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CFTC Is Suing a DAO. Here’s Why DeFi Users Should Be Alarmed

CFTC Is Suing a DAO. Here’s Why DeFi Users Should Be Alarmed

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Key Takeaways

  • The CFTC has filed suit against the decentralized autonomous organization behind the Ooki protocol, Ooki DAO, for allegedly operating an illegal derivatives trading system.
  • The lawsuit marks the first time a government agency has charged the holders of the decentralized, non-freedom blockchain protocol’s administrative tokens with allegedly violating the law.
  • The case could set a terrible legal precedent for DAOs and DeFi management token holders.

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In the lawsuit, the Commodity Futures Trading Commission argued that “DAOs are not immune from enforcement and cannot violate the law with impunity.”

CFTC Sues Ooki DAO in Landmark Case

The Commodity Futures Trading Commission has launched an attack on The DAO that could have serious consequences for DeFi.

The US government agency announced in a press release on Thursday that it had simultaneously filed and settled charges against the former operators of the bZx protocol (later renamed the Ooki Protocol), bZeroX, LLC, and its founders Tom Bean and Kyle Kistner.

In the settlement, the CFTC alleged that by designing, implementing and marketing the bZx protocol – a decentralized smart contract-based protocol for margin trading – the defendants illegally engaged in a designated contract market (DCM) without registering with the agency. operations can only be performed by Registered Futures Commission Merchants (FCMs) and have not completed the mandatory Know Your Customer (KYC) check for platform users.

The CFTC also filed a federal civil enforcement action against the Ooki DAO—the decentralized autonomous organization that later assumed control of the Ooki protocol—on the same charges. This case is significant because it is the first time a regulatory agency has sued the DAO, and because the legal ramifications of a CFTC win could set a dire legal precedent for token holders of other crypto projects, including many DeFi protocols.

In the lawsuit, the CFTC defined the Ooki DAO as an “unincorporated association” made up of BZRX token holders “who vote those tokens to control (eg, modify, use, market and take other actions) with respect to the bZx protocol.” The agency claims that bZx’s founders, Bean and Kistner, transferred control of the protocol to the community in an attempt to circumvent regulations. It said:

“BZeroX’s central goal in transferring control of the bZx protocol (now the Ooki protocol) to the bZx DAO (now the Ooki DAO) was to try to make the bZx DAO enforceable due to its decentralized nature. Simply put, the founders of bZx believed they had found a way to break the law and regulations and other laws without consequence.”

“However, the founders of BZx were wrong,” the CFTC stated, arguing that “DAOs are not immune from enforcement and cannot violate the law with impunity.”

Implications for DeFi Token Holders

By designating the DAO as an unincorporated association, the CFTC has effectively stated that its members have unlimited liability and are fully responsible for all of its actions. This claim is particularly troubling because the regulator ignored the fact that the Ooki protocol is a decentralized, non-custodial protocol that runs on smart contracts. As such, it cannot comply with the current regulations designed for centralized financial entities, and cannot be shut down by members of the DAO or any other party.

If the CFTC wins the case, it would set a legal precedent that could make it easier for the agency to target other decentralized derivatives trading protocols such as Synthetix, GMX, dYdX, Injective, Gains Network and Perpetual Protocol. If this ever happens, SNX, GMX, DYDX, INJ, GNS, and PERP token holders who have voted on any governance proposal could be held liable and prosecuted for potentially illegal activities in the protocol.

Several prominent figures in the crypto community have criticized the CFTC for the lawsuit. By According to Miles Jennings, general counsel and head of diversification at renowned private equity firm Andreessen Horowitz, the critical problem with the CFTC case is that the agency is “trying to apply [Commodities Exchange Act] protocol and DAO at all.” Passed in 1936, nearly half a decade before the Internet was invented, the CEA was intended to regulate commodity and derivative trading on centralized marketplaces, so it is not, in its current form, suitable for regulating software-based non-custodial trading platforms. .

Jake Chervinsky, attorney and director of policy at the Blockchain Association, said that the move “may be the most egregious example of regulation by enforcement in crypto history.” He added that “we’ve been complaining for a long time about the SEC abusing this tactic, but the CFTC has put them to shame.”

The CFTC’s move comes after the cryptocurrency legal community has shown overwhelming support for the agency’s new push to become the primary cryptocurrency regulator. In August, U.S. Senators Debbie Stabenow (D-MI), John Boozman (R-AR), Cory Booker (D-NJ) and John Thune (R-SD) introduced the Digital Goods Consumer Protection Act, which aims to close regulatory gaps. between state and federal cryptocurrency regulation. If passed, the DCCPA would make the CFTC the lead regulatory agency for cryptocurrencies, which are not otherwise considered securities.

In light of the many negative experiences with the Securities and Exchange Commission, the crypto industry largely viewed the DCCPA as a bill that could unseat the securities regulator and bring much-needed regulatory clarity. However, with its latest enforcement actions, the CFTC appears to have wiped away any goodwill it had previously earned from industry stakeholders, drawing public dissent from one of its own commissioners, Summer K. Mersinger.

CFTC profit potential

Notably, Commissioner Mersinger issued a dissenting opinion opposing the CFTC’s strategy in the Ooki DAO case. In particular, he questioned the agency’s approach to determining the liability of DAO token holders based on their participation in governance voting. “This approach arbitrarily defines Ooki DAO as an unregistered association in a way that unfairly picks winners and losers, and undermines the public interest by preventing the encouragement of good governance in this new crypto environment,” he said.

In addition, Mersinger argued that the approach did not rely on any statutory authority or related case law in the CEA, represented unwelcome “regulation by enforcement,” and ignored well-established precedent for determining liability in similar violations.

The matter was commented on Twitter by William Hughes, the former deputy attorney general of the Ministry of Justice and the current head of global regulatory affairs at ConsenSys, said that “the court must agree with the CFTC for these theories of DAO liability for the token to be relevant.” He added that the CFTC “isn’t going to be easy” to convince any court, suggesting that the lawsuit may not be as alarming as it first appears.

It’s clear that the CFTC’s reasoning is pretty shaky, and the agency will likely struggle to win the case in a landslide — assuming bZeroX, LLC and its founders put up an adequate defense. If the CFTC loses the case, it should set a very promising legal precedent for DAOs and token holders.

Disclosure: At the time of writing, the author of this feature owned ETH and several other cryptocurrencies.

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