dYdX details: how to build a legal framework of trust in the form of DAO (applicable outside the United States)

The dYdX Foundation is introducing a framework for creating a Guernsey Purpose Trust. This trust structure offers a potential solution to several problems DAOs face:

  1. Limit the responsibilities of DAO and DAO Committee participants;
  2. Allow DAOs to carry out off-chain activities;
  3. Clarify whether there are any U.S. tax payment and reporting obligations.

     

In addition, purpose trusts created under Guernsey law specifically create additional benefits that may not exist in trusts in other jurisdictions: flexible trust requirements and favorable tax rates.

Purpose Trusts are considered in the context of DAO funding schemes, but can also be adopted by other subDAOs and potential DAOs. A purpose trust is likely to be a suitable structure for transferring funds from the DAO community treasury that are earmarked for the growth and development of a given protocol. The purpose of making this framework public is to provide a starting point for DAOs to assess the suitability of purpose trusts for their operations, allowing them to focus on building protocols and ecosystems rather than finding an efficient operating structure. While DAOs still require the assistance of legal counsel, the framework seeks to significantly reduce the time and cost associated with engaging legal counsel to assess the viability of a similar structure.

introduce

As the use of DAOs has increased, efforts to make DAOs work efficiently have become an important area of ​​research. In the absence of comprehensive guidelines, DAOs must devote significant resources to ensuring that their operations comply with the rules of any number of jurisdictions. In particular, the United States has many existing laws applicable to DAOs, but lacks guidance that specifically addresses key issues facing DAOs. Addressing U.S. legal and tax issues and even structuring DAO operations within the U.S. to more Fulfilling reporting obligations easily is an important part of most analyses. As a result, exploring DAO solutions outside of the US often becomes moot due to the complexity of US compliance issues.

Consider using this framework when:

  • The DAO token governance protocol, whose governance contract can only be changed by the token holder, is generally the case for DeFi protocols, but may not be the case for other protocols, including L1 blockchain networks.
  • The purpose trust acts as a DAO or subDAO committee tool, focusing on specific tasks, such as delegation, without encapsulating the DAO.
  • DAO token holders want a compliant structure that does not require the formation of a government-approved entity nor their ongoing filing or reporting obligations.
  • DAO token holders want a compliant structure that does not subject the purpose trust to unnecessary levels of taxation.

     

While this framework does not take this into account, it is possible that the framework can be used as a wrapper for the entire DAO, with some modifications to the mechanisms in the governance document.

trust structure

The purpose trust envisaged in this framework is formed under Guernsey law. Assets are transferred from a DAO-controlled smart contract to a destination trust, and one or more trustees (“Trustees”) and an executor (“Executor”) enter into a written agreement, thereby allowing the destination trust to exist.

The Purpose Trust is governed by a Purpose Trust Instrument (“Trust Agreement”), which establishes the relationship between the Trustee and the Executor with respect to the assets transferred to the Purpose Trust. A trust agreement sets out one or more purposes for which the trustee is obligated to perform for the purpose of the trust.

The trustee must administer the purpose trust in accordance with the terms of the trust agreement and must discharge the general fiduciary duties, including acting with honesty and in the best interests of the purpose trust at all times, acting as a prudent business person and using reasonable skill and Proceed with caution. The trustee can use the funds transferred to the destination trust for any transaction or arrangement that furthers the purpose of the destination trust, and the transaction of the destination trust can be performed using the multisig wallet of the DAO transfer token. Delegates have the right to continue to receive compensation for their role as delegates, as long as that compensation is approved by DAO token holders. A trustee is always removed by other trustees based on the voting instructions of DAO token holders. Specifically, trustees must (and can only) remove other trustees at the request of DAO token holders.

The executor oversees the activities of the trustee to ensure that the purpose of the purpose trust is carried out, similar to the role of the supervisor. Enforcers can be given a wide range of rights. This framework envisages the Enforcer’s right to disclose information from the trustee, including the trustee’s distributions and disbursements from the purpose trust, and the trustee’s potential conflicts of interest in relation to any actions of the trustee. The powers of the executors are those of the trustees, which means that they need to periodically consider whether to exercise these powers, and they must be exercised in accordance with the trust agreement and not arbitrarily, arbitrarily or maliciously. The enforcer is always subject to the removal of the trustee, and the trustee must (and can only) remove the enforcer at the request of the DAO token holder.

If the DAO token holders wish to transfer the assets in the purpose trust to a different purpose trust or elsewhere, then, with the affirmative vote of the DAO token holders, they can instruct the trustee to terminate the purpose trust and transfer the assets to that different purpose trust the purpose of the trust or elsewhere, the trustee must act in accordance with the instructions. However, the trustee shall not transfer the assets of the purpose trust to the DAO or any DAO token holder, regardless of the instructions of the DAO token holder. To address situations where no decision has been made to transfer the assets of the purpose trust after its dissolution, the trust agreement may consider a transfer for a qualifying charity.

Here is a fiduciary agreement under consideration for the DAO’s funding scheme. It contains other mechanisms to ensure the efficient functioning of the purpose trust and to minimize the trust that DAO token holders place in the trustee and executor.

  • Instead of requiring a physical address, trustees and executors provide Twitter IDs, email addresses, and Ethereum addresses for multisig.
  • Ideally, the trust agreement to be signed would be hosted on IPFS rather than a private server, and the trustee and executor would sign the trust agreement by signing an Ethereum message referencing the IPFS hash of the trust agreement. However, Guernsey law does not allow trust agreements to be signed electronically. Therefore, the trustee and executor must wet-sign the trust agreement, and the signed trust agreement is uploaded to IPFS as the source of truth for the trust agreement.
  • Trustees follow general operations in the absence of a purpose trust, which includes through real-time written communications, such as Signal, rather than requiring more standard meetings, and funding grants by means of multiple signatures, in the absence of a purpose trust is also like this.
  • DAO token holders take actions permitted by the trust protocol through Snapshot with reference to the voting requirements at the time to approve proposals using Snapshot, and only DAO token holders can modify these requirements.
  • Governance can be transferred to another chain, and the fiduciary agreement takes into account the right of DAO token holders to continue voting on the other chain.
  • When voting for a trustee, the trustee must take the following actions:
  • terminate the purpose trust;
  • After the termination of the purpose trust, transfer the assets of the purpose trust to the place instructed by the DAO token holder, but the assets of the purpose trust shall not be transferred to the DAO or the DAO token holder;
  • Compensate trustees and executors;
  • Add and remove a purpose from the purpose trust;
  • change the legal jurisdiction applicable to the purpose trust;
  • appoint and remove trustees and executors;
  • Amend the trust agreement with the consent of the trustee and executor;

     

Problems with DAOs

Purpose Trusts address the main issues DAOs face with regard to their physical structure:

  1. Limit the liability of DAO participants;
  2. Provide a legal form to engage in off-chain activities;
  3. Clarify existing tax obligations

     

Trustee’s Limited Liability and Impact on Token Holders

There is significant uncertainty surrounding the state of the DAO, including the potential liability of DAO token holders. Such potential liability could include unlimited liability for DAO token holders for their own actions, unlimited liability for all DAO token holders for the actions of another holder, or a subset of DAO token holders for Unlimited liability for the actions of the holders of that subset.

When the purpose trust replaces the function of the DAO committee or subDAO, rather than the encapsulation of the entire DAO, it eases the actions of the DAO token holders to perform their duties. Since they don’t act, any attempt to hold them accountable is the act of the trustee, who is not part of the DAO. Therefore, the potential liability of DAO token holders is greatly reduced.

In contrast, a purpose trust requires the trustee to take action. As long as they act within the terms of the purpose trust, act in accordance with their fiduciary duties, and make it clear to any third party that they are acting as the purpose trust trustee, the trustee’s liability for their actions as trustee is limited to their control The value of the trust assets under the purpose. Therefore, the purpose trust enables the trustee to take action to achieve the purpose of the purpose trust without increasing the liability of the trustee and with limited risk to DAO token holders. In addition, trustees can receive compensation for actions they take as trustees.

Off-chain activities by or for the benefit of token holders

One problem plaguing DAOs is their inability to act in the off-chain world, which requires DAOs to:

  1. The initial development company signs the agreement on its behalf, posing significant risk to the development company;
  2. A DAO token holder signs an agreement that creates significant risk to that DAO token holder and possibly all other holders;
  3. The DAO signs the agreement, essentially acknowledging the unlimited liability of the DAO token holders;
  4. Or DAOs avoid interacting with the off-chain world.

     

These options are sub-optimal.

Purpose trusts solve the problem of DAOs being unable to act in the off-chain world, as trustees can engage in the same types of activities as other entities, which means, among other things, they can open bank accounts and sign agreements. Although a purpose trust is not a legal person, a trustee holds its assets and acts as a trustee on its behalf. When a trustee opens a bank account, they open the account in the name of the trustee on behalf of the destination trust and are bound by all trustee obligations under the destination trust, and so long as they do so in their capacity as trustee, they enjoy Trustee’s Limited Liability. The same is true when signing the agreement. Therefore, all the off-chain constraints that DAOs have traditionally faced no longer exist when operating with a purpose trust fund.

Clarify existing tax obligations

So far, there has been little guidance that directly applies to the problems DAOs face, especially regarding the distribution of tokens they control. In the U.S., DAO token holders can be considered to hold an interest in a pass-through entity, which in various circumstances brings taxable income to the DAO token holder.

Solutions that have been created to date have either perpetuated these risks or experienced significant tax leakage in addressing them. For example, the UNA in the US provides a tool to pay taxes and comply with reporting requirements, it is not a tax-advantaged structure, and the US federal tax rate on taxable income is 21%.

When significant steps are taken to eliminate or substantially reduce U.S. citizens’ ownership of governance tokens and the DAO’s activities in the U.S., choosing a structure that places the DAO on the 21% tax rate is not ideal. Instead, a structure that benefits from the non-US nature of the DAO and those involved in the DAO is a more appropriate solution.

Since the purpose trust contemplated by this paper is established under Guernsey law and clearly meets the requirements to be treated as a foreign trust (rather than a US trust) for US tax purposes, the main issue in determining US tax liability is that of a foreign purpose trust Whether it should be classified as a donor or non-donor trust. This issue is critical for purpose trusts and DAO token holders because generally, the income of foreign donor trusts is taxed on the trust’s donor, not on the trust or the trust’s beneficiaries (in this case, the giver is the DAO token holder). In general, foreign non-donor trusts are taxed upon distributions to U.S. beneficiaries, and the trust itself is responsible for any U.S. tax obligations while the trust retains U.S. sourced or validly connected income.

Sections 673-679 of the Internal Revenue Code contain various requirements for identifying the age of a donor trust. The core issue is that if the donor retains sufficient dominance and control over the assets of the trust, then it is appropriate to treat the donor as the owner of the trust for U.S. federal income tax purposes. In contrast, there is no test for non-donor trusts, as any foreign trust that is not a donor trust is a non-donor trust.

While under this framework, DAO token holders do retain minimum rights with respect to assets transferred to the Purpose Trust, they have no right to revoke the Purpose Trust and distribute assets to the DAO or individuals, have no right to substitute assets, and have no right to use the Purpose Trust The assets of the trust are secured against loans or paid directly to beneficiaries. In essence, DAO token holders retain sufficient control to ensure that trustees and executors fulfill their fiduciary responsibilities, but since DAO token holders cannot direct the assets or decide how to use them for the intended purpose of the trust, It is therefore the purpose trust itself that has control and control over the assets of the purpose trust and should be the party responsible for any tax obligations.

A purpose trust with these specific facts has no U.S. tax reporting or income reporting because the trust is not funded through involving U.S. persons, the purpose trust has no U.S. beneficiaries, and the purpose trust does not generate U.S.-sourced income.

A purpose trust has no Guernsey resident beneficiaries and no Guernsey source income under Guernsey law and will not be subject to any tax under Guernsey law, but may still be subject to taxation in other jurisdictions. If a purpose trust distributes funds to a U.S. beneficiary or a person who may be deemed a U.S. beneficiary for tax purposes in the United States, the trustee will be obligated to provide the beneficiary with a beneficiary declaration to pay the tax on the distribution. If the purpose trust receives U.S. sourced income or income that is effectively linked, then the purpose trust will need to obtain a U.S. tax identification number and the trustee will need to file Form 1040-NR to report and pay taxes related to that activity.

Problems solved by Guernsey

Purpose trusts under Guernsey law create additional benefits that may not exist in trusts in other jurisdictions: purpose trusts have no taxable income and flexible trust requirements.

Tax obligations of token holders and trustees

As mentioned above, the purpose trust minimizes the tax risk for DAO token holders and trustees. Creating a purpose trust under Guernsey law also has the added benefit of clarifying the tax liability of DAO token holders when tokens are transferred or exchanged from the purpose trust. In the event that the DAO grant committee and some other committees or subDAOs periodically transfer tokens, the transfer will be made in accordance with Guernsey law and not subject to U.S. tax treatment. In addition, the Purpose Trust Fund is not expected to have any tax filing or reporting obligations in Guernsey in relation to the activity.

Flexible trust structure for token holders

Purpose trusts under Guernsey law provide a great deal of flexibility to create an arrangement that maximises the benefit of DAO token holders and participants of purpose trusts. In addition to flexibility in drafting documents, Guernsey law is flexible in who can act as trustee and executor, in addition to reserving powers over trustee and executor for third parties.

Other jurisdictions with favorable tax regimes, such as the Cayman Islands and the British Virgin Islands, have more rigidity. For example, both jurisdictions require the trustee to include a licensed local trust company, which means that as a matter of practicality, a typical DAO committee member cannot act exclusively as a trustee, and the trust will be subject to government decisions on trust licenses . The same requirement does not apply in Guernsey (or Jersey).

DAO Status and Fiduciary Requirements

Preserving the DAO’s interests and limiting trust in anything other than code should be a primary consideration when evaluating the ideal jurisdiction and type of entity to serve as a DAO or subDAO committee. A purpose trust under Guernsey law allows the DAO to retain all the characteristics of a DAO and continue to minimise trust in any group or individual.

Benefits of DAOs

One of the main concerns of introducing a legal structure in a DAO is that compliance with corporate formalities designed for centralized and individual organizational structures may undermine the benefits of decentralization and autonomous operations. The benefits of not relying on government, the lack of any central point of failure, effective cooperation among participants, and active participation from the wider community are all too easily lost when complying with the obligation to keep pace with technological progress.

Purpose trusts under Guernsey law eliminate some of the problems that other proposed entity structures have historically faced. A key issue is the need for an executive body such as a state government to allow the existence of the entity. A purpose trust under Guernsey law does not require such approval; instead, a purpose trust exists the moment the assets are transferred to it and the trustee and executor sign the trust agreement.

Under Guernsey law, the only government involvement in a purpose trust is for the Guernsey courts to decide the matters applicable to it. This involvement is the same as the court’s potential impact on the DAO. As a matter of law, only a court can terminate the existence of a DAO, just as it can terminate the existence of a purpose trust.

trust minimization

The purpose trust under Guernsey law does not change the trust required for multi-signature token holders to transfer all tokens from the DAO to it, but significantly changes the legal rights to align with the intent of most DAOs.

Historically, DAOs have transferred or flowed funds to multi-signatures for distribution by key holders. In doing so, the DAO loses control over how the funds are used once the funds are moved across multiple platforms. It is unclear what rights DAO token holders retain to demand funds be returned to the DAO, or to force key holders to be removed from multisigs or have new holders join them. Instead, the DAO token holder can only trust the key holder to do the right thing with the funds transferred to the multi-signature controlled by the key holder.

When using a purpose trust under Guernsey law, DAO token holders retain more rights, enhancing multi-signature arrangements. At a high level, DAO token holders retain the legal right to instruct trustees to remove trustees, add trustees, remove executors, add executors, or terminate the purpose trust and transfer funds to DAO token holders Where it is decided (other than DAO or DAO token holders). A purpose trust structure with the above rights ensures that trustees and executors can always be held accountable. However, the trustee retains control over day-to-day decisions regarding the use of funds, including the transfer of all funds to specific uses consistent with the purpose of the purpose trust, and DAO token holders have no right to direct these transfers.

trustee

Current Risks for Multisig Key Holders

All key holders in multisig are exposed to some degree of regulatory and private litigation risk. In addition, the tax consequences associated with their activities are unclear, and multi-signature holders have limited ability to act effectively.

In terms of regulatory and private litigation risks, multisig keyholders have no limited liability protection, meaning that each of them may be personally liable for their own actions or possibly for the actions of other multisig keyholders. This liability can arise in a number of ways, the multi-signature key holder may become a trustee of the DAO token holder when the token is transferred to hold the multi-signature, or they may face lawsuits from the grants made, It depends on how the relationship with the grantee develops, including the decision to stop funding the grantee for any reason.

With regard to tax issues, the responsibility for distributing tokens from the multiple tokens the DAO receives funds is uncertain. A multisig key holder may be deemed to hold an interest in a pass-through entity, causing the multisig key holder to generate taxable income when transferring tokens to recipients or exchanging one token for another. Therefore, these transactions may impose tax liabilities on the multisig key holder. The validity of the multi-signature key holder is also limited. They cannot sign contracts or open bank accounts without putting themselves at extra risk. This limits the ability of multisig key holders to evolve the protocol in the most efficient way.

The above risks and limitations are the same in all DAOs, anytime someone participates in multisig in a way that usually happens in DAOs. However, purpose trusts offer an alternative solution to these risks and limitations.

Benefits of Multisig Key Holders

Purpose Trust addresses the risks and limitations of multi-signature key holders by:

  1. limit the liability of the trustee;
  2. ensure their tax compliance;
  3. Make them more effective in off-chain activities.

     

Limited Liability

As mentioned above, a purpose trust requires the trustee to take action to achieve one or more of the purposes of the purpose trust, and the trustee has limited liability for its actions as trustee. Under the trust agreement provided as an example of this framework, no trustee shall be liable for any loss to the purpose trust fund, whether due to the failure, devaluation or loss of any investment made or retained in good faith, or due to any error committed in good faith or negligence or otherwise, except for fraud, wilful misconduct or gross negligence of the fiduciary for whom it is claimed.

In addition, the trustee was compensated in this trust agreement. The trustee is entitled to receive compensation from the funds of the purpose trust to cover all obligations or liabilities of the trustee reasonably and properly assumed as a trustee in the performance of its functions in accordance with the terms of the trust agreement.

comply with tax obligations

A purpose trust minimises the tax risk of the trustee as they are clearly not the beneficiaries of the purpose trust. Furthermore, the purpose trust is not subject to tax liability under Guernsey law, and the transfer or exchange of tokens is not taxable under Guernsey law. Where the trustee is acting as trustee to transfer cryptocurrencies on an ongoing basis, the transfer or the exchange of the token to another person and the transfer can be made without the purpose trust having any tax liability in Guernsey. There are also no tax filing or reporting obligations under Guernsey law, which allows the trustee to continue to operate in the same manner as it did before the purpose trust existed, albeit under a fiduciary duty under the trust agreement.

Off-chain activity

If a trustee wishes to interact with the off-chain world, such as signing an off-chain agreement or opening a bank account to pay someone who does not accept tokens, the trustee will be able to do so as a trustee. A purpose trust is not a legal person, but acts in the name of a trustee who acts as a trustee. By acting as a trustee and informing any third party that they are acting as a trustee, the trustee can maintain the limited liability described above, but can operate more efficiently to achieve the purpose of the purpose trust. For example, a trustee may sign an agreement with a grantee to ensure that the grantee opens up all copyrighted works they create with grant funds and has an enforceable agreement on other terms of the grant to the grantee.

Executor

The executor has only the powers given to it in the trust agreement. These powers allow the executor to provide significant value to DAO token holders by ensuring that the trustee executes the purpose of the purpose trust.

Specifically, in the trust agreement provided as an example in this framework, the powers of the executor include obtaining disclosures about the trustee’s distributions and expenditures from the assets of the purpose trust, as well as any actions that may exist in connection with the trustee’s actions. conflict of interest.

The Executor shall not be liable for any loss of funds in the Purpose Trust unless due to the Executor’s fraud, willful misconduct or gross negligence. In addition, the executor is indemnified for all reasonable and appropriate costs and liabilities associated with the trust agreement.

Therefore, with great certainty in terms of limitation of liability and indemnity, the executor can ensure that the trustee will meet its obligations to achieve the purpose of the purpose trust.

Summarize

The DAO community should consider exploring the use of purpose trusts under Guernsey law to determine whether it is an appropriate vehicle for DAO and protocol growth. This framework only touches on one specific use case, but many more exist, such as:

  1. Encapsulate the entire DAO, and all DAO token holders are trustees;
  2. Hold the treasury of the DAO;
  3. hold all intellectual property rights (including copyrights and trademarks) and transfer repurchases of copyrighted code;
  4. To hold fees received from applicable agreements, to distribute directly to trusts for other purposes that perform functions for the DAO; or to serve as the financial and operational center of the DAO.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/dydx-details-how-to-build-a-legal-framework-of-trust-in-the-form-of-dao-applicable-outside-the-united-states/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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