CFTC Lawsuit Aims to Rein in DeFi

A pair of lawsuits by the Commodity Futures Trading Commission (CFTC) could upend the decentralized finance (DeFi) industry as we know it, making the projects ungovernable and threatening anyone who participates in the governance voting that manages one with civil and possibly criminal liability.

The issue came in an otherwise unremarkable enforcement lawsuit against DeFi exchange developers bZeroX and its founders, who agreed to a $250,000 settlement for failing to register as Futures Commission Merchants (FCM) or enforce Bank Secrecy Act know your customer (KYC) regulations, the CFTC said on Sept. 22.

But at the same time, the agency announced another lawsuit against the decentralized autonomous organization (DAO) that runs the Ooki, which offers crypto lending, borrowing and margin trading of cryptocurrencies. That sent shockwaves through the entire crypto community, as it essentially unwinds the presumption that governance token-holders who participate in votes that manage the DAO are not liable for its actions.

See also: Unpacking DeFi and DAO

It also drives a truck-sized hole through the widespread belief that DAOs, which in theory have no human managers, headquarters or corporate structure, are immune from regulations and legal requirements.

“It is clear that the CFTC believes that anyone who participates in governance of a protocol, even on one occasion, should be held liable for activity on the protocol that violates laws the CFTC enforces,” Marc Boiron, chief legal officer at Polygon Companies, which builds blockchain infrastructure, told Bloomberg.

“By transferring control to a DAO, bZeroX’s founders touted to bZeroX community members the operations would be enforcement-proof,” the CFTC said in the announcement. “The DAO was an unincorporated association of which [its developers] were actively participating members and liable for the Ooki DAO’s violations of the CEA and CFTC regulations.”

Read more: ‘Decentralization Theater’ and the Myth of DeFi

It’s the second time in two months that U.S. regulators have taken on DeFi projects by treating them like businesses and going after developers.

On Aug. 8, the Treasury Department’s Office of Foreign Assets Control (OFAC) placed sanctions on crypto mixing service Tornado Cash, alleging that it helped North Korean hackers launder stolen crypto that supports its nuclear program.

Related: Tornado Cash Arrest Signals Gathering AML Storm for DeFi Developers

Meanwhile, saying that DeFi had not yet really touched mainstream financial markets, Federal Reserve Chairman Jerome Powell warned at a Banque de France panel on Tuesday (Sept. 27) that the state of affairs will not last. As a result, he said, “as DeFi expands and starts to touch more and more retail customers, there’s a real need for more appropriate regulation to be in place.”

Around the World

A source at the European Union told CoinDesk on Sept. 28 that it will punish Russia for its “sham” independence votes in occupied Ukraine by scrapping a €10,000 cap on crypto holdings by Russians, which the publication said could mean the new cap will be zero — effectively banning any Russian crypto transactions to the EU.

Hard on the heels of a U.S. Justice Department report that announced a new Crypto Crime prosecutors division and sought to double jail time for money transmission crimes (citing crypto’s involvement in them), the United Kingdom introduced a new Economic Crime and Corporate Transparency Bill that seeks to make it quicker and easier for law enforcement to “seize, freeze and recover cryptoassets,” Decrypt said on Sept. 23.

Learn more: DOJ Seeks to Double Jail Time for Money Transmission Crimes

Furthermore, Japan plans to pass a law toughening remittance rules that would make it harder for criminals to launder money using cryptocurrencies by strengthening the anti-money laundering (AML) and KYC requirements for transfers between exchanges, according to Nikkei Asia.

In addition, the Foreign Exchange and Foreign Trade Act will be updated to add stablecoins to its list of regulated assets.

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