# RWAs Exposure Risks

## Regulatory and Legal Risks

### Regulatory Risk

The risk of negative impact to the DAO’s investments in Real-World Assets (RWAs) due to changes in laws, regulations, or governmental policies. The cryptocurrency and blockchain industry is subject to a rapidly evolving regulatory landscape. Governments and regulatory bodies around the world are continually updating their stances on digital assets, which can include imposing new restrictions, altering tax laws, or changing compliance requirements. For example, a government may introduce legislation that restricts or prohibits certain types of investments, requires additional reporting, or reclassifies digital assets in a way that affects the DAO’s operations. Such changes can lead to increased costs, operational challenges, or even render certain investments non-viable.

The DAO should avoid being perceived as an on-chain ‘venture fund’ or ‘commodities pool’ holding diversified assets, especially in light of the SEC’s DAO Report. Additionally, the DAO should avoid classification as a money-service business (MSB) or crypto-asset service provider, which are subject to rigorous licensing requirements in various jurisdictions.

To mitigate the risk the DAO may setup separate legal entities, such as SPVs or subsidiaries, to hold and manage RWAs. This segregation ensures that the DAO itself does not directly own or control these assets, reducing the risk of receiving involuntary classifications.

### Legal Risk

The risk arising from the legal frameworks and entities used to hold and manage RWAs. If the DAO lacks a proper legal structure, it may face difficulties in enforcing contracts, protecting its assets, or may be exposed to unintended liabilities. For instance, without a legally recognized entity, the DAO may be unable to enter into enforceable agreements with counterparties, leaving it vulnerable in legal disputes. Additionally, individual members could be personally liable for the DAO’s obligations, which can deter participation and investment.

The DAO concept lacks legal recognition in most jurisdictions. If unincorporated, the DAO and its affiliated organizations running RWA investments risk involuntary legal classifications, potentially exposing individual members to personal liability.

A recommended mitigation is to establish the DAO's operational arm as a legal entity in a jurisdiction that provides legal recognition for DAOs. Ensure the chosen legal structure limits the personal liability of members, protecting individual assets from legal claims against the DAO.

### Compliance Risk

The possibility of legal or regulatory sanctions, financial loss, or reputational damage the DAO might suffer as a result of its failure to comply with laws, regulations, codes of conduct, or standards of best practice. This includes adherence to anti-money laundering (AML) laws, securities regulations, tax obligations, and other relevant legal requirements. Non-compliance can result in fines or legal action, which can have severe financial and reputational consequences for the DAO.

Meeting various compliance requirements depends on having a legal entity recognized by competent authorities. Without such an entity, the DAO may be unable to fulfill legal certain obligations, risking operational hindrances.

To effectively mitigate compliance risks associated with RWA investments, it is advisable for the DAO to establish an incorporated legal entity that would serve as the legally recognized interface between the DAO and external parties, fulfilling regulatory requirements and facilitating compliant operations. The incorporated entity can undergo Know Your Customer (KYC) and Anti-Money Laundering (AML) checks required by RWA service providers and financial institutions. The entity can legally hold tokens received in exchange for investments. It can also be empowered to execute transactions, including withdrawals, based on predefined criteria set by the DAO.

## Operational Risks

### Rogue Actor Risk

This risk from individuals or entities within or associated with the DAO acting in bad faith to compromise assets or operations. Rogue actors may attempt unauthorized transactions, manipulate processes, or exploit vulnerabilities for personal gain.

Mitigations include implementing multi-signature transaction approvals, where multiple parties must authorize a transaction before it is executed, and involving reputable, licensed service providers with stringent oversight mechanisms. Regular audits, strict access controls, and transparent governance practices also help reduce this risk.

### Operational Process Risk

Operational process risk is the potential for loss due to failures in internal processes, systems, or human errors. This can include mistakes in transaction execution, mismanagement of funds, inadequate controls, or process inefficiencies. For example, insufficient verification procedures might allow erroneous or fraudulent transactions to occur.

Mitigation strategies involve establishing robust operational procedures, process automation where feasible, and continuous monitoring and improvement of internal controls.

### Technological Risk

This encompasses risks related to technological failures, system outages, software bugs, or execution errors that can disrupt operations or lead to financial losses. For instance, if the platform in use experiences technical glitches or downtime, transactions may not be executed as intended, resulting in missed opportunities or unintended positions.

To mitigate these risks, the DAO should employ reliable technology solutions, maintain backup systems, perform regular testing and updates, and have contingency plans in place for critical system failures.

## Counterparty Risks

### Counterparty Credit Risk

The risk stemming from a counterparty—such as a broker, custodian, or service provider—failure to fulfill their contractual obligations, leading to financial losses for the DAO. If a counterparty becomes insolvent or defaults on agreements, the DAO may be unable to recover funds or assets entrusted to them.

Mitigation involves conducting thorough due diligence on counterparties, diversifying counterparties to avoid over-reliance on a single entity, and employing legal agreements that protect the DAO’s interests, such as collateral arrangements or default provisions.

### Broker Bankruptcy Risk

The potential insolvency of a broker through which the DAO conducts transactions. Even if assets held with the broker are legally the property of the DAO, recovering them during bankruptcy proceedings can be complex and time-consuming. There may also be legal uncertainties regarding the treatment of digital assets in such events.

To mitigate this risk, the DAO should ensure that assets are held in segregated accounts, understand the legal protections in place, and perhaps limit the amount of assets held with any single broker.

### Custodial Risk

Custodial risk involves the potential loss of assets due to failures or malfeasance by the custodian holding the DAO’s assets. This can include theft by insiders, external hacks, or operational failures leading to loss or inaccessibility of assets.

To mitigate this risk, the DAO should use reputable custodians with strong security protocols, insurance coverage for assets under custody, regular audits, and legal agreements that clearly define the custodian’s responsibilities and liabilities.

### Custodian Bankruptcy Risk

Similar to broker bankruptcy risk, this refers to the possibility that a custodian holding the DAO’s assets becomes insolvent. The DAO may face delays or losses in accessing its assets if the custodian enters bankruptcy.

Mitigation strategies include using reputable custodians with strong financial positions, ensuring assets are held in segregated accounts, and understanding the legal framework governing asset custody and client asset protections in the custodian’s jurisdiction.

## Strategic Risks

### Emergency Shutdown Risk

This risk is associated with the DAO’s ability to respond effectively to critical events that necessitate an emergency shutdown of operations or systems. Such events could include severe security breaches, regulatory actions, or catastrophic failures in infrastructure. An emergency shutdown might impede access to assets, disrupt operations, and cause financial losses.

Mitigation includes a proper structuring of asset holdings to ensure they are protected during an emergency, such as by using trusts or special purpose vehicles (SPVs) that can operate independently. Ensure contracts with custodians, exchanges, brokers, and other service providers include clauses that require them to support emergency shutdown procedures, such as freezing transactions or safeguarding assets upon request.

### Unforeseen Events Risk

Unforeseen events risk encompasses any unexpected occurrences that could significantly impact the RWA investments. This includes natural disasters, geopolitical events, pandemics, economic crises, or so-called “black swan” events that are rare but have severe consequences. These events can disrupt markets, affect counterparties, impair infrastructure, or alter regulatory environments.

Mitigation involves entering into flexible contractual arrangements via DAO-designated entity. Thus the DAO’s liability can be limited reducing potential legal exposure caused by unforeseen events. Certain clauses of the contract may provide for renegotiation or termination if significant unforeseen events negatively impact the DAO or its counterparties.