Hey folks. I’m in San Francisco covering Circle’s Converge conference this week. Around? Say hi. But in the meantime, let’s talk about the CFTC and the sudden chill it has cast over the crypto world.
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The Commodity Futures Trading Commission (CFTC) sued Ooki DAO, a decentralized autonomous organization, last week. The CFTC alleged Ooki DAO was offering leveraged and margin trading products without registering as a Futures Commission Merchant (FCM), a legal requirement in the U.S.
Why it matters
The complaint is a dagger into the belief that decentralization is a defense against regulation. Admittedly, it’s not the first time we’ve seen U.S. regulators indicate that decentralization really isn’t a defense, but because of the way the CFTC has worded its complaint it seems especially concerning. The short version is that, in the CFTC’s view, every single voting participant in a DAO can and should be held individually liable for any illicit activity conducted by the DAO.
Breaking it down
If you missed this news last week, the slightly longer version of what happened is the CFTC settled charges with bZeroX and its founders Tom Bean and Kyle Kistner, alleging the company had illegally offered leveraged and margin trading products to U.S. persons without registering as a Designated Contract Market (DCM) or an FCM.
I tweeted my read-through of the case – you can catch up on that thread on the link – but basically the CFTC said bZeroX offered products the regulator should be overseeing. Bean and Kistner offered to settle, paying a (paltry) $250,000 fine and promising not to break the law or CFTC rules again.
The decentralized squiggle here is bZeroX converted from a service provided by a centralized company with two operators to a service provided by a DAO with many operators. The CFTC filed a complaint against the DAO (originally called bZx, now named Ooki), alleging basically the same things alleged against bZeroX.
My interpretation of what happened next is that the CFTC, having found a settlement with these two intrepid individuals who were unwilling to be dragged into an expensive legal fight, saw the DAO as a natural extension of the company and felt that it had to bring similar charges. What’s more, because Ooki and bZeroX literally did the same thing, the CFTC didn’t really need to stretch to find its cause of action.
“A key bZeroX objective in transferring control of the bZx Protocol (now the Ooki Protocol) to the bZx DAO (now the Ooki DAO) was to attempt to render the bZx DAO, by its decentralized nature, enforcement-proof. Put simply, the bZx Founders believed they had identified a way to violate the Act and Regulations, as well as other laws, without consequence … The bZx Founders were wrong, however. DAOs are not immune from enforcement and may not violate the law with impunity,” the complaint said.
And it’s worth noting that, despite this edition’s headline, the decentralization or lack thereof of a DAO doesn’t seem to be a concern for this action. Rather, it’s the actual activities the DAO engaged in – i.e., the same activities bZeroX engaged in – that are the source of this lawsuit.
CFTC targets voting token holders
No one seems to have any issue with the events as they occurred up to this point. Where things get hairy is in assigning liability to the DAO operators. And, in fairness to the regulators, this is a bit of a tough needle to thread.
The CFTC decided that anyone who voted as part of the DAO’s governance process should be held individually liable. That's a pretty broad net. Some of the alternative choices the CFTC had would have been to charge every token holder – which would have been even more broad and perhaps difficult to enforce – or identify which voters specifically chose to engage in the illegal actions at stake.
In turn, charging every recipient of an airdrop would have been, quite frankly, ridiculous. People get tokens all the time through airdrops for projects in which they didn’t necessarily plan to participate. It would be like the Treasury Department charging a celebrity who got dusted with Tornado Cash ether.
It would also probably be a logistical nightmare.
Identifying more specific users would be pretty difficult, too, I imagine. Plus, the CFTC could always argue that the mere act of participating in the governance process of a DAO explicitly engaged in illegal activity makes someone liable. It’s not like Ooki DAO started off engaging in only legal activity and later started getting into leveraged products. The DAO was specifically created to continue operating the unregistered FCM.
We’ve also seen regulators repeatedly go after companies and entities for allegedly illegal activity, even if the company has started taking steps to transition away from that activity. Just recently, eight state regulators sued crypto lender Nexo, which announced in February it would stop offering its yield-generating Earn interest products to U.S. users after fellow lender BlockFi settled charges with the Securities and Exchange Commission (SEC) and several state regulators.
So the fact the CFTC did indeed choose to go the route that it did should not be a total surprise. But, of course, it’s going to be controversial. CFTC Commissioner Summer Mersinger explained her disagreement with the CFTC’s chosen path in a dissent, but added in a footnote that merely capturing all token holders is also not ideal.
CoinDesk’s Cheyenne Ligon spoke to several lawyers about the implications of the case, who all largely agreed that while the CFTC saying decentralization doesn’t protect against regulatory action, they were surprised by the targeting of voting token holders.
The next steps, I think, are answering some of the following questions:
- Who’s actually going to be held liable? Is the CFTC looking for a way to identify the Ooki DAO participants who are liable under the regulator’s interpretation?
- How active is the DAO anyway?
- How will Ooki DAO respond?
- Does this mean the CFTC is no longer the “friendlier” regulator?
- What does this mean for decentralization?
That last question, at least, I think has an easy answer: Nothing. The CFTC is saying decentralization isn’t a defense against regulatory action, something we saw before when the U.S. Treasury Department sanctioned Tornado Cash. I don’t think we can really read more into the case than that at this point.
And for whatever it’s worth, I lurked a bit in Ooki’s Discord and Telegram groups and they didn’t seem particularly active. Will this DAO now push a proposal to hire a lawyer (and then another one to pick a specific attorney)?
Changing of the guard
You can also join the group conversation on Telegram.
See ya’ll next week!