In 2022 the dYdX Foundation introduced the Guernsey special purpose trust as a vehicle for DAO management. (D)YdX contended that the purpose trust provided a better management alternative than multi-sig wallets and traditional business entities. But what exactly is a Guernsey special purpose trust and what do DAOs need to understand if they want to utilize the purpose trust for their activities?

Where (or what) is Guernsey?

Guernsey is an island bailiwick (or territory) in the Channel Islands, which are located off the northern French coast of Normandy. Although Guernsey isn’t part of the United Kingdom it’s a member of the British Commonwealth (For Americans the British Commonwealth is a league of countries and bailiwicks that used to be part of or connected to the former British Empire; and for the record the USA isn’t in the Commonwealth, because we’ve never submitted an application to join).

Guernsey is arguably most famous for its cows and goats. The “Golden Guernsey” goat is a rare dairy goat that lives on the island and has a gorgeous golden brown coat.

And Guernsey cows are famous for their high quality milk and cheese products.

More relevant to our discussion are Guernsey’s tax advantages. The island has no capital gains or inheritance taxes and non-banking and non-trading businesses are exempt from paying corporate taxes. And like other island tax havens, Guernsey allows foreign registration of trusts, partnerships, foundations and LLCs.

And Guernsey’s big appeal for dYdX are Guernsey’s flexible trust laws. Along with allowing special purpose trusts (which are discussed shortly) Guernsey doesn’t have a rule against perpetuities so trusts can last indefinitely (although there are qualifications to this) and perhaps most importantly, Guernsey doesn’t require trustees to be island residents or licensed Guernsey trust companies.

And that’s huge, because many island jurisdictions like the British Virgin Islands and the Caymans require at least one trustee to be either an island resident or a licensed island company. So registering a trust in the Caymans requires hiring a resident or a licensed resident company to serve as a trustee. This typically involves both start-up and annual fees, resulting in tens of thousands of dollars in fees over the trust’s lifetime. So, removing the resident requirement provides significant financial savings, not to mention avoiding an unfamiliar third-party serving as your trustee.

Trust Mechanics

Before I discuss special purpose trusts, it’s important to explain how a trust works. Although many clients have heard about trusts, few actually know what they are and how they work. Trusts are not entities like corporations or LLCs, but are legal arrangements that are established by a grantor or settlor (I’ll use grantor from here on out). The grantor creates the trusts for the benefit of certain individuals who are called beneficiaries. The grantor funds the trust with property, e.g., real estate, cash or cryptocurrency, and places a trustee (either an individual or entity) to manage and administer the trust and trust property. A trust agreement is created between the grantor, trustee and beneficiaries, naming the beneficiaries and defining what their benefits are and when they’ll receive them, while also explaining the trustee’s roles and duties.

For example, imagine a grantor wants to give his children an annual sum of money each year. The grantor takes an empty jar and stuffs the jar with cash and closes the lid. The grantor selects a trustee and gives the jar to the trustee to hold and manage the cash inside the jar. The grantor makes an agreement with the trustee, identifying his children as the beneficiaries, and describing when and how the trustee distributes cash to his children. And if the grantor wishes, he can instruct the trustee to use the cash to invest in bonds, mutual funds, etc., with all revenue earned from those investments returning to the jar for the children’s benefit.

The Special Purpose Trust

A special purpose trust is exactly the same as our cash jar example with a major difference: there are no beneficiaries because the grantor doesn’t create the trust to provide a benefit; rather the trust is established to carry out a purpose identified by the grantor (but like most things there is an exception and Guernsey allows beneficiaries to be added to a purpose trust after its creation). So, rather than manage the cash jar for a grantor’s children, the trustee in our example manages the jar to fulfill the purpose of the trust.

In Guernsey special purpose trusts are divided into two distinct categories: charitable and non-charitable. As their names suggest, a charitable purpose trust is established for a philanthropic purpose, while a non-charitable trust isn’t. But Guernsey also allows a third option, a hybrid purpose trust for both charitable and non-charitable objectives. Since dYdX only discusses the non-charitable purpose that’s the one we’ll stay with (although the hybrid trust is very interesting for DAOs that engage in both for-profit and not-for-profit activities).

A further advantage of Guernsey is its broad requirements for a valid trust purpose. Guernsey only requires that a trust’s purpose isn’t illegal or against public policy and that the trust agreement must explicitly state the trust’s purpose, along with the trust’s intent and goals so that the trustee clearly knows how to execute their duties and fulfill the trust’s purpose.

The Enforcer

Another difference from our jar example is the addition of a new trust position, the enforcer. A trust enforcer is an entity or individual who’s responsible for reviewing the actions of a trustee and serves as a “check” to ensure the trustee complies with its duties and obligations under the trust agreement. An enforcer has a right to access trust documents and financials and can review transactions to ensure the trustee is acting in good faith and isn’t committing fraud or self-dealing. But an enforcer can’t dictate how the trust is managed and can’t prevent the trustee from acting. The enforcer can only review trustee actions and report any suspicious activity to the grantor.

Applying the special purpose trust to DAOs, a DAO is the grantor, two DAO members are elected to serve as trustees (Guernsey requires a minimum of two trustees) and one member is elected as the enforcer. DAO members vote to appoint and remove the trustees and enforcer and also set term limits for how long members serve in those positions.

But it’s important to understand that DAO members don’t control how trustees manage the property. Like in our example, a DAO hands the cash jar to the trustees for them to hold and manage and the trustees act on their own without DAO approval. So, a DAO both entrusts and relies on the trustees to administer the purpose trust effectively.

Why Use a Special Purpose Trust?

(D)Ydx argues that purpose trusts are better options for DAOs than traditional entities (e.g., corporations and LLCs), because trusts don’t require government approval, renewal or ongoing compliance. And since traditional entities require directors, officers or managers, the individuals appointed to those positions must ensure that the entity is governed correctly and remains compliant with government rules. But this creates what dYdX calls a “central point of failure” for DAOs, because if these individuals are negligent or fail to act then the entity may be suspended or lose authorization to transact business.

In contrast, a purpose trust does not need approval, nor does it require ongoing compliance. This means that a trust does not run the risk of suspension by a government agency, eliminating the possibility of a "central point of failure" for DAOs relying on individuals to keep the trust active or compliant.

DAO Member Protections

(D)YdX also points out that purpose trusts are better for DAO members who are multi-signature wallet key holders, as multi-sig key holders lack any liability protections for the DAO’s legal obligations. So key holders risk assuming liability when signing contracts or opening bank accounts for the DAO and individual key holders may even be liable for the actions of other key holders. It’s also possible that a jurisdiction could view a DAO as a pass-through entity and the multi-sig key holders its owners. This means that key holders could be held personally responsible for the DAO’s unpaid tax debts.

But a purpose trust replaces the key holder with the trustee and the trust agreement gives trustees protections that multi-sig key holders don’t enjoy. So, trustees can open bank accounts and sign agreements for the trust without worrying about their personal liability, because the trust indemnifies the trustees and absolves them from any fees or liabilities resulting from their actions under the terms of the trust agreement.

Additionally, purpose trusts provide DAO members with a heightened level of protection against multi-sig rug pulls. For each trustee assumes fiduciary duties to the trust when they take on the position, meaning that they are held personally liable for any fraudulent or self-dealing activities. So DAO members can sue trustees for embezzling funds and self-dealing, not to mention trustees can face punitive damages for their breaches which multiple the monetary damages owed to the DAO, providing a strong deterrent against rug-pulls.

Tax Benefits

Lastly, dYdX favors the Guernsey purpose trust for its tax advantages. First there are no transfer taxes when a DAO sends money to fund the trust. Second there are no taxes on revenue earned by the trust so long as that income isn’t generated on the island and neither the grantor nor the beneficiaries (if any) reside in Guernsey. But remember that taxes will be owed by the person or entity who receives funds sent by the trust; so a purpose trust must comply with tax rules and submit the proper tax documentation (i.e., 1099) when applicable.

Purpose Trust Criticisms

Although a purpose trust has its advantages, it’s important to consider the trustee’s power and authority. A DAO must depend on the trustee to effectively and efficiently manage the trust and satisfy the trust purpose. And DAOs cannot direct the trustee to act and DAOs can’t veto a trustee’s action; rather DAOs must rely on the trustee’s judgment especially if the trustee is allowed to invest or spend the trust property.

For a trustee is only personally liable for fraudulent or self-interested transactions and not for faulty investments. For example, if a trustee invested in Terra or FTX before their respective collapses, the trustee wouldn’t be liable if they were just wrong investments at the wrong time. In that situation, the only recourse for the DAO is to remove the trustees from their positions; but the DAO couldn’t recover its losses from them.

Now a counter to the above is to have the trust agreement restrict the trustee’s duties to prevent investing altogether, or include in the trust agreement a specific list of member voted and approved investment strategies that the trustee must follow if making investments.

Another criticism doesn’t involve the purpose trust but with dYdX’s contention that corporations and LLCs are unsuitable entities for DAOs. Government registration and renewal is easy to obtain and observing corporate formalities is neither hard nor burdensome. Although there’s reliance on directors and officers, a DAO could avoid creating “central point of failures” if the entities are properly structured. And there are instances where LLCs offer better liability protection and tax benefits than trusts, so refusing to use traditional entities is unreasonable when they can offer strategic advantages in certain situations.

Should DAOs Use a Guernsey Purpose Trust?

Yes, the tax savings and the flexibility to appoint you own trustees instead of hiring a licensed resident company makes Guernsey a great jurisdiction to begin with. The special purpose trust vehicle is an added bonus (although if the reader is anti-Guernsey for whatever reason, Guernsey’s island neighbor, Jersey-the old Jersey not the new one-offers the same purpose trust vehicle with similar relaxed laws and requirements)

But keep in mind that there are no right or wrong entities for DAOs. A special purpose trust, an LLC, a cooperative, a Wyoming DAO entity, these are all tools that have their time and place. And just like a flat head screwdriver, a Philips screwdriver, a socket wrench or a hand wrench, one tool may be right for one job but impractical for another. And some projects may demand you use all four tools, while other projects don’t require their use at all. It all depends on the specific need that must be met. And all that matters for DAOs is finding and using the right tool at the right time.

Yet, if your DAO wants an off-shore trust with great tax advantages then Guernsey is worth considering.