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CFTC Sues a DAO, Raising Legal Questions for DeFi Founders and Users

CFTC Sues a DAO, Raising Legal Questions for DeFi Founders and Users

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The regulatory crackdown on crypto continues.

The Commodity Futures Trading Commission announced on Thursday that it had cleared the charges against the founders of bZeroX, the company behind the bZx protocol. The CFTC fined bZx founders Tom Bean and Kyle Kistner $250,000 for allegedly “offering illegal leveraged and margin retail commodity transactions in digital assets” and failing to implement customer identification requirements known as KYC.

But in a new move, the CFTC also filed suit against the related DAO. The CFTC alleges that the Ooki DAO, which Bean and Kistner allegedly founded as a way to decentralize control of the bZx protocol, also violated the same laws. While Bean and Kistner settled the charges against themselves and bZeroX, while not admitting or denying the allegations, the CFTC is seeking penalties against The DAO, including decentralization, fines, and possible trading and registration bans.

“According to the decision, DAO was an unregistered association whose members Bean and Kistner were actively involved and responsible for Ooki DAO’s violations. [Commodity Exchange Act] and CFTC regulations,” the commission stated in a press release.

A DAO is an organizational structure in which control is decentralized rather than hierarchical. DAOs use smart contracts on the blockchain, and participants use governance tokens to vote on proposals.

In an unprecedented move, the CFTC argued that Bean and Kistner are responsible for the DAO’s alleged illegal conduct because they held Ooki tokens and voted on governance proposals related to the DAO’s operations. In a dissenting opinion, CFTC Commissioner Summer Mersinger called the action a “flagrant enforcement provision” and said it “lacks confidence” in the legal authority of the commission’s mandate.

“I cannot accept the Commission’s approach of assigning liability to DAO token holders based on their participation in the governance vote for several reasons,” Mersinger wrote.

The way the CFTC defined Ooki DAO as an unincorporated association and determined the liability of bZx’s founders could have far-reaching consequences DeFi and DAOs— the latter of which is becoming an increasingly popular way to quickly organize large groups of people toward a single goal, including fundraising for a common cause, while decentralizing decision-making to the group.

According to Delphi Labs general counsel Gabriel Shapiro, the enforcement actions are already having a chilling effect on certain DAOs. “I can already see the DAO representatives talking about giving up their role,” he tweeted earlier today. “If you are a DeFi founder facing regulatory action, please be aware that you may have options other than mediation,” he warned.

By e-mail to the address DecryptThe DeFi Education Fund called the lawsuit against Ooki DAO an “unprecedented action.” [that] seeks to create a new kind of policy in response to new problems, all through enforcement.” Jake Chervinsky, director of policy at the crypto lobbying group Blockchain Association, echoed the sentiment, tweeted yesterday: “The CFTC’s bZx enforcement actions may be the most egregious example of regulation by enforcement in crypto history.”

There is already growing concern in the crypto industry that the CFTC’s approach in cracking down on bZx and its founders could be broadly applied to other DAOs and their members.

“I think the real challenge is what the CFTC decides whether this is part of their approach to tracking down individual management token holders,” Prime Trust Vice President of Regulatory Affairs Jeremy Sheridan said. Decrypt in the interview. “Given the novel nature of this approach, this is a precedent and damaging to the rest of the industry, and that’s a cause for concern.”

Sheridan said we may see an unfortunate consequence of the escalation, and the CFTC, after seeing how the SEC has gotten involved in regulating cryptocurrencies, may try to flex its regulatory muscle to gain more power.

“It’s a challenge and an unfortunate consequence of not having sensible effective, concrete regulatory structures that provide the lines of responsibility, the lines of engagement that all those working in the industry really require,” Sheridan said.

However, other legal experts are not so sure. Stephen Palley, legal partner at Brown Rudnick, is not surprised by the way the CFTC defined Ooki DAO as an unincorporated association, but said Decrypt that the action nevertheless raises important questions.

“The more interesting questions,” Palley said, “are whether or not the underlying protocol actually fits. [Commodity Exchange Act] or is it [Commodity Exchange Act] suitable for the purposes of a decentralized protocol.”

If nothing else, the CFTC has made clear that merely organizing as a “DAO” does not exempt participants from compliance with existing regulations.

“Being a DAO in the US is a dangerous business,” Snapshot Ecosystem CEO Nathan van der Heyden said. Decrypt. “Just sharing a token and having a few votes does not absolve the founders who break the law from all legal responsibility,” he said.

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