What are they and how are they regulated in Germany

This article is first on the Fin Law Blog published.

Decentralized Autonomous Organizations (“DAOs”) are defined, among other things, as permanent organizations that consist of program code that is executed and stored in a decentralized manner. You are allocated your own capital in the form of crypto assets, which is managed directly by the investors in accordance with the automated and specified rules of the program code. These definitions are only of limited help to the average user or interested investor. In particular, they do not provide any statements on how DAOs or shares in them are to be classified legally.

However, it is precisely these questions that are naturally of crucial importance both for initiators of DAOs and for participants in a DAO. Basically, the first question that arises here is whether DAOs can qualify as companies under German corporate law. It is not possible to make a generally valid statement as to whether a DAO is a company. If, based on the specific structure of the DAO, one can assume that the DAO is based on a contractual basis, then a DAO could, for example, qualify as a civil-law partnership or as a general partnership. If the DAO were to be a corporate structure in the individual case, then the question then arises as to the regulatory qualification of such DAO shares.

Classification as a security through tokenization

If the DAO were a company, shares in a DAO that grant their owners a share in the results of the DAO can regularly be classified as an investment within the meaning of the Asset Investment Act (“VermAnlG”). If these were tokenized, which is likely to be the norm, BaFin would, according to its administrative practice, classify the tokens in question as a security of its own kind, with the consequence that the regulations of the Securities Prospectus Act (“WpPG”) would apply to the tokens.

This would be the case if the transferability and tradability of the tokens on the financial market and the mediation of securities-like rights through the tokens were achieved through tokenization. Even in the event that the tokens do not convey any participation in the results of the DAO and are therefore not legally an investment, the tokens can still be qualified as a security of their own kind, provided that the aforementioned properties of transferability, tradability and rights conveyance are given are. An example would be that a token does not grant any participation in the results of the DAO in question, but conveys membership rights to the DAO, e.g. in the form of voting rights. Before such tokens are offered to the public, a prospectus or securities information sheet would have to be prepared and published.

Applicability of the MiCA to shares in DAOs

In principle, the EU Regulation on Markets in Crypto Assets (“MiCAR”) will not apply to the shares in DAOs described above. This is because the shares described are transferable securities and thus financial instruments within the meaning of the Markets in Financial Instruments Directive II (“MiFID II”). But the MiCA will not be applicable to such. Should this not be the case for a specific DAO, i.e. in particular in cases in which the shares in the DAO do not qualify as transferable securities in the aforementioned sense and therefore also not as financial instruments, the provisions of the MiCA on the shares would be good applicable. Here, as is generally the case in this very complex subject area, a precise review will have to be carried out on a case-by-case basis in order to minimize liability risks and achieve a legally compliant structure.