It may not be “conventional” private client work, but the rapidly evolving nature of the digital economy has created exciting opportunities for Guernsey trustees and trusts professionals, with Guernsey purpose trusts establishing themselves as popular structures for decentralised autonomous organisations (“DAOs“) to bridge the gap between online and traditional economies.
This article discusses how purpose trusts are utilised by DAOs in Guernsey, the opportunities for trustees in Guernsey who are willing to deal with digital assets and innovative business structures, and the issues that trustees need to consider in respect of dealing with digital assets.
What is a DAO?
The key difference between DAOs and traditional corporate structures is that DAOs have no single central governing body or individual, instead the management and decision making is distributed across the DAO community. Membership to a DAO is obtained through the acquisition of tokens. Members are then able to vote in respect of the DAOs governance and initiatives. Any decisions in respect of the DAO are indelibly recorded on a public block chain.
By their very nature – with decisions indelibly recorded on the public blockchain – DAOs allow like-minded people from all over the world with aligned incentives to come together and make decisions regarding a DAO’s initiatives.
What are DAOs used for?
DAOs are increasingly being used for a variety of purposes such as the collection of valuable assets, licencing of intellectual property rights, philanthropy and funding litigation.
However, as DAOs exist in digital form they do not have a legal personality and therefore cannot themselves enter into the legal actions required to pursue projects. It is therefore necessary for DAOs to utilise executory vehicles.
Despite the fact that several other jurisdictions have incorporated DAOs into their legal systems (for example Cayman and Swiss foundation companies are often used as legal “wrappers” for DAOs) the use of Guernsey purpose trusts remains a popular choice by DAOs in the furtherance of their objectives.
Purpose Trusts as a solution
Unlike some jurisdictions, Guernsey law (by virtue of the Trusts (Guernsey) Law, 2007 (the “Law”)) allows for trusts to be created for non-charitable purposes. Like traditional trusts, there must be certainty as to the settlor’s intention to establish the purpose trust and the property that is being held by the purpose trust must also be certain. However, instead of having beneficiaries as its objects, the assets of the purpose trust are vested in the trustees for specific purposes (although Guernsey also allows for the creation of hybrid purpose trusts where trust assets are held for both beneficiaries as well as for the furtherance of particular purposes).
Although Guernsey law has a very broad definition of “purpose”, the purposes of the trust must be clearly drafted so that at all times it is possible to state with certainty whether a proposed use of the trust fund is within the scope of the trust’s purposes. The purposes must be legally valid and cannot be contrary to public policy.
Purpose trusts will also have trustees who will hold the settled property on trust subject to the powers and duties set out in the trust instrument and the Law. However, one of the distinguishing features of a purpose trust is that an enforcer must be appointed. The role of the enforcer is to ensure that the trustees are properly exercising their powers and utilising the trust fund to fulfil the specific purposes of the trust.
How do DAOs use purpose trusts in practice?
Because DAO communities are generally comprised of thousands of individuals around the world who have free rein to join and leave the community, regulatory problems arise when it comes to DAO communities acting as settlors of a trust. It is therefore more usual for the DAO’s founders to act as the settlor and create a trust with the aim of furthering the purposes of the DAO community. More recently, DAOs have been using Cayman and Swiss foundation companies as legal “wrappers” and so there will be instances where a Cayman or Swiss foundation may act as the settlor of the trust.
The DAO community will typically “elect” members of the community to act as trustees. The benefits afforded by Guernsey trust laws is that there are no requirements that the trustees should be based in Guernsey.
Using purpose trusts to further the growth of DAO communities
DAOs will often use purpose trusts as a means of encouraging the development of their online ecosystems by setting aside assets in the purpose trust as a means to provide funding and financial resources for projects which will promote growth. Applicants submit grant proposals to the community, who vote on each proposal and decide the funds that are to be allocated to the successful applicants. The terms of the trust instrument will set out how the trustees may exercise their powers and discretion to provide funding to certain initiatives which have been approved by a majority vote of the DAO members.
Using purpose trusts to protect the intellectual property of a DAO
Purpose trusts may also be used as a depository to hold and protect the intellectual property of a DAO. The DAO founders assign the intellectual property to the trustees of the purpose trust who then hold the assets for the benefit of the wider community.
Using purpose trusts protect against risk in respect of a DAO
Purpose trusts are used by DAO communities to provide funding for legal costs and expenses for potential existential threats in relation to the DAO, its digital assets or its community.
In such instances, risk purpose trusts may be utilised. Risk purpose trusts have evolved from traditional purpose trusts and operate by allowing entities to ring fence assets, which may then be used to provide funding for potential business risks such as litigation. The benefit of risk purpose trusts are that they are considered less rigid than traditional insurance based products and they are not subject to insurance regulations.
Trustee considerations
There are some key practical points for trustees involved in the administration of purpose trusts for DAOs to consider.
Fiduciary obligations
In all instances, Guernsey trustees must adhere to their fiduciary obligations and the requirement to observe the utmost good faith and act en bon père de famille. Trustees will therefore need to ensure that they familiarise themselves properly with their duties under the trust instrument and ensure that they are acting in the furtherance of the purposes.
Anti-Money laundering and counter- terrorism
Trustees are subject to stringent anti-money laundering and counter-terrorism obligations and must maintain reliable records of the source of wealth and source of funds in respect of the assets they hold. A benefit of digital assets is that all transactions in respect of them are recorded and are fully trackable. Nevertheles, trustees should obtain ongoing advice to ensure that they are acting in compliance with any applicable regulatory obligations.
Security
Digital assets are usually held in wallets which automatically create a pair of keys (codes) – the public key and the private key. The public key is recorded on the blockchain and can be used by anyone to send digital assets into the wallet, the private key allows the wallet-holder to access and deal with the digital assets. Trustees need be alert to threats of cyber-attacks and hacking and must ensure that wallets are held securely. In order to do so, trustees may wish to use a digital assets custodian to safeguard the assets. Trustees should also ensure that there are robust provisions in the trust instrument to cover their liability in respect of any losses causes by hacking or theft of the wallet.
Volatility
The volatile nature of digital assets may make the trustees more vulnerable to claims of breaches of trust by beneficiaries/enforcers aggrieved by a loss of value in the assets held. This can be addressed during the initial stages of negotiating the terms of the trust instrument for instance by ensuring that the instrument clearly sets out what the trustee may or may not do in respect of the digital assets or by reserving investment decisions and powers to the settlor. If the trust instrument allows for the delegation of investment powers, the trustee will be able to delegate these decisions to a suitably qualified investment adviser and in doing so obtain an indemnity from the beneficiary/enforcer in respect of any losses caused to the trust fund as a result of any decisions made by the investment adviser.
Conclusion
In spite of the fact that several jurisdictions have incorporated DAOs into their legal systems, Guernsey purpose trusts are still used in a number of ways by DAOs to help further their initiatives strengthening Guernsey’s position as a global leader in the realm of digital assets.
This article was first published in the STEP Journal, Vol 3, Issue 2023
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