The CFTC throws DAO liability into question
Good morning, and welcome to Protocol Fintech. This Monday: the big question of DAO liability, Gov. Gavin Newsom’s veto of California’s big crypto bill, and the search for Do Kwon.
Co-byline with Tomio Geron
DAO unto others
The winds from Washington blow ever colder in crypto winter. The industry is once again up in arms about what many call another “regulation by enforcement” action. But this time, Gary Gensler’s SEC isn’t the subject of their complaints. Instead, it’s the ostensibly more crypto-friendly CFTC that’s angered them, after the agency swept in members of a DAO into a civil enforcement action.
The CFTC is raising fundamental questions about a DAO’s liability. The organizations may be decentralized and autonomous, but they’re not beyond reach of the law.
The CFTC filed and settled charges against bZeroX, an LLC, and founders Tom Bean and Kyle Kistner, imposing a $250,000 penalty for violations of the Commodity Exchange Act and related regulations in their trading of digital assets.
It also filed suit against the Ooki DAO, which it called a “successor” to bZeroX, after it assumed control of a DeFi protocol at the heart of the CFTC’s action. The DAO, it said, was an “unincorporated association,” whose members are personally liable for the group’s actions.
It’s the first time the commission has pursued enforcement actions against a decentralized organization, and it’s also arguing that those who have voted on any previous DAO proposals are liable.
Even CFTC Commissioner Summer Mersinger disagreed. In a dissenting opinion, Mersinger argued that a decentralized protocol shouldn’t be treated like a company, nor voting token holders as that company’s operators.
“There is no provision in the CEA that holds members of a for-profit unincorporated association personally liable for violations of the CEA or CFTC rules committed by the association based solely on their status as members of that association,” she wrote.
Instead, she says the commission should have relied on Section 13(a) of the CEA, its aiding-and-abetting standard. The section requires knowledge of wrongdoing underlying a CEA violation or CFTC rules, and the intent to assist the individual leading in unlawful efforts.
Mersinger warned that by pursuing DAO members, the CFTC could cause a “chilling effect” on participation. Signs of that are already apparent: Sushiswap co-founder Ross Campbell tweeted Thursday that “if a DAO is really providing something like a public good or financial service that could be regulated, involving people is dumb.”
The actions may sound harsh, but they shouldn’t be a surprise. Though he agrees with Mersinger’s dissent, digital commerce lawyer Stephen Palley told Protocol it’s fairly predictable that the CFTC would treat a DAO as something that “looks like a business.”
Corporation law hasn’t caught up with DAOs. Wyoming has provided for legal recognition of DAOs, allowing the organizations to register as a special category of LLCs. Elsewhere and nationally, their legal status remains unsettled.
The Lummis-Gillibrand crypto bill has a brief section on DAOs, mostly recognizing them as taxable business entities, but doesn’t really clarify liability except to require that they be “properly incorporated.” That wouldn’t help organizations like the Ooki DAO.
The CFTC’s administrative action doesn’t set legal “precedent,” as some Twitter observers worried. But it does give insight into the views of the CFTC, which is poised to take on a larger role overseeing crypto markets.
This isn’t the only legal challenge Ooki DAO is facing. Users of the protocol who lost money after a hack last year are also attempting to sue the DAO.
The next move is in San Francisco, where the district court must decide whether to take up the CFTC’s case. Palley said he was skeptical it would, considering the resources required to track down individual voting members of the DAO from their wallet addresses. It also, as Consensys lawyer Bill Hughes pointed out, would have to agree the CFTC’s argument has merit. In the legal gray areas created by blockchain technology, DAO members will find out if they will hang together or hang separately.
Protocol link: https://www.protocol.com/newsletters/protocol-fintech/ooki-dao-cftc-liability