A bad news for the Chinese blockchain industry: Several key members of a well-known DAO organization have been arrested in multiple locations in China.
Their involvement in the issuance of tokens and member incentives within the DAO organization led to a police investigation, making this potentially the first criminal DAO organization in China.
The Manquin Law Firm has been entrusted to provide legal services in criminal law, striving to reveal the truth of the incident and promote compliance in the industry.
DAO organizations, as a special phenomenon in the blockchain industry, are often seen by practitioners as symbols of freedom, borderless collaboration, and fair distribution, and even become a fashion trend within the industry. However, people often overlook the potential legal risks associated with them, especially criminal risks.
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In this article, we will discuss the criminal risks faced by the initiators and core builders of DAO organizations, especially those in China.
Please note that this article only represents the personal views of Lawyer Honglin and does not constitute legal advice on specific matters and cases.
What is a DAO?
Inspired by decentralized cryptocurrencies, a group of developers proposed the concept of Decentralized Autonomous Organizations (DAO) in 2016.
DAO is an organizational form based on blockchain technology. Unlike traditional centralized organizations, decision-making and management power are decentralized to community members, rather than controlled by a single central management team.
Decentralization is the core feature of DAO. In traditional companies or organizations, decisions are usually made by a small group of individuals or management, such as boards of directors, CEOs, etc. However, in DAO, power is distributed among every member of the community, and everyone can participate in the decision-making and management process. There is no single centralized control, and community members typically participate in the decision-making process of DAO through voting or other governance mechanisms. Once the community reaches a consensus on a certain matter, blockchain technology can automatically implement the decision without the need for intermediaries.
How does DAO operate?
The goal of DAO is to allow members to participate in the operation and decision-making of the organization in a fair and transparent manner, without relying on centralized institutions or authorities.
In order to achieve this goal, DAO organizations typically operate in the following ways:
1. Community Governance: The operational model of DAO organizations revolves around the community. Community members collectively manage and operate the DAO through voting and participation in decision-making. Each member has equal rights to propose suggestions, vote on decisions, and participate in voting on important issues.
2. Smart Contracts: DAOs use smart contracts to enforce community decisions. Smart contracts are pre-programmed automated rules that execute when specific conditions are met. These contracts ensure transparency and credibility of decisions, eliminating the possibility of human manipulation.
3. Proposals and Voting: Community members can submit proposals, such as introducing new features, modifying rules, or supporting project development. Proposals are openly discussed in the community and voted upon. In general, most proposals require majority support or support exceeding a specific threshold to be approved.
4. Rewards and Incentives: DAO incentivizes community members’ participation and contributions through reward mechanisms. These rewards are typically distributed in the form of the DAO’s own tokens, rewarding members who contribute to the development of the DAO.
5. Voting Weight: Different DAOs may adopt different voting weight rules. Some DAOs adopt equal weight, where each member has the same voting weight, while others may assign different voting weights based on contribution level or token holdings.
6. Community Collaboration: DAO organizations encourage cooperation and collaboration among community members. Members can form working groups or committees to collectively advance specific projects or tasks in order to achieve consensus and goals.
7. Security and Risk Management: DAOs face security and risk challenges, such as attacks and asymmetrical incentives. Therefore, DAOs must take appropriate security measures to ensure the protection of community interests.
How does DAO address funding issues?
Revolution requires capital, and DAO organizations are no exception.
In order to sustain the operation of DAO organizations, they also require funding. Typically, DAO organizations solve their operational funding issues through the following methods.
1. Token Issuance: DAOs can obtain funds by issuing their own tokens. These tokens can be sold to supporters and investors through crowdfunding or pre-sales during the initial stage to raise startup capital.
2. Member Contributions: DAOs encourage community members to participate and contribute their own resources, such as time, skills, and knowledge. Some DAOs may incentivize member contributions through reward mechanisms, such as token payments or other forms of compensation.
3. Rewards and Voting Weight: Some DAOs allocate a portion of tokens as rewards to members who contribute to the project’s success. At the same time, the amount of tokens held may affect a member’s voting weight in decision-making, which serves as an incentive measure.
4. Governance Fund: DAOs can establish a governance fund to support project development and community operations. This fund may come from token sales or project profits and is jointly managed and decided upon by the community for its use.
5. Smart Contract Automation: DAOs can set up smart contracts to automatically execute fund allocations under specific conditions. For example, when a proposal is approved through voting, the corresponding funds will be automatically transferred to the address responsible for executing the proposal.
6. Governance Parameters: DAOs can set certain governance parameters, such as fee structures and minimum voting requirements for proposals, to ensure the proper use of funds and protection of community interests.
7. External Financing: Some DAOs may seek external financing, such as partnering with investors or venture capital firms, to obtain additional funding support.
Overall, DAO organizations have various methods to solve operational funding issues, but the core idea is to rely on community support and contributions, as well as the automation mechanism of smart contracts, to ensure transparent use of funds and fair distribution. This allows DAOs to operate and develop effectively without traditional centralized institutions.
For well-known DAO organizations in China, the funds needed for development often come from external financing (or donations, to put it more high-end). For example, by issuing tokens to raise funds and fill the treasury of the DAO organization, as a contribution return to DAO investors, token holders are granted certain voting rights, usually proportional to their token holdings.
Criminal Risks for Chinese DAO Organizations
Currently, the architectural models of DAOs in the market can be roughly divided into the following two types:
One type is to establish the DAO as a traditional legal entity, such as a limited liability company or foundation; the other type is not established as a legal entity and is not considered to have independent legal personality. If it involves related criminal activities, the former may be charged as a corporate entity, while the latter needs to penetrate into individuals within the organization.
Based on the common operational models of DAO organizations at present, the potential criminal legal risks for the development of DAO organizations in China mainly lie in these two aspects:
Firstly, during the fundraising process, their fundraising activities may constitute crimes such as illegal issuance of securities, illegal fundraising, financial fraud, and pyramid schemes. Regardless of whether the fundraising is in the form of issuing community points or NFTs representing community membership, these methods all have certain criminal risks. DAO tokens often have various functions, including fundraising, voting rights to vote on how DAO allocates resources, and receiving dividends based on project profits. According to Announcement No. 94, “Risk Warning on Preventing ICO Activities in Disguise,” Announcement No. 924, etc., issuing DAO tokens to raise funds in China, whether in RMB or virtual currency, is highly likely to be an illegal ICO, thereby constituting crimes such as fundraising fraud, fraud, and pyramid schemes.
Secondly, based on the decentralized nature of DAO organizations, they have numerous members scattered around the world. Some DAO organizations adopt a model of recruiting members to expand their influence, rewarding members at different levels, which may involve pyramid schemes. According to the “Opinions on Several Issues Concerning the Application of Laws in Handling Criminal Cases of Organizational Leadership in Pyramid Selling Activities,” “Pyramid selling organizations that deceive and coerce participants into continuing to develop others to participate, deceive property, and disrupt the economic and social order under the name of promoting the sale of goods, providing services, and other business activities, and whose internal participants engaging in pyramid selling activities number more than thirty and have a hierarchy of more than three levels, shall investigate the criminal responsibility of the organizers and leaders.” For some DAOs, if airdrops or the tokens they issue are used as rewards for recruiting new members, when the number of recruits reaches more than thirty people and the hierarchy reaches more than three levels, it may constitute the crime of organizing and leading pyramid selling activities.
Advice from Lawyer Man Kuhn
The development of anything is a spiral upward process, the future may be bright, but the path is bound to be tortuous.
For volunteers participating in DAO organizations, as an emerging organization, it is necessary to conduct thorough investigations and understanding before participating to avoid bringing harm to oneself by generating love and instead falling into criminal liability risks.
For initiators and core decision makers of DAO organizations, it is particularly important to avoid criminal legal risks, with the following three points being crucial:
1. Compliance awareness and transparency: In the process of creating and operating DAO organizations, initiators and core participants should always maintain compliance awareness. Understand and comply with relevant financial policies and legal regulations in China to ensure that fundraising and recruitment activities are legal and compliant. At the same time, maintain transparency by promptly disclosing project information, fundraising purposes, and member rights and interests, in order to reduce risks.
2. Risk assessment and monitoring: Comprehensive risk assessment is necessary before initiating and operating DAO organizations. The assessment should include potential criminal legal risks and compliance challenges. At the same time, closely monitor regulations and policy changes issued by relevant regulatory agencies of the Chinese government, and adjust operational strategies in a timely manner to ensure compliance at all times.
3. Legal consultation and community norms: To reduce criminal legal risks, it is recommended to collaborate with a professional legal team for consultation on relevant legal issues. Especially when fundraising and recruiting members, customize clear community rules to regulate the rights and obligations of participants, and avoid community disputes and illegal activities.
Through compliance awareness, risk assessment and monitoring, as well as professional legal consultation and community norms, initiators and core participants of DAO organizations can minimize criminal legal risks, ensuring the stable development and legal operation of the organization.