A DAO is a decentralized autonomous organization that drives a business or project forward using smart contracts without a specific owner or manager. Overseas clients sometimes ask our firm whether they can sell DAO tokens in Japan.
| (1) You need to consider Japanese regulations when you sell DAO tokens to Japanese residents, even if you reside outside Japan. (2) Regulations on DAO tokens differ depending on whether they are investment DAO tokens or community DAO tokens. (3) Investment DAO tokens are generally considered “security.” Their sale is usually regulated by the Financial Instrument and Exchange Act (FIEA). The seller must obtain FIEA registration or delegate the sale’s activities to a licensed FIEA company. Some exemptions exist, but they are not easy to use. (4) Sales of community DAO tokens are either (i) unregulated, (ii) regulated by the Crypto Asset Exchange Business Law, or (iii) regulated by the FIEA, depending on the nature of the tokens. |
Below is a chart you need to consider before selling DAO tokens to Japanese residents.
<Chart to be considered>
Community DAOs often issue governance tokens.
To consider the financial regulation of sales of DAO tokens in Japan, we must look at (a) whether the DAO provides some kind of dividend or more than 100% redemption of the principal (“Dividend, Etc.”), (b) whether the DAO has any legal entity nature that is similar to a joint stock company or LLC and whether the tokens represent nature similar to shareholders rights, and (c) whether DAO tokens can be used as a payment method.
Tokens in most community DAO do not have any dividend feature or profit distribution feature for token holders. If there are such features, the regulation on investment DAO tokens will be applied. Please see item 4 below.
If a DAO is structured in the form of a company, which happens rarely, and the DAO token awards member rights of the company to token holders, the right might be deemed as securities. Type 1 Financial Instruments Business Registration is required for the sale of those tokens.
In general, many DAOs are formed without clarification of the legal form. Some DAOs just use a smart contract and do not have any form of legal entity. Under Japanese law, such DAOs may be classified as partnerships or “associations without a juridical person.” The rights of partnerships and associations without juridical persons do not fall under securities unless there are Dividend, Etc.
The sale of DAO tokens without Dividend, Etc. and so on issued by an organization other than a company should be classified as a crypto asset or NFT.
If the tokens fall under the definition of crypto asset, their sale shall be made by a licensed crypto asset exchange business operator.
However, if the DAO token is considered an NFT, there are no restrictions on its sale.
In 2023, the Financial Services Agency (FSA) issued guidelines stating the distinction between a crypto asset (FT) and an NFT: (https://www.fsa.go.jp/news/r4/sonota/20221216-2/20221216-2.html).
The guideline states that if the asset does not have “means of payment” characteristics, it is not a crypto asset and that having “means of payment” characteristics can be determined by the following criteria: In general, if (a) DAO tokens cannot be used as a payment method, and (b-1) the price of the token is more than JPY 1,000 or (b-2) the issued number of tokens is less than 1M, the tokens are considered NFTs, and their sale is not regulated.
| FSA’s revised guidelines a) The issuer must make it clear that the tokens are not intended to be used to pay for goods or services to an unspecified person. For, example the terms and conditions provided by the issuer or business operator handling the product clearly prohibit the use of the product as a payment method, or the system is designed to prevent the use of the product as a payment method. b) Taking into consideration the price and quantity of the relevant property value, technical characteristics and specifications, and other factors as a whole, the tokens that can be used to reimburse an unspecified person for the price of the goods and so on must be limited. For example, the tokens must have one of the following characteristics: ・The price per minimum transaction unit must be high enough not to be used as an ordinary means of settlement (JPY 1,000 or more). ・The issued number of tokens divided by the minimum trading unit (issued volume considered after divisibility) must be limited (1 million or less). |
Under the FIEA, DAO tokens that pay Dividend, Etc. generally fall under the category of “electronically recorded transfer rights.” Thus, in order to sell electronically recorded transfer rights, you must either register as a Type 1 Financial Instruments Exchange Business Operator (Type 1 FIEBO) and conduct the sales yourself or have a Type 1 FIEBO do it for you. Furthermore, when soliciting 50 or more persons and issuing 100 million yen or more, the solicitation of the tokens becomes a public offering (Article 2, Paragraph 3 of the FIEA), which requires the submission of complex offering documents and continuous disclosure.
As an exception, if sales are made only to qualified institutional investors (QIIs, professional investors) or wealthy individuals (with financial assets of JPY 100 million or more) who are 49 or younger, and if technical restrictions are in place to prevent other individuals from becoming DAO token holders through resale, then the sale falls under the exception category called “special business for qualified institutions, etc.,” and self-offering only requires a simple notification under Article 63 of FIEA.
We have heard that many investment DAOs in the US are issued to QIIs, and many investment DAOs limit their sales to avoid US security regulations. The problem in Japan is that the definition of “professional investors” is much narrower than in the US. In Japan, one criterion for becoming QII is that corporations and individuals must have at least JPY 1 billion in securities. In the US, a person who has more than USD200,000 annual income can become a QII, and in the EU, a person who has more than EUR500,000 in financial assets (in addition to satisfying other requirements) can be a QII. These requirements are much easier to satisfy than the requirements in Japan.
Japan also has a narrower exception to submit offering documents. In Japan, offering documents are required for offerings exceeding JPY 100 million. In contrast, exemptions apply for offerings less than USD6 million in the US (sales by Reg A Tier 1) and less than EUR5 million in some countries in the EU.
In light of the above, the issuance of investment DAOs is not popular in Japan but is still possible if you obey Japanese regulations.
EOD
Introduction
Clients often ask us whether it is possible to structure a Decentralized Autonomous Organization (DAO) in Japan. Currently, Japan does not have regulations targeting DAOs, unlike Wyoming State or the Marshall Islands. So, we have written this article summarizing what is typically considered when forming a DAO in Japan.
1.1 What is DAO?
A decentralized autonomous organization (DAO) is a new legal structure with no central authority and members committed to acting in the organization’s best interests. DAOs are used to make decisions in a bottoms-up management style and have gained popularity among cryptocurrency enthusiasts and blockchain technology.
1.2 Classification of DAOs
There are several classifications of DAO described below:
| 1. Investment DAO Investment DAOs are for-profit DAOs aim at co-investing in a project. They are more likely to attract funds than Grant DAOs because they aim to generate profits mainly through “economic capital.” Examples: Genesis DAO, The LAO, BitDAO, etc. 2. Grant DAO The community contributes monies to the grant pool and votes on funds allocation and distribution decisions in a Grant DAO. Innovative DeFi projects are funded using these DAOs, showing how decentralized communities are more flexible with funding than traditional organizations. Examples: MolochDAO, MetaCarteDAO, Aave Protocol, Uniswap Grants, etc. 3. Protocol DAO When tokens serve as a voting metric for implementing any changes in the protocol, such a governance structure represents protocol DAOs. For instance, MakerDAO has revolutionized the DeFi space with its DAI stablecoin. Examples: Maker, Compound, Uniswap, Aave, Yearn, Sushi, etc. 4. Service DAO A Service DAO is a decentralized working group. They can receive tokens as compensation for their projects. Examples: RAID GUILD, DXdao, PartyDAO, etc… 5. Social DAO A Social DAO offers digital democracy where opinions are heard, and people can share common interests. Example: Bored Apes (BAYC) 6. Collector DAO Artists who use nonfungible tokens (NFTs) to create art rely upon collector DAOs to establish ownership of their art. Example: PleasrDAO 7. Media DAO Media DAOs allow product owners of content (i.e., readers) to contribute directly without involving advertisers for the native token as a reward in return for their contributions. Example: Fore Front (FF), Bankless DAO, etc… Source https://cointelegraph.com/daos-for-beginners/types-of-daos |
1.3. Example of an Existing Overseas Law
A few places where DAOs are regulated are Wyoming State and the Marshall Islands. Below is a short description of forming a DAO in the Marshall Islands.
The Legal Form of a DAO on the Marshall IslandsMarshall Islands proposes a non-profit corporation (limited liability company) as a legal entity form for DAO, which stands out from the general practice to establish DAO as a foundation. Such a company is established in compliance with the general corporate law of the Marshall Islands with specific features that:
How does this work?Generally speaking, such a company works as a limited liability company managed by its members. It has three essential constitutional documents: Certificate of Incorporation, Operating Agreement, and Charter of the Company.The Operating Agreement should include the most crucial matters of your DAO management:
You can amend any of these matters by the members’ decision in compliance with the procedure prescribed in the previous version of the Operating Agreement. Registering a Marshall Islands LLC for DAOHere’s what the process of establishing a legal wrapper for DAO on the Marshall Islands looks like:
The above is a reference from Taras Zharan Web 3 Virtual Legal Officer. https://legalnodes.com/article/marshall-islands-llc-as-a-dao-legal-wrapper |
2.1. Points to Consider
When structuring a DAO, one must consider the financial regulations and the legal form characteristics.
Here are several points to keep in mind:
1. Security regulation under the Financial Instrument and Exchange Act (“FIEA”) may apply when tokens have the possibility of dividends or redemption of the principal of more than 100% (dividends and redemption of the principal of more than 100% are from now on collectively referred to as “dividends, etc.”). As a general rule, token sales of such DAO must be conducted by a Type 1 Financial Instrument and Exchange Business Operator (“Type I license”) or by obtaining a Type 2 Financial Instrument Exchange Business Operator license (“Type II license”).
2. When selling Fungible Tokens without dividends, etc., it is necessary to have a Crypto Asset Exchange Operator conduct the sale or to obtain a Crypto Asset Exchange Operator license.
In contrast, these financial regulations generally do not apply when selling NFTs without dividends, etc.
3. You also need to consider the tax benefits. If you want to pursue tax advantages in an Investment DAO with dividends, etc., you can use a partnership or GK-TK scheme. If tax advantages are not particularly important, an association without rights, a general incorporated association, or a limited liability company can be considered a scheme to issue tokens. For the issuance of Fungible tokens or NFTs without dividends, etc., it may be better to have no particular legal structure.
2.2. Reference Table of Conclusions
The table below summarizes the legal scheme and financial regulations that should be considered in establishing a DAO.
The following regulations apply to token sales of Investment DAOs with dividends, etc. (assuming dividends or principal redemption of more than 100%).
| Type of Member’s Rights | Form under Japanese Law | Free distribution of Tokens | Token Sale | Investment Management |
| DAO member’s rights as shareholders’ rights in Limited Liability Companies and Joint-stock Companies | Tokenization of shareholders’ rights of limited liability companies, etc. | Free distribution of the shareholders’ rights is not allowed under corporate law, etc. |
Sales by a third party for an issuer need a Type I license. A Type II license is necessary for the self-offering of a limited liability company. No license is required in the case of self-offering of a joint-stock company. In the case of solicitation of 50 or more people, there needs to be a submission of a registration statement regarding securities, etc. |
No regulation |
| DAO member’s rights (with dividends), not including shareholders’ rights | TK investment, partnership investment, tokenization of rights that are difficult to classify into prescribed legal forms, etc. | Unregulated |
Sales by a third party for an issuer need a Type I license. Self-offering needs a Type II license. In the case of solicitation of 50 or more people, there needs to be a submission of a registration statement regarding securities, etc. |
No regulation (Possibility of Investment Management Business license in the case of securities investment) |
On the other hand, a DAO without dividends, etc., is also possible. Its regulations are as follows:
| Tokens/NFT | Free Token Distribution | Sale of Tokens | Investment Management(Assuming no dividend) |
| Utility Tokens | No regulation | Crypto Asset Exchange Business regulation | No regulation |
| NFT | No regulation | No regulation | No regulation |
With respect to possible legal forms for DAOs, the following comparisons can be made:
| Status | Legal Form | Limited Liability | Is it possible to distribute? | Avoid Double Taxation | Others, Comprehensive Evaluation |
| No Legal Entity Status | Association without rights +Tokens with unclear rights | 〇? | 〇 | × |
△~〇 High degree of freedom. A good scheme if there is no problem with double taxation. |
| Civil Law Partnership + Partnership Equity Token | × | 〇 | 〇 |
△~〇 High degree of freedom. A good scheme if there is no problem with limited liability. |
|
| Investment Business Limited Liability Partnership + partnership Equity Token | 〇 | 〇 | 〇 |
× Although other points are reasonable, there are restrictions on investment destinations and businesses, such as not being able to purchase NFTs. It’s usually hard to use this scheme as DAO. |
|
| Limited Liability Partnership + Partnership Equity Token | 〇 | 〇 | 〇 |
× There are valid points; however, to use as a DAO is problematic because of the need to register the name of the union member. |
|
| DAO has Legal Entity Status |
Corporation (*1) + Tokenization of Anonymous Partnership (e.g., TK-GK scheme) |
〇 | 〇 | 〇 | △ It is necessary to operate in accordance with the Companies Act and the General Incorporated Associations Act. It should be noted that TK holders do not have the right to instruction. The good point is that there is no double taxation and limited liability. |
|
Corporation (*1) + Token with unknown rights |
〇? | 〇 | × | △ ~ 〇 It is necessary to operate under the Companies Act and the General Incorporated Associations Act. Besides that, it has a high degree of freedom and is a good scheme if you don’t mind the double taxation problem. | |
|
Corporations (*1) + Tokenization of shareholders rights (*2) |
〇 | 〇(× For general incorporated associations) | × |
× Is there a low degree of freedom due to the need to operate per the Companies Act and the General Incorporated Associations Act? For example, it is necessary to manage members as shareholders. |
*1 Legal entities include limited liability companies, stock companies, and general incorporated associations. LLCs are generally easier to establish and operate than joint-stock companies. If you want to have a more public image, use a general incorporated association.
*2 Membership rights of a limited liability company, stocks of a stock company, membership rights of a general incorporated association.
2.3 Tokenization of Rights
Tokenization of rights of funds or partnership, where there is an investment of funds (including money and crypto assets), investment management, dividends, or redemption of the principal of more than 100%, would be broadly considered a collective investment scheme (fund) under Japanese law. Below is the summary of the Definition of a Collective Investment Scheme.
| Summary of Definition of Collective Investment Scheme |
| Rights that satisfy the following (i) to (iv) |
| (i) Rights under a partnership agreement as defined in Article 667(1) of the Civil Code, a silent partnership agreement as defined in Article 535 of the Commercial Code, an investment limited partnership agreement as defined in Article 3(1) of the Act on Limited Liability Partnership Agreement for Investment Business, or a limited liability partnership agreement as defined in Article 3(1) of the Act on Limited Liability Partnership Agreement for Investment |
| (ii) The existence of a business (the “Invested Business”) in which money (including cryptographic assets) contributed or contributed by the person who has such rights (the “Investor”) is allocated to the Invested Business; |
| (iii) The investors are entitled to receive dividends of profit generated from the invested business or distribution of assets related to the invested business; |
| (iv) There are no exceptional circumstances, such as all investors being constantly involved in the business. |
The revised Financial Instruments and Exchange Act, which came into effect on May 1, 2020, created the legal concept of Electronic Record Transfer Rights. The rights of tokenized collective investment schemes usually fall under the Electronic Record Transfer Rights below.
| Outline of Definition of Electronically Recorded Transfer Rights |
| Rights that satisfy the following (i) to (iii) but exclude (iv) (Article 2, Paragraph 3 of the FIEA): |
| (i) Rights listed in each item of Article 2, Paragraph 2 of the FIEA (funds, trust beneficiary rights, members’ rights of general partnerships, limited partnerships, limited liability partnerships, etc.); |
| (ii) When they are expressed in property values that can be transferred through an electronic data processing system; |
| (iii) When recorded in electronic devices or other objects by electronic means; |
| (iv) Cases provided in the Cabinet Office Ordinance have considered the nature of distribution and other circumstances. |
The sale of this electronic record transfer right requires a Type 1 Financial Business registration. If soliciting more than 50 people, it will be a public offering (Article 2, Paragraph 3 of the Financial Instruments and Exchange Act), and a securities registration statement must be submitted based on Article 5 of the FIEA.
If the sale is limited to qualified institutional investors or wealthy people of 49 or less, and even if there is resale, there are technical restrictions so that other people cannot become DAO token holders.
When the Investment DAO is formed, it can be sold in such a limited form at first, and after it grows, it can be sold to the general public while complying with increased regulations.
2.4 Tokenization of Company Membership Rights and Financial Registration Regulations
Regarding tokenization of company membership rights, a Type I FIBO license is necessary when a third party sells the rights, and Type II is essential in the case of self-solicitation. In the case of tokenization of company membership rights (shareholders rights) of a joint stock company, a Type I license is necessary in the case of solicitation by a third party, and no license is required in the case of self-solicitation.
2.5 Regulations on Public Offerings, etc.
If any of the following applies, it becomes a public offering. In principle, it is necessary to submit a securities registration statement.
| (i) When soliciting the acquisition of securities from 50 or more persons (excluding Qualified Institutional Investors (QII) in the case there are restrictions on resale other than QII); (ii) When it does not fall under any of the following categories: Private Placement for QII, Private Placement for Professional Investors, and Private Placement for Small Groups. |
2.6 Financial Regulations for DAOs without Dividends
If DAOs have no dividends, etc., they are not considered securities, but different financial regulations may apply.
| Tokens/NFTs | Free token distribution | Token Sales | Investment Management (Assumption without dividends) |
| Utility Tokens | Unregulated | Crypto Asset Exchange Business License | Unregulated |
| NFTs | Unregulated | Unregulated | Unregulated |
Disclaimer
The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may therefore change in the future. This article does not recommend investment in DAO. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.