Commodity Regulators Targeting DeFi for Its Decentralised Features

    Simar Marwaha
    Simar Marwaha
    Published on October 27, 2022 6:20 PM

    Updated on January 25, 2023 7:54 PM

    Commodity Futures Trading Commission asserted in the case that "DAOs are not exempt from enforcement and may not violate the law with impunity."
    Commodity Regulators Targeting DeFi for Its Decentralised Features

    Regulators have long struggled to handle decentralized finance (DeFi), one of the ecosystems in the crypto market developing the fastest.

    DeFi is Permissionless as per DCCPA

    In 2022, American officials gave the developing region its undivided attention while prioritizing removing the ecosystem's anonymity.

    Users can trade, borrow, and lend digital assets directly to each other via  DeFi protocols. Decentralized autonomous organizations and automated intelligent contracts manage most initiatives in DeFi ecosystems by nature (DAOs).

    Condemning the fact and features of a DAO-dominated DeFi market, CFTC has imposed several restrictions on DeFi projects and DAOs through DCCPA (Digital Commodities Consumer Protection Act).

    Decentralized autonomous organizations (or "DAOs") have been seen as a mechanism to protect against regulatory action due to their decentralized nature within the current legal frameworks. The recent and first attempt by the Commodity Futures Trading Commission (CFTC) to hold a DAO and its members accountable challenges that presumption and sheds light on the future of decentralized finance (or "DeFi") in the United States.

    CFTC Targeting DAO Projects 

    In a recent Order, the CFTC ruled that bZeroX, LLC and its two founders had violated the Commodity Exchange Act ("CEA") by engaging in activities that could only have been legally performed by registered futures commission merchants ("FCM") or designated contract markets ("DCM"). 

    The Order also ruled that each DAO member who voted on governance changes is jointly and severally liable for the debts of the DAO as an unincorporated association.

    Under the same allegations, the CFTC also brought a federal civil enforcement action against Ooki DAO, a decentralized autonomous organization that later took over governance of the Ooki Protocol. 

    This lawsuit is noteworthy because it is the first time a regulatory body has brought legal action against a DAO. Should the CFTC prevail, it might have disastrous legal ramifications for those who own governance tokens in other cryptocurrency projects, including several DeFi protocols.

    CFTC has been active since the DAO industry has become widespread in numbers and public interest. 

    DeFi is at Risk from Commodity Regulators 

    The unique aspects of DeFi are in danger from the DCCPA. Although the term "decentralized" is not used once in the law, DEXs are most likely covered by its reach because of the broad definition of "digital commodity trading facility" (i.e., anything that makes it possible to execute the sale or exchange of digital commodities between individuals). 

    As a result, DEXs would have to comply with various regulations, starting with the need to register with the CFTC.

    The issue with these regulations is that many of them target "intermediary risks," or the possibility for financial middlemen to misuse the assets and information in their control, as current CFTC Commissioner Kristin N. Johnson put it in a 2021 law review article.

    Although the possibility that DAOs could avoid having their tokens classified as securities has strengthened the use of a fully decentralized structure lacking legal form, the risk of a general partnership—and particularly voting member liability as an "unincorporated association"—will likely lead to an increase in the use of conventional legal entities in DAO formation and governance for both the DAO and individual participants.