The ultimate legal structuring guide for Web3 founders of DApps (DeFi, GameFi, SocialFi, and others)
Most DApps need a legal structure to bridge the gap between the “on-chain world” and the “off-chain world.” In this guide, Nestor Dubnevych, co-founder & COO of Legal Nodes, explores the most common legal models to achieve that.
More articles about Web3 legal issues you can read in Legal Nodes blog.
What are Decentralized Apps (DeFi, GameFi, SocialFi and other FI+ projects)?
Today, the number of Web3 projects running as DApps (Decentralized Applications) is multiplying. These include:
- DeFi (staking, yielding, crypto lending applications);
- GameFi (play-to-earn games); and
- SocialFi (move-to-earn, social platforms for creators, such as NFT platforms, etc.).
Many analysts predict that these applications will become an indispensable element of the metaverse, to which the world is moving towards everyday.
Most DApps are a set of smart contracts developed by a group of enthusiasts. Each DApp smart contract is responsible for the autonomous operation of a specific part of the DApp, including:
- various transaction algorithms (token issuance, token mining/minting, token swap);
- the formation and storage of Treasury, reserve funds and liquidity pools, which are automatically filled with virtual assets following the rules programmed in smart contracts;
- the participation of key contributors and stakeholders of the DApp ecosystem (validators, oracles, supervisors, guardians) in a DAO (DAO members can vote with private keys to change the rules of operation of specific smart contracts and manage the Treasury).
The legal status of DApps
These smart contracts are usually uploaded (deployed) once to the blockchain network (e.g., Ethereum, NEAR, Solana, etc.) and operate entirely autonomously. These decentralized applications (smart contracts) do not require administrators, servers, domain providers, etc. They “live” in a blockchain network and operate autonomously, without the need for human intervention and centralized services for their storage and operation. That’s why DApps are also called “on-chain entities”.
Since DApps do not have owners, administrators or other final beneficiaries and are entirely autonomous applications, they require a particular approach to their legal structuring to create an effective Legal Wrapper for them to operate in real-world business.
Why do DApps need Legal Wrappers?
When Web3 founders begin working on their DApps, many don’t see the need to create any legal structures for their DApps–these applications are decentralized after all, so what legal structuring could they need? Well, most Web3 founders will need their fully decentralized Web3 projects to interact with the outside world, and this is where a proper Legal Wrapper is essential.
“Real-world” or “off-chain world” interactions could include:
- creation of centralized interfaces for DApps (even though smart contracts make DApps “live” autonomously in the blockchain network, for users to interact with them, these DApps need user-friendly interfaces; usually in the form of websites, mobile applications with their subsequent listing in application stores, browser plug-ins, etc.);
- connection of payment gateways for the conversion of virtual assets, which can be obtained (mined, minted, swapped, staked) in the process of using DApps, into fiat currencies or other virtual assets;
- fundraising with the use of tokens (when attracting investments in a Web3 project involves not only the allocation of shares but also the allocation of tokens, and investors ask which company will sign SAFT or other investment agreement on the part of a Web3 project); and
- distribution of tokens by listing them on crypto exchanges or launchpads (exchanges ask a Web3 company to undergo KYC for token listing) and using tokens in Token Incentive Schemes for team members and advisors.
In all of the mentioned cases, founders will need to build “legal bridges” between an entirely virtual autonomous DApp and centralized market players such as application stores, payment systems, centralized exchanges, venture funds and others.
The legal structure of a Legal Wrapper for DApps
As mentioned above, DApps do not have centralized administrators or beneficiaries. Thus, all DApps are ownerless (ownership-free) and permissionless (moderators-free) applications. This fact, in turn, creates the need to build an ownerless (ownership-free) legal structure for DApps.
Building these “legal bridges” for a DApp to interact with the outside world usually implies registering a group of companies around a DApp that will function as a “legal wrapper”. Each of these companies has its own purpose and “area of responsibility” to ensure the interaction of a DApp with the outside world. Here’s a common example of a structure for these companies:
Development Laboratory Company
Generally speaking, there are three types of companies required to build a Legal Wrapper for DApps:
- a Dev Lab Company;
- a Token & Product Distribution Company; and
- a DAO Company.
Each of these companies acts as a service provider for a DApp, creating the legal conditions for a DApp to interact with the outside (off-chain) world.
For Web3 founders to start developing a Web3 project, they need to hire a team of software engineers who will develop smart contracts for a DApp, create the interfaces and provide the technical support. Founders will need to set up the salary payments for developers. For this purpose, the Development Laboratory (Dev Lab) Company is usually registered, which, in addition, also performs other operational tasks like renting an office, paying for software subscriptions, accumulating IP rights, etc.
Product & Token Distribution Company
When Web3 founders open a new round of investments and offer Web3 funds not only company shares but also tokens–they will need to create a Token Distribution Company. This is because the Web3 funds will want to know which company will be specified in the investment documents.
This Product & Token Distribution company is also responsible for listing tokens on exchanges and launchpads. Most token listing platforms require a Token Legal Opinion, which, in most cases, cannot be prepared without a registered legal entity (such a legal entity is usually responsible for token distribution through the exchange).
DAO Legal Wrapper as a part of the legal framework for DApps
Suppose founders of the Web3 project decide to create a DAO around their DApps. In this case, they will probably want to provide DAO members (usually key contributors to the DApps ecosystem) with the right to participate in decentralized governance and Treasury management. DAO members exercise this right with the help of private keys following the algorithms of the DApp smart contracts.
Creating a DAO company addresses two main legal needs:
- It helps to create a Legal Wrapper for DAO members, which aims to limit (protect) DAO members from judicial, tax, financial and other liability for the activities of such DAO. Otherwise, DAO may be recognized as a general partnership, which will result in the unlimited liability of each DAO member for the activities of the DAO.
- It ensures compliance with the procedures in cases of Treasury management, for example, ensuring AML & KYC procedures for the issuance of grants from DAO Treasury, etc.
DApps need legal structures
A well-established legal structure for DApps will allow Web3 founders to solve the following key tasks:
- Create “legal bridges” for the interaction of virtual autonomous (on-chain) DApps with participants in the outside (off-chain) world such as crypto exchanges, payment systems, application stores, etc.;
- Distribute the responsibility for different components of a DApp between separate legal entities. To date, DApps regulation is at a very early stage, so to reduce the risks associated with regulatory uncertainty, responsibility for different DApp activities is shared between separate companies;
- Protect (limit) members of the DApps ecosystem (developers, contributors, DAO members, etc.) from liability, similar to how traditional shareholding companies limit the liability of their shareholders and directors; and
- Save the concept of the ownerless / permissionless structure of a DApp.
If you’d like to learn more about the process of legal structuring of DApps, we’re planning to run a webinar on this topic soon. Click here to leave your email and we’ll send you a link to register for the webinar once the registration is open.
Written by Nestor Dubnevych, co-founder & COO of Legal Nodes