- The CFTC has filed a lawsuit against the decentralized autonomous organization behind the Ooki Protocol, Ooki DAO, for allegedly operating an illegal derivatives trading platform.
- The lawsuit marks the first time a government agency has accused governance token holders of a non-custodial decentralized blockchain protocol of allegedly violating the law.
- The case could set a terrible legal precedent for DAO and DeFi governance token holders.
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In the lawsuit, the Commodity Futures Trading Commission said that “DAOs are not immune from enforcement and cannot break the law with impunity.”
CFTC sues Ooki DAO in historical case
The Commodity Futures Trading Commission has launched a controversial attack on a DAO and could have serious consequences for DeFi.
In a press release on Thursday, the US government agency announced that it had simultaneously compiled and resolved charges against 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 said that by designing, implementing and marketing the bZx protocol, a decentralized protocol based on smart contracts for margin trading, without registering with the agency, the defendants were illegally operating a designated contract market (DCM), engaged in activities that only Registered Future Commission (FCM) traders can perform and have not conducted mandatory know-your-customer (KYC) diligence on platform users.
The CFTC also filed federal civil enforcement action against the Ooki DAO, a decentralized autonomous organization that subsequently took over governance over the Ooki Protocol, on the same charges. This case is significant because it marks the first time a regulatory agency has sued a DAO and because the legal implications of the CFTC’s victory could set a terrible legal precedent for governance token holders of other crypto projects, including many DeFi protocols.
In the lawsuit, the CFTC defined Ooki DAO as an “unincorporated association” comprised of BZRX token holders “who vote those tokens to govern (for example, to modify, operate, market and take other actions with respect to) the bZx protocol.” The agency says bZx founders Bean and Kistner have transferred control of the protocol to the community in an effort to circumvent the regulations. He said:
“A key goal of bZeroX in transferring control of the bZx protocol (now Ooki protocol) to the DAO bZx (now DAO Ooki) was to try to make the DAO bZx, due to its decentralized nature, application-proof. Put simply, the founders of bZx believed they had found a way to violate the law and regulations, as well as other laws, without consequences. “
“The founders of bZx were wrong, however,” concluded the CFTC, stating that “DAOs are not immune to enforcement and cannot break the law with impunity.”
The implications for DeFi token holders
By labeling the DAO as an association with no legal personality, the CFTC has effectively stated that its members have unlimited liability and are fully accountable for any of its actions. This topic is of particular concern given that the regulator didn’t care that the Ooki protocol was a decentralized, non-custodial protocol powered by smart contracts. As such, it cannot comply with existing regulations designed for centralized financial entities, nor can it be closed by DAO members or any other party.
The CFTC winning the court case would set a legal precedent that could make it much easier for the agency to target other decentralized derivatives trading protocols such as Synthetix, GMX, dYdX, Injective, Gains Network, and Perpetual Protocol. Should this ever happen, SNX, GMX, DYDX, INJ, GNS and PERP token holders who voted on any governance proposal could become accountable and liable for potentially illegal operations of the protocol.
Several prominent figures in the cryptocurrency community have criticized the CFTC for the cause. According to the general council and head of decentralization at renowned venture capital firm Andreessen Horowitz, Miles Jennings, the critical issue with the CFTC case is that the agency “is trying to enforce the [Commodities Exchange Act] to a protocol and DAO to all. “Approved in 1936, nearly half a decade before the invention of the Internet, the CEA was designed to regulate the trading of commodities and derivatives on centralized markets and therefore cannot, in its current form, be suitable for regulating trading platforms. software-based non-custodial trading.
CFTC’s bZx executive action may be the most striking example of regulation by application in the history of cryptocurrencies. We’ve long complained that the SEC abused this tactic, but the CFTC put them to shame. Read Comm’r Mersinger’s dissent: https://t.co/0T3l3y79H7
– Jake Chervinsky (@jchervinsky) September 22, 2022
Jake Chervinsky, attorney and chief of policy at the Blockchain Association, She said that the move “could be the most striking example of regulation by application in the history of cryptocurrencies.” He added that “we complained for a long time that the SEC abused this tactic, but the CFTC put them to shame.”
The CFTC’s move comes after the cryptocurrency legal community showed overwhelming support for the agency’s renewed drive to become the leading cryptocurrency regulator. In August, US Senators Debbie Stabenow (D-MI), John Boozman (R-AR), Cory Booker (D-NJ) and John Thune (R-SD) introduced the Digital Commodities Consumer Protection Act which seeks to bridge regulatory gaps between state and federal cryptocurrency regulation. If approved, the DCCPA would make the CFTC the primary oversight agency for cryptocurrencies that are not otherwise considered securities.
In light of its many negative experiences with the Securities and Exchange Commission, the cryptocurrency industry has broadly embraced the DCCPA as a bill that could lift the securities regulator and introduce the necessary regulatory clarity. With its most recent executive action, however, the CFTC appears to have wiped out any benevolence previously gained from industry stakeholders and sparked public dissent from one of its own commissioners, Summer K. Mersinger.
CFTC Winning Prospects
Notably, Commissioner Mersinger issued a dissenting statement opposing the CFTC strategy in the Ooki DAO case. In particular, he challenged the agency’s approach to determining liability for DAO token holders based on their participation in the governance vote. “This approach arbitrarily defines the unincorporated Ooki DAO association in a way that unfairly chooses winners and losers and undermines public interest by discouraging good governance in this new crypto environment,” he said.
Furthermore, Mersinger argued that the approach was not based on any legal authority granted in the CEA or relevant case law, represented undesirable “regulation by application” and ignored established precedent for determining liability in similar violations.
Commenting on the matter on Twitter, former associate deputy attorney general at the Department of Justice and current director of global regulatory affairs at ConsenSys, William Hughes, She said that “a court must agree with the CFTC for these theories of DAO liability for a token to be meaningful.” He added that “it won’t be easy” for the CFTC to convince any court, suggesting that the lawsuit may not be as alarming as it first appears.
It is clear that the CFTC’s arguments rest on rather unstable ground and the agency will likely struggle to win the case overwhelmingly, assuming adequate defense from bZeroX, LLC and its founders. If the CFTC loses the lawsuit, this should set a very promising legal precedent for DAO and governance token holders.
Disclosure: At the time of writing, the author of this feature owned ETH and several other cryptocurrencies.