What’s next for DAOs? Breaking down the CFTC’s latest enforcement action


On Sept. 22, the Commodity Futures Trading Commission (CFTC) filed a lawsuit against Ooki DAO in the U.S. District Court for the Northern District of California.

The complaint alleged that the DAO was an unincorporated association involved in unlawful activity.

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This complaint has broad implications for the entire crypto industry. There are now 2,276 DAOs, according to DeepDAO, which control a wide array of blockchain-based financial tools and look after $9.5 billion in cryptocurrency among their treasuries.

These DAOs include 3.9 million governance token holders and 696,000 active participants — many of whom may well be affected by this type of regulatory approach.

As might be expected, the bulk of the industry responses to the enforcement action skewed negatively. 

“The CFTC’s bZx enforcement action may be the most egregious example of regulation by enforcement in the history of crypto. We’ve complained at length about the SEC abusing this tactic, but the CFTC has put them to shame,” said Jake Chervinsky, head of policy at the Blockchain Association.

Breaking down the complaint

The enforcement action was quite clear. The CFTC argued that the Ooki DAO was responsible for running an unlicensed exchange offering margin and futures trading over multiple blockchains. 

The complaint applied this to every individual who has voted on decisions with the DAO’s governance tokens — but also included any other person or entity associated with the DAO. The CFTC claimed jurisdiction since some DAO members have resided in the U.S. and voted on governance decisions from within the U.S.

The complaint asked for a range of actions from the court, such as a finding that the DAO and its members violated CFTC regulations. The regulator also wants an injunction placed on such members to prevent them from offering such trading services.

The CFTC is also seeking a second injunction to prevent members from trading on registered exchanges and applying for registration with the commission, among other things, as well as penalties and repayment to investors. 

Not everyone at the CFTC was in full support, however.

Commissioner Summer Mersinger wrote a letter of dissent, criticizing its lack of “legal authority” and describing it as “blatant ‘regulation by enforcement’.”

Plus, Mersinger pointed out that it unfairly sweeps all token holders who have voted on any issues — no matter how unrelated to the platform’s core purpose — under one umbrella. She also provided an alternative means of enforcement.

What will the impact be?

Multiple lawyers and commentators expressed concerns that this approach — if approved by the courts — will have negative implications for the DAO space and those who participate in distributed, protocol-level governance.

“The effect of this order is that any protocol DAO token holders who vote are members of an unincorporated [association] that – if it’s doing DeFi things – is likely breaking CFTC rules. This is really bad,” said Jason Schwartz, tax partner and co-head of digital assets at Fried Frank.

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One key element is that this could apply to many types of DAOs since most are primarily focused on financial tools and resources. This includes many complex financial platforms that offer margin and leverage trading for tokens, plus token staking and derivative tokens tied to those processes.

Gabriel Shapiro, general counsel at Delphi Digital Labs, pointed out this could even apply to MakerDAO’s vaults, where tokens are locked up in order to create units of the decentralized stablecoin DAI. He said such transactions could constitute leveraged retail commodities transactions under the premise of the latest CFTC enforcement action.

The other element is that the CFTC action could apply broadly to those taking part in DAO governance, even if they only played a small role.

“This is a horrible precedent. It means that both on-chain governance voters AND multi-sig signers have liability, but on-chain governance spreads liability to many more people,” said Will Papper, co-founder of SyndicateDAO, adding:

“Under this more pessimistic view, if the DAO did something that it could be liable for, everyone involved could be held liable. For multi-sigs, that’s the signers. For on-chain governance, that’s the voters. That’s right, you can be liable for voting in a governance proposal.”

DAOs and compliance 

The developments lead to a key question: whether this enforcement action is the beginning of the end for DAOs. Or, if the CFTC moves could force DAOs to be compliant with all rules and regulations and even result in the adoption of KYC and AML procedures.

Drew Hinkes, a partner at K&L Gates, weighed in: “Maybe this isn’t the death of all Daos but a strong reminder that you shouldn’t offer regulated transactions to U.S. persons if you’re not complying with the regulations?”

Another possibility: DAOs either adhere to U.S. regulations or stay out of the American sphere entirely, possibly through the use of geoblocking. Still, that approach is easier said than done, given that blockchains can be directly accessed from anywhere with an internet connection. 

Collins Belton, managing partner at Brookwood P.C., said: “I see weakness in their [futures commission merchant] perspective but if allowed to stand, I don’t see an easy path forward for governance DAOs.”

Not everyone was overly fearful, however.

Bill Hughes, senior counsel and director of global regulatory matters at ConsenSys, said: “A court has to agree with the CFTC for these theories about DAO liability for a token to be meaningful. That’s not going to be easy for the CFTC.”

“Chill out everybody. World hasn’t ended,” he added.

 

© 2022 The Block Crypto, Inc. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.




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