Summary
In the CFTC v. Ooki DAO case, since Ooki DAO did not respond to the lawsuit, the CFTC won an overwhelming victory. The court ruled that Ooki DAO should stop operating in the United States, close its website and delete its content, and pay a fine of $643,542.
The judge agreed with the CFTC's definition of DAO as an unincorporated organization, so DAO can be sued and bear legal responsibility
After DAO can be sued, the chain is no longer a lawless place. Regulatory enforcement agencies can use this as a breakthrough to regulate DAO, DeFi, and DEX projects on the chain.
On-chain DAO = Unincorporated Association = All governance members may bear joint liability of the DAO
1. CFTC’s Victory
On June 9, 2023, the U.S. Commodity Futures Trading Commission (CFTC) announced that it had achieved a "sweeping victory" against Ooki DAO at the judicial level, setting an unprecedented precedent for DAO to bear legal responsibility as a defendant.
In the case of CFTC v. Ooki DAO, a California judge in the United States made a "non-response ruling" in favor of the CFTC on June 8, 2023, ruling that Ooki DAO was civilly liable for operating an illegal trading platform and unlawfully acting as a Futures Commission Merchant (FCM), and imposed a fine of $643,542, and ordered the permanent closure of Ooki DAO's website and the removal of its content from the Internet.
Crucially, in this precedent-setting ruling, the court held that Ooki DAO was a "person" under the U.S. Commodity Exchange Act and could be held legally liable as a defendant. CFTC officials said: "This ruling should serve as a wake-up call to those who think they can circumvent the law by adopting a DAO structure and intend to avoid regulatory enforcement and ultimately put the public at risk."
This ruling is crucial for DAO and DeFi project owners: (1) The court defines DAO as a suable subject (Person), and the chain is no longer a lawless place. Regulatory enforcement agencies can use this as a breakthrough to regulate on-chain DAO, DeFi, and DEX projects; (2) The on-chain DAO is defined by the CFTC as an "unincorporated association" in terms of legal attributes, and is accepted by the court, which means that members participating in DAO governance may bear joint and several legal liability for the DAO.
2. Ooki Case Details
The bZx protocol is a blockchain-based decentralized DeFi protocol that allows users to provide virtual assets as collateral to establish leveraged positions for trading. The value of the transaction is determined by the price difference between the two virtual assets and does not involve the sale of actual virtual assets.
The bZx protocol was originally developed and maintained by bZeroX LLC and its founders. On approximately August 23, 2021, bZeroX LLC transferred control of the bZx protocol to the bZx DAO (ultimately renamed Ooki DAO on November 18, 2021). From that point on, Ooki DAO could only be governed through votes by OOKI Token holders. The CFTC quoted one of the bZx protocol founders as saying at the time: "Transitioning to a DAO would shield the bZx protocol from legal regulation and accountability." Obviously, the CFTC disagrees.
On September 22, 2022, the CFTC brought two enforcement actions against Ooki DAO: (1) penalties against bZeroX LLC and the founders of the bZx protocol, which were ultimately settled; and (2) an action against Ooki DAO for (i) illegally offering over-the-counter leveraged and margined retail commodity trading; (ii) engaging in futures trading (FCM) without a registration; and (iii) failing to perform KYC verification and customer identification procedures (CIP) as required by FCMs under the Bank Secrecy Act. The court subsequently approved notice and service of subpoenas on Ooki DAO and DAO members via forum chatbots and forum post announcements.
Subsequently, four Web3 institutions, including Paradigm, a16z, DeFi Education Fund (supported by UniSwap), and LeXpunK_Army (supported by Yearn, Curve & Lido), submitted Amicus Briefs to the court in support of Ooki DAO, stating that it was unreasonable for the CFTC to require DAO members/token holders to bear the DAO's responsibilities simply through governance voting. Miles Jennings, general counsel of a16z, further stated that the focus should be on those members who voted for the illegal behavior of the DAO rather than the members of the entire DAO.
After Ooki DAO missed the final deadline of January 2023 to respond, the CFTC began to apply to the court for a “non-response ruling” on the case, which means that Ooki DAO failed to defend itself in court. It may also be a “strategic” abandonment. Obviously, no DAO member is willing to bear the CFTC’s accountability.
On June 8, 2023, a California judge finally ruled in favor of the CFTC, which means that the CFTC does not need to prove its case against Ooki DAO. Although Ooki DAO has many supporters, the fact that no one responded to the lawsuit has set a bad precedent for the regulator's supervision of DAO.
CFTC Chairman Rostin Behnam believes that Ooki DAO is a clear case of fraud, and the organizers are suspected of trying to evade CFTC supervision and illegally provide leveraged and margin digital asset derivatives trading to retail customers in the United States. He described DAO as a unique technology, but this does not exempt DAO from the regulatory framework at the state or federal level.
III. Impact and consequences of the CFTC’s victory
Since Ooki DAO did not respond to the lawsuit, the California judge basically agreed to all the CFTC's claims, and the CFTC did not need to make any explanation for its claims. Since the United States is a country of common law, this ruling is bound to have a huge impact on the crypto world: DAO is defined as a subject of litigation, and the chain is no longer a lawless place. Regulatory enforcement agencies can use this case as a breakthrough to supervise DAO, DeFi, and DEX projects; at the same time, members participating in DAO governance may bear joint and several legal liability for DAO.
3.1 On-chain DAO is no longer a lawless place
In the Digital Assets column of the CFTC’s official website, all virtual assets, including all virtual currencies, are classified as “commodities”. This will give the CFTC the authority to regulate derivative transactions in the virtual asset futures market, as well as fraud and market manipulation in the virtual asset spot market. However, the CFTC has no authority to regulate virtual asset transactions in the spot market that do not involve margin, leverage or financing.
Before bZeroX LLC was transformed into a DAO, bZeroX and its founders were undoubtedly responsible for the corresponding legal liabilities of the violations. It is worth noting that the California judge agreed with the CFTC’s definition of Ooki DAO as an “unincorporated association”, which is a person subject to action under the Commodity Exchange Act and can bear legal liability as a defendant.
This means that after this case, the CFTC will have the right to regulate and file lawsuits against projects such as DAO and DeFi that are engaged in the virtual asset futures derivatives market. Is it estimated that decentralized derivatives exchanges such as dYdX and Synthetix are trembling? What is more intensively feared is whether the SEC can use this judgment to directly enforce administrative law against those project parties and decentralized exchanges (DEX) that the SEC believes are "issuing and selling unregistered securities"?
(https://www.bitstamp.net/learn/web3/what-is-a-decentralized-exchange-dex/)
3.2 Members of the DAO may be required to bear joint and several legal liability of the DAO
Although the judge's penalty was only imposed on Ooki DAO, the CFTC, based on federal law and a series of state precedents on partnership law, determined that members of a for-profit unincorporated organization are required to bear personal joint and several liability for the organization's actions, which means that members participating in Ooki DAO governance may be exposed to the risk of assuming personal joint and several liability. It is not yet known how the CFTC will implement the fine.
This is fatal for DAO, which is different from legal entities such as LLC or Corp, which can distinguish the liability of legal entities from the liability of individuals. The CFTC compared bZeroX LLC with Ooki DAO, that is, LLC and Ooki DAO both control the bZx protocol, and LLC and Ooki DAO both govern the bZx protocol through member voting. Therefore, the CFTC stated: Once the OOKI Token holder influences the outcome of the Ooki DAO governance proposal through governance token voting, the OOKI Token holder can be deemed to have voluntarily participated in the Ooki DAO governance and needs to bear personal responsibility for the actions of the DAO.
3.3 Regulation of DeFi opens up new avenues of thinking
Following the US regulators' sanctions on the mixer DeFi protocol Tonardo Cash in August 2022, the US regulators further expanded the regulatory dimension of on-chain DeFi projects. For Tonardo Cash, the US regulators listed it on the SDN list on the grounds of money laundering for terrorists, which means that all US individuals or entities are prohibited from trading with Tonardo Cash or wallet addresses bound to the protocol. Ooki DAO went a step further. The US regulators directly required the relevant servers to shut down the Ooki DAO website and delete online content on the grounds that DAO's business violated laws and regulations, and prohibited Ooki DAO from conducting any business in the United States.
On April 6, 2023, the U.S. Treasury Department released the 2023 DeFi Illegal Financial Activity Assessment Report, the world's first DeFi-based illegal financial activity assessment report. The report recommends strengthening U.S. AML/CFT supervision and, where possible, strengthening law enforcement on virtual asset activities (including DeFi services) to improve virtual asset service providers' compliance with BSA obligations. It can be seen that U.S. supervision also follows this line of thought, supervising the deposit and withdrawal business of virtual assets from the perspective of AML/CTF, controlling the source, and then supervising the compliance of the business of specific projects from the perspective of investor protection.
4. Solution - Legal Wrapper for DAO
Obviously, the CFTC can tear down the barrier of the lawless place on the chain with this case. Therefore, the chain is no longer a lawless place. And legally wrapping decentralized DAO and DeFi projects to protect the limited liability of members is already a must, not an option.
The DAO Legal Wrapper is a set of legal frameworks or legal entities specifically for DAOs, which provides DAOs with a recognized legal status in relevant jurisdictions. Its essence is to "wrap" DAOs in a legal framework, so that DAOs can be linked to the traditional legal system, ensuring compliance with relevant laws and regulations, protecting the limited liability of DAO members, and bridging the gap between DAOs and the real world.
Founders and members of unregistered DAOs face legal risks, in particular:
A. Risk of legal liability. Like Ooki DAO, an unregistered DAO can be considered a general partnership. Once a DAO is recognized as a general partnership, each member of the DAO may be personally jointly and severally liable for all assets and liabilities of the DAO. A registered DAO can be a separate legal entity, which can meet the compliance requirements of the place of registration and other jurisdictions, and more importantly, provide DAO members with limited liability similar to a corporate organization.
B. Tax risks. DAO members may face fines or other penalties if they fail to pay income tax. A registered DAO can make a series of mature tax declarations based on its organizational form and meet the tax compliance requirements of relevant jurisdictions.
C. Financial compliance risks. Absorbing funds or engaging in economic activities in the anonymous blockchain world without relevant KYC/AML/CTF verification procedures to check the source of funds may lead to administrative and criminal investigations involving securities compliance, AML/CTF compliance, and financial crimes.
DAO legal entities can be registered as different organizational forms: Foundations, Associations, Non-Profit LLC or For-Profit LLC. The actual choice of organizational form and jurisdiction depends on the type of DAO (community/protocol, service, investment), business model, token functionality and other factors. When deciding which jurisdiction to establish a DAO, it depends entirely on the DAO's business model, legal needs and preferences. There are usually three main criteria for judgment: (1) Does the DAO want to generate revenue and distribute it to members? (2) The degree of decentralization of the DAO; (3) Will the DAO issue tokens in the future?
5. Final Thoughts
After the US regulators recovered from the FTX incident, they conducted regulatory enforcement activities against many major players in the crypto world, such as Coinbase, Kraken, Paxos, Silvergate Bank, Signature Bank, Justin Sun, and Binance in the first quarter of 2023. In particular, the SEC recently chose to challenge the two major crypto giants, Coinbase and Binance, and listed some of their listed tokens as "securities", while the CFTC has torn open the barrier of the crypto world behind the scenes, exposing nearly 12,745 DAO organizations and their $20 billion virtual assets in the crypto chain world to the CFTC's gun.
DAO, DeFi, and DEX project parties need to be especially vigilant!
