Role of DLT Foundations in Network Economy of DLT Ecosystems

A short introduction into the Governance Framework of DLT Foundations

DLT Ecosystems deal at a certain point with the question of how best to manage their off-chain activities. The scope for design is wide because, unlike classic business ecosystems, there is no pre-existing lead company that dictates ecosystem strategy and value creation. The whole governance framework for the management and control of off-chain activities in DLT Ecosystems must be practically created from scratch. With these brief explanations, we address the factors determining the governance framework of DLT Ecosystems and the role of DLT Foundations within its network economy.

 

Context

Governance framework for the management and control of off-chain activities in DLT Ecosystems is determined by the following aspects:

1. Token functionality in relation to token holder (Financial Market Regulatory Framework);

2. Token functionality in relation to network (Network Economics);

3. Distributed value creation and complexity of network interaction (DLT Ecosystem);

4. On-chain and off-chain transaction areas;

5. Control over off-chain areas by network participants and/or by third parties (control); and

6. Community protection of network participants (community approach).

If there are centralized administrative and management areas (off-chain transactions) that cannot be automated via the blockchain, then there is usually a need to create an administrative and management entity taking over this task for the DLT Ecosystem (the central management entity, “CME”).

The ecosystem is basically free to choose the legal form of CME. The question of the appropriate legal form cannot be answered in an abstract and general manner, as there is no general categorization of DLT projects due to a high degree of individualisation. The concrete circumstances of the individual case are decisive, but the following criteria generally play a role: (1) General characteristics of CME in DLT Ecosystems; (2) control; and (3) community protection.

 

General Characteristics of CMEs in DLT Ecosystems

CMEs share some general characteristics given by the DLT Ecosystem context, regardles of their legal form. First, CMEs have an ecosystem-wide significance and influence (comparable with the lead firm in business ecosystems). Second, they have structurally no value creation interests of their own and are thus formally not participants in the ecosystem. Third, in the absence of own value creating interests, they are not subject to intrinsic economic performance controls. Forth, they generally assume wide control rights in the DLT Ecosystem (asset and control decentralization) and thus have a powerful position in the DLT Ecosystem.

 

Control

Corporations (stock corporation or limited liability company) are generally used as a legal form for CMEs when third parties (shareholders) with their own value creation interests want to exert influence on the CME and thus usually on the network/DLT Ecosystem. Third parties can be internal and external to the network. The essence of this legal form is that the third parties structurally not only exercise control but can also exercise direct value creation interests in the CME and indirectly in the network. The rights of control also include several possibilities for change and restructuring of CME (mergers, splitting, capital change, cooperation, etc.), which are ordered by capital and do not exist in other legal forms. There is also the possibility to terminate the CME (voluntary liquidation upon the resolution of the shareholders) what could result in the termination of the DLT Ecosystem/DLT project and the network, potentially initiated by network external persons.

Associations are generally used when third parties (without their own value creation interests) are to be given control over the network. Here, too, third parties can exert influence on the CME. The influence is not based on capital share and with value-added interest, but on members and thus has more institutional character as corporations. In the case of associations, there is a tendency for individuals internal to the network to participate rather than members external to the network.

In both associations and corporations, the circle of shareholders or members is closed, and it is thus possible that there are network participants who have control over CME while others cannot.

Foundations are used when the network does not want third parties to have control, nor does it want participants of the network to have control and wants to implement the decentralized idea consistently and generally immutably, even in the central administrative (off-chain) areas. Here, the principle of self-control exists, but it can be broken through with certain control mechanisms.

 

Community Protection

If the DLT Ecosystem is managed and administrated through a foundation, then all participants are treated equally under equal conditions by the foundation as the CME of the DLT Ecosystem. No participant has structural influence over the foundation's activities. In this respect, control over the ecosystem is exercised institutionally and participants are institutionally protected as a community. Administration and management of DLT Ecosystems with a foundation thus leads to a consequent community approach.

There is however, neither network nor ownership control, which can lead to tensions between the foundation and the community under certain circumstances. This is especially the case when some or all the community members believe that the foundation does not play its role in the ecosystem or does not play it properly.

DLT Foundations are subject to administrational control by the supervisory authority. This state control is not shaped to handle internal control and management conflicts and even crisis between the foundation and its ecosystem. For this reason, when choosing the foundation as the legal form for DLT ecosystem management, it is important to ensure that the foundation fulfils its role (purpose) and that participants receive effective participant protection (e.g. via electoral and supervisory body) on foundation governance level.

 

FAQ Foundation Law

How is a foundation established? The foundation can be established in the following three steps:

• Recording the founder's will, the context of the foundation and the wording of the foundation's purpose; determining and establishing the organization of the foundation, drafting of the charter document (deed).

• Notarization of deed before notary public.

• Entry in the commercial register, subordination to the supervisory authority, tax exemption, regulation of the banking relationship.

How is it possible to create a solid governance protection for the network participants within the legal framework of a DLT Foundation? The purpose of the foundation must be drafted in correlation to the rights transferred to the foundation and should reflect the function of the foundation within the network/ecosystem. In addition, the organisation of the foundation should include internal control mechanism providing that community complaints can be addressed and handled on foundation level. Community protection should be made institutionally rather than transferring individual rights to community members.

How can it be ensured that the DLT Foundation is independent from the ecosystem? Within the process of establishment of the foundation it must be ensured that pre-existing control rights and intellectual property rights will be transferred to the foundation upon its registration in the commercial register (asset and control decentralization).

Can the organization of the foundation be changed subsequently? The organization can be designed in such a way that subsequent changes are possible.

Is it possible to set up a two-tier organization consisting of a foundation board and management? A two-tier organization and the delegation of foundation tasks to a management board are permissible.

Is it possible for a foundation to establish a company that has its registered office outside Switzerland and that performs certain tasks of the foundation? The foundation may hold shares in companies (corporate foundations are permitted without limitation).

Do members of the foundation board have to be Swiss or domiciled in Switzerland? One member of the foundation board or the management must be resident in Switzerland.

Which accounting regulations apply to foundations? The same accounting regulations apply to foundations as to corporations.

Can the election of an auditor be waived? The election of an auditor can be waived under certain conditions. In the case of DLT Ecosystems, the supervisory authority assumes more complex contexts, which generally does not permit a waiver. DLT Foundations thus require an auditor.

Are there any regulations regarding the minimum size of the foundation board? There are no regulations. For DLT Foundations that are in the context of a DLT Ecosystem, a foundation board with at least 5 members is recommended.

Why do global acting DLT Ecosystem choose Switzerland as the operating location for their CMEs? Switzerland as a foundation location enjoys a very good reputation. This is due to the stable political and economic conditions and the fact that Swiss foundation law offers the necessary flexibility for different foundation contexts.

April 2021 | Author: Thomas Müller

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