Bad news, the Chinese blockchain DAO organization has been arrested for criminal involvement.

Chinese blockchain DAO organization arrested for criminal involvement.

Bad news for the Chinese blockchain industry: Multiple core members of a well-known DAO organization in China have been arrested in different locations simultaneously.

The police have initiated investigations against them for the issuance of tokens and member incentives within the DAO organization. This may be the first DAO organization in China suspected of criminal activities.

The Mann Law Firm has been entrusted to provide criminal legal services, striving to uncover the truth of the incident and promote compliant development in the industry.

DAO organizations are seen by practitioners in the blockchain industry as symbols of ideals such as freedom, borderless collaboration, and fair distribution. They have even become a trendy phenomenon within the circle. However, people often overlook the potential legal risks, especially those related to criminal offenses.

In this article, we will discuss the criminal risks faced by the initiators and core builders of DAO organizations, particularly in China.

• Why is it said that DeFi stablecoins are entering a golden age?
• Starknet blockchain gaming ecosystem is ready to go
• Some thoughts on the issue of the native tendency of chains

It should be noted that this article only represents the personal views of Lawyer Hong Lin and does not constitute legal advice on specific matters and cases.

01

What is 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 powers are distributed to community members in DAOs, rather than being controlled by a single central management team.

Decentralization is the core feature of DAOs. In traditional companies or organizations, decisions are usually made by a small group of people or management, such as the board of directors or CEO. However, in DAOs, power is dispersed among every member of the community, allowing everyone to participate in the decision-making and management process. There is no centralized control, and community members typically participate in DAO’s decision-making process 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.

02

How does DAO operate?

The goal of DAOs is to enable members to participate in the operation and decision-making of an organization in a fair and transparent manner, without relying on centralized institutions or authorities.

To achieve this goal, DAO organizations typically operate in the following ways:

1. Community Governance: The operation model of DAO organizations revolves around the community. Community members collectively manage and operate the DAO through voting and participation in decision-making. Every member has equal rights and can propose suggestions, vote on decisions, and participate in voting on important issues.

2. Smart Contracts: DAOs use smart contracts to execute community decisions. Smart contracts are pre-programmed automated rules that automatically execute when certain 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 publicly discussed and voted upon in the community. In general, most proposals require majority or a specific percentage of support to be passed.

4. Rewards and Incentives: DAOs incentivize 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 may have equal weights, where each member’s voting weight is the same, while others may assign different voting weights based on contribution level or token holdings.

6. Community Collaboration: DAOs encourage 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 asymmetric incentives. Therefore, DAOs must take appropriate security measures to protect the interests of the community.

03

How does a DAO solve the problem of money?

Revolution requires capital, and so does a DAO organization.

In order to sustain the operation of a DAO organization, it also needs funding. Typically, DAO organizations address the issue of operational funding through the following methods.

1. Token Issuance: DAOs can raise funds by issuing their own tokens. These tokens can be sold to supporters and investors through crowdfunding or presale in the initial stage to raise startup capital.

2. Member Contributions: DAOs encourage community members to participate and contribute their 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 have contributed to the project’s success. At the same time, token holdings may affect members’ voting weights in decision-making, serving 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 collectively managed and decided upon by the community for its use.

5. Smart Contract Automation: DAOs can set up smart contracts to automatically execute fund allocation under specific conditions. For example, when a proposal is approved through voting, the corresponding funds will be automatically transferred to the address 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 more funding support.

Overall, DAO organizations have various methods to address 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 and fair distribution of funds. This enables DAOs to operate and develop effectively without traditional centralized institutions.

For well-known DAO organizations in China, the necessary funds for development often come from external financing (a more high-end term would be donation). 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.

04

Criminal Risks of Chinese DAO Organizations

Currently, the architectural models of DAOs in the market can be broadly divided into the following two types:

One is to establish DAOs as traditional legal entities, such as limited liability companies, foundations, and other legal entities; the other is not established as a legal entity and is not considered to have independent legal personality. If it involves related criminal offenses, the former may be held as a unit offender, while the latter would have to be traced to individuals within the organization.

Based on the common operating models of DAO organizations at present, the potential criminal legal risks for the development of DAO organizations in China mainly lie in the following two aspects:

Firstly, in 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 carry certain criminal risks. DAO tokens often serve multiple purposes, including fundraising, voting rights to vote on how resources are allocated within the DAO, and receiving dividends based on project earnings. According to notices such as the “Notice on Preventing Risks of Disguised ICO Activities” and the “Notice on Preventing Risks of ICO Activities,” issuing DAO tokens to raise funds in China, whether in Renminbi or virtual currency, is highly likely to be considered 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 referral model to expand their influence, rewarding referrals based on different levels. Such behavior may be suspected of being a pyramid scheme. According to the “Opinions on Handling Criminal Cases of Organizing and Leading Pyramid Selling Activities” stipulated by the Chinese government, “Pyramid selling organizations that use sales activities, service provision, and other business activities as a pretext, require participants to pay fees or purchase goods, services, etc. to obtain membership qualifications, form a hierarchical structure in a certain order, directly or indirectly use the number of recruits as the basis for remuneration or rebates, lure or coerce participants to continue to develop others, deceive property, and disrupt the economic and social order. If the number of participants engaging in pyramid selling activities within the organization exceeds thirty and the hierarchy reaches three levels or more, the organizers and leaders shall be held criminally liable.” For certain DAOs, distributing tokens through airdrops or as rewards for recruiting new members, if the recruitment level reaches three levels or more and the number of people exceeds thirty, it may be suspected of organizing and leading pyramid selling activities.

05

Lawyer’s Suggestions

The development of anything is a process of spiral ascension. The future may be bright, but the path is bound to be tortuous.

For volunteers participating in DAO organizations, as an emerging type of organization, it is necessary to conduct thorough investigation and understanding before participation to avoid bringing harm to oneself and getting involved in criminal liability risks.

For initiators and key 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 key participants should always maintain compliance awareness. Understand and comply with relevant financial policies and legal regulations in China to ensure that fundraising and member recruitment activities are legal and compliant. At the same time, maintain transparency by promptly disclosing project information, fundraising purposes, and member rights, etc., 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 the 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, it is advisable to establish 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 key participants of DAO organizations can minimize criminal legal risks, ensuring the organization’s stable development and lawful operation.