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

Key Takeaways

The CFTC has filed a lawsuit towards the decentralized autonomous group behind the Ooki Protocol, Ooki DAO, for allegedly working an unlawful derivatives buying and selling platform.
The lawsuit marks the primary time a authorities company has charged governance token holders of a decentralized non-custodial blockchain protocol for allegedly breaking the regulation.
The case might set a horrible authorized precedent for DAOs and DeFi governance token holders.

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Within the lawsuit, the Commodity Futures Buying and selling Fee claimed that “DAOs should not immune from enforcement and will not violate the regulation with impunity.”

CFTC Sues Ooki DAO in Landmark Case

The Commodity Futures Buying and selling Fee has launched a controversial assault on a DAO, and it might have severe penalties for DeFi.

In a Thursday press launch, the U.S. authorities company introduced that it had concurrently filed and settled fees towards the previous operators of the bZx Protocol (later renamed to Ooki Protocol), bZeroX, LLC, and its founders, Tom Bean and Kyle Kistner. The CFTC additionally filed a federal civil enforcement motion towards Ooki DAO. 

Within the settlement, the CFTC argued that by designing, deploying, and advertising the bZx Protocol—a decentralized sensible contract-based protocol for margin buying and selling—with out registering with the company, the defendants illegally operated a delegated contract market (DCM), engaged in actions solely registered futures fee retailers (FCM) can carry out and didn’t conduct necessary know-your-customer (KYC) diligence on the platform’s customers.

The CFTC additionally filed a federal civil enforcement motion towards Ooki DAO—a decentralized autonomous group that subsequently assumed governance management over the Ooki Protocol—below the identical fees. This case is critical as a result of it marks the primary time a regulatory company has sued a DAO and since the authorized implications of the CFTC profitable the case might set a horrible authorized precedent for governance token holders of different crypto initiatives, together with many DeFi protocols. 

Within the lawsuit, the CFTC outlined Ooki DAO as an “unincorporated affiliation” comprised of BZRX token holders “who vote these tokens to manipulate (e.g., to switch, function, market, and take different actions with respect to) the bZx Protocol.” The company claims that the bZx founders, Bean and Kistner, transferred management over the protocol to the group in an try to skirt rules. It stated:

“A key bZeroX goal in transferring management of the bZx Protocol (now the Ooki Protocol) to the bZx DAO (now Ooki DAO) was to try to render the bZx DAO, by its decentralized nature, enforcement-proof. Put merely, the bZx Founders believed they’d recognized a option to violate the Act and Rules, in addition to different legal guidelines, with out consequence.”

“The bZx Founders have been unsuitable, nevertheless,” the CFTC concluded, claiming that “DAOs should not immune from enforcement and will not violate the regulation with impunity.”

The Implications for DeFi Token Holders

By labeling the DAO as an unincorporated affiliation, the CFTC has successfully acknowledged that its members have limitless legal responsibility and are totally accountable for any of its actions. This argument is very regarding provided that the regulator didn’t care that the Ooki Protocol is a decentralized, non-custodial protocol powered by sensible contracts. As such, it may possibly’t adjust to the prevailing rules designed for centralized monetary entities, nor can it’s shut down by DAO members or another get together.

The CFTC profitable the case in courtroom would set up a authorized precedent that might make it a lot simpler for the company to focus on different decentralized derivatives buying and selling protocols like Synthetix, GMX, dYdX, Injective, Beneficial properties Community, and Perpetual Protocol. If that ever occurs, then SNX, GMX, DYDX, INJ, GNS, and PERP token holders which have voted on any governance proposals might turn out to be liable and topic to prosecution for the protocol’s doubtlessly unlawful operations.

A number of distinguished figures within the crypto group have slammed the CFTC over the lawsuit. In response to the final council and head of decentralization on the famend enterprise capital agency Andreessen Horowitz, Miles Jennings, the vital situation with the CFTC’s case is that the company “is attempting to use the [Commodities Exchange Act] to a protocol and DAO in any respect.” Handed in 1936, virtually half a decade earlier than the Web was invented, the CEA was designed to control commodities and derivatives buying and selling on centralized marketplaces and due to this fact can’t—in its present kind—be appropriate for regulating software-based non-custodial buying and selling platforms.

The CFTC’s bZx enforcement motion would be the most egregious instance of regulation by enforcement within the historical past of crypto. We have complained at size concerning the SEC abusing this tactic, however the CFTC has put them to disgrace. Learn Comm’r Mersinger’s dissent:

— Jake Chervinsky (@jchervinsky) September 22, 2022

Jake Chervinsky, lawyer and head of coverage on the Blockchain Affiliation, stated that the transfer “would be the most egregious instance of regulation by enforcement within the historical past of crypto.” He added that “we’ve complained at size concerning the SEC abusing this tactic, however the CFTC has put them to disgrace.” 

The CFTC’s transfer comes after crypto’s authorized group has proven overwhelming assist for the company’s renewed push to turn out to be the first regulator of cryptocurrencies. In August, U.S. Senators Debbie Stabenow (D-MI), John Boozman (R-AR), Cory Booker (D-NJ), and John Thune (R-SD) launched the Digital Commodities Shopper Safety Act that seeks to shut regulatory gaps between state and federal regulation of cryptocurrencies. If handed, the DCCPA would make the CFTC the main oversight company for cryptocurrencies that aren’t in any other case deemed securities. 

In mild of its many destructive experiences with the Securities and Trade Fee, the crypto business largely embraced the DCCPA as a invoice that might get the securities regulator off its again and introduce some much-needed regulatory readability. With its most up-to-date enforcement motion, nevertheless, the CFTC appears to have erased any goodwill it had beforehand earned from the business’s stakeholders and prompted public dissent from one in every of its personal commissioners, Summer season Ok. Mersinger.

CFTC’s Prospects of Successful

Notably, commissioner Mersinger revealed a dissenting assertion opposing the CFTC’s technique within the Ooki DAO case. Particularly, he took situation with the company’s strategy to figuring out legal responsibility for DAO token holders based mostly on their participation in governance voting. “This strategy arbitrarily defines the Ooki DAO unincorporated affiliation in a way that unfairly picks winners and losers, and undermines the general public curiosity by disincentivizing good governance on this new crypto setting,” he stated.

Moreover, Mersinger argued that the strategy didn’t depend on any authorized authority granted within the CEA or related case regulation, represented undesirable “regulation by enforcement,” and ignored well-established precedent for figuring out legal responsibility in related violations. 

Commenting on the difficulty on Twitter, the previous affiliate deputy legal professional normal on the Division of Justice and present director of world regulatory issues at ConsenSys, William Hughes, stated that “a courtroom has to agree with the CFTC for these theories about DAO legal responsibility for a token to be significant.” He added that it’s “not going to be simple” for the CFTC to persuade any courtroom, suggesting that the lawsuit might not be as alarming because it first seems. 

It’s obvious that the CFTC’s arguments stand on relatively shaky floor, and the company will possible battle to win the case in a landslide—assuming satisfactory protection from Ooki DAO. If the CFTC loses the case, that ought to set a really promising authorized precedent for DAOs and governance token holders.

Disclosure: On the time of writing, the writer of this characteristic owned ETH and several other different cryptocurrencies.

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