, distinguished by the data provided in the transaction:
[0,i,K,V] to register a proposal with index i to change the address at storage index K to value V
[1,i] to register a vote in favor of proposal i
[2,i] to finalize proposal i if enough votes have been made
The contract would then have clauses for each of these. It would maintain a record of all open storage changes, along with a list of who voted for them. It would also have a list of all members. When any storage change gets to two thirds of members voting for it, a finalizing transaction could execute the change. A more sophisticated skeleton would also have built-in voting ability for features like sending a transaction, adding members and removing members, and may even provide for Liquid Democracy-style vote delegation (ie. anyone can assign someone to vote for them, and assignment is transitive so if A assigns B and B assigns C then C determines A’s vote). This design would allow the DAO to grow organically as a decentralized community, allowing people to eventually delegate the task of filtering out who is a member to specialists, although unlike in the “current system” specialists can easily pop in and out of existence over time as individual community members change their alignments.
An alternative model is for a decentralized corporation, where any account can have zero or more shares, and two thirds of the shares are required to make a decision. A complete skeleton would involve asset management functionality, the ability to make an offer to buy or sell shares, and the ability to accept offers (preferably with an order-matching mechanism inside the contract). Delegation would also exist Liquid Democracy-style, generalizing the concept of a “board of directors”.
While all of it sounds great, the reality is any such pooling of funds in a common enterprise in pursuit of profit for its members is effectively a securities offering.
And the general understanding is that making a securities offering especially to retail (mum and dad investors) is quite complicated, cumbersome and often ends up in the too hard bucket esp. For the tech guys who want to implement constructs like the DAO.
In addition a securities offering in one country is not necessarily automatically valid in another. While the virtual world may have no borders, the real world does. Countries are soveriegn and most nations have their own securities regulator who are quite territorial about what goes on in their jurisdictions. Try promoting a securities offer in the US which is not registered with the SEC and you will bring out the full wrath and fury of the US government on you.
So for a truly global DAO, you would not only need a full retail public offer (which is hard to get going in even one country) but you would need to register that offer in every single country worldwide. The amount of bureaucracy and paperwork that would go into getting such a organization up and running is truly mind boggling.
Doing a fully regulated global DAO is going to be a marathon, not a spring.
Before we contemplate such a structure lets first lay down some basic parameters:
- We will not look to define the basic mechanics of the DAO such as voting percentages, profit sharing (short and long term), stakeholder roles and incentives, what it will do under what conditions. All of that can be decided at a later date in a manner that is agreeable to its participants.
- We will not look to discuss technology implementation, that portion is straightforward to implement. We will highlight a couple of specific things on how updates are provided and how actions can be triggered but the technical guts is not in the scope of this document, our focus is more on the regulatory side here.
- Our DAO should be global, but it can’t be truly global on day 1. Rome was not conquered in a day, it will have to start in a specific country and then with time it can be implemented in other jurisdictions one by one (a bit like UBER).
- Such a country should have crypto friendly regulators, well established rule of law, transparency in governance, a well developed security/finance industry and a reasonably deep pool of investors who can support early adoption.
- The aim should always be open to retail investors, even from day 1
- System should encourage and reward early adopters
- An investment in DAO should be liquid (ideally from day 1, but if not atleast as soon as possible), while achieving that is a function of number of interested investors. But often times there are restrictions on secondary trading depending on the investment structure. Any investment structure that is chosen should be compliant with the requirements for secondary trading.
- The DAO should be able to get running as fast as possible and with minimal cash investment to seed it. In due time it will start getting more complicated and expensive to operate it, but hopefully the operations and their extent will justify it then.
- The structure should allow the basic premise behind DAO where investments are allocated based upon investor/stakeholder votes
Such a country should have crypto friendly regulators, well established rule of law, transparency in governance, a well developed security/finance industry and a reasonably deep pool of investors who can support early adoption.
The DAO should be able to get running as fast as possible and with minimal cash investment to seed it.
The aim should always be open to retail investors, even from day 1
The US is obviously the biggest financial market out there. But going retail is not that easy, even with the JOBS act and all the new regulations that are coming out. The US regulatory framework can often be a patchwork quilt with different rules based on different states. Even a Reg D offer can set you back by a few tens of thousands of dollars and has limitations on whom you can promote to.
The UK, Canada, NZ all have come up with their own crowdfunding legislations but they usually require a special crowdfunding license, the process of whose acquisition can be quite cumbersome from time and money perspective. Singapore and HK are also exploring fintech and blockchain and can be plausible candidates.
Jurisdictions like Caymans do not command the necessary respect internationally. Malta and Gibraltar are taking some interesting steps to position themselves as market leaders in this space from a regulatory standpoint.
But my best bet is Australia. For the following reasons
- Western country based on rule of law
- Transparent and strong governance of the financial sector
- ASIC, the securities regulator has been flexible and been developing a principles based, technology agnostic regulatory framework
- Strong financial sector with over 3 trillion AUD in investable super money, 1/3rd of which is directly controlled in self managed individually control trusts.
- A strong crypto community
- I live here :)
If you know what you are doing you can get a full retail offer open to mum and dad investors in Australia up for less than 4000 AUD and within a matter of few weeks end to end. Such an offer would have no regulatory restrictions on
- How much you can raise (limited to the goals of the raise)
- Whom you promote the offer to (limited to Australians ofcourse)
- How you promote, you can promote openly
- How much can an individual investor invest
If you know of any other jurisdiction that falls in this goldilocks zone please let me know. But for now Australia is the best country in the world to be in the regulated security tokens space.
Nuts and bolts
Now coming to the mechanics of how such an offer would be structured. The ideal structure for this would be a Part A, Part B style Managed Investment Scheme. A MIS is actually quite expensive to get going especially if it is open to retail investors. There is also an ongoing cost of running a MIS that includes custodians, trustees, responsible entities, compliance plans etc and so on. But it has some significant advantages that make it suited for something like this for 2 specific reasons. And as far as the costs are concerned, we will discuss a solution to them later on.
The beauty of a Part A, Part B style PDS is that you can have a 2 part offer document. The core or master document would describe the structure of the fund, about how participating investors can propose potential investment opportunities and if the unit holders vote carries through then a new class of units can be issued which will be focused on that specific venture.
Ideally the participation in this new venture would be voluntary where the master unit holders can swap their units to the units in this new class or buy the units separately.
Such ventures details will be described in a part 2 PDS which would be duly lodged with ASIC. However the beauty is that such Part 2 PDS offers do not carry additional separate lodgement fees and also do not carry an additional exposure period. ASIC can still shoot down such offers if they do not meet the guidelines around clear, concise and effective disclosure in RG228 but the bulk of the disclosures are provided in the Master PDS.
Any units in such a fund would be represented as a security token recorded on a distributed share registry such as Konkrete.
The second advantage of a MIS structure is you are allowed to make a market in the units in your own scheme without having a special market license.
This addresses any issues around liquidity of such an offering atleast from a regulatory standpoint.
Seed Capital using OIS or Prospectus
Setting up a MIS is not easy and can be quite expensive both to setup as well as operate on an ongoing basis. So in order to raise the money we would first issue a Prospectus under a public company structure. If you have a company that is atleast 12 months old then you can also do an Offer Information Statement which is easier to draft, is a bit less expensive to lodge ($2000 vs $3200 for Prospectus) but it does require audited financials for the last 12 months and is limited to $10 Million in raise vs no limits on a Prospectus. All up around $4000 to get everything up and running.
These early investors would raise the capital required to get a MIS setup and also contribute to marketing and operational costs of the MIS for a few years. They would be suitably rewarded for the risk they take as a significant chunk of the master units in the MIS would be allocated to them once the MIS is setup.
Assumption 2 at the start of this paper suggested,
For a truly global DAO, you would not only need a full retail public offer (which is hard to get going in even one country) but you would need to register that offer in every single country worldwide.
This is however an exaggeration when you think about it from a practical perspective. Bar US SEC most regulators lack the resources to chase down issuers from overseas jurisdictions accepting investors from their country.
Plus the rules are more around promotions, and a DAO like this would spread through word of mouth, attract an audience of a certain mindset rather than through active investor solicitation. The DAO would not be advertising itself as an investment offer in foreign jurisdictions.
Having said that for countries like the US and a few other major advanced economies it is probably a good idea to setup their own regulatory structures open to retail investors in due time that would invest in the MIS based in Australia as their sole asset.
Investors in these countries would hold units or shares in their respective entities duly registered in that jurisdiction. In order to liquidate they would place a sell order, the entity would then put up a sell order for an equivalent number of units in the main MIS giving the investors the outcome they seek.
Overseas rollout would start in a year or two but if investor and user adoption takes off then it may be faster.
All investors would have a right to vote on various decisions in the investment process and replace management if necessary through the necessary voting outcomes.