CFTC wins lawsuit against Ooki DAO, setting a precedent for DAOs to be held legally responsible.
CFTC wins lawsuit against Ooki DAO, setting legal precedent for DAOs' liability.
Abstract
In the case of CFTC v. Ooki DAO, due to the lack of response from Ooki DAO, the CFTC achieved a sweeping victory. The court ruled that Ooki DAO must stop operating in the United States, close its website and delete its content, as well as pay a fine of $643,542;
The judge agreed with the CFTC’s definition of DAO as an unincorporated association, making DAO a subject of litigation and thus liable for legal responsibility;
After DAO became a subject of litigation, the on-chain space is no longer a legal vacuum, and regulatory agencies can use this as a breakthrough to regulate on-chain DAOs, DeFi, and DEX projects;
On-chain DAO = unincorporated association = all participating governance members may bear joint liability for DAO.
I. CFTC’s Victory
On June 9th, 2023, the U.S. Commodity Futures Trading Commission (CFTC) announced that it had achieved a “sweeping victory” over Ooki DAO in the judicial sphere, creating an unprecedented precedent for DAO as a subject of litigation and thus liable for legal responsibility.
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In the case of CFTC v. Ooki DAO, U.S. California judge issued an “uncontested ruling” 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 $643,542 fine, and ordered the permanent closure of Ooki DAO’s website and the removal of its content from the Internet.
Importantly, in this precedent-setting ruling, the court held that Ooki DAO is a “person” as defined by the U.S. Commodity Exchange Act and can be held legally liable as a defendant. CFTC officials said: “This ruling should sound the alarm for those who think they can evade the law by adopting DAO architecture and intend to avoid regulatory enforcement and ultimately endanger the public.”
This ruling is critical for DAOs and DeFi projects: (1) the court defined DAOs as subjects of litigation (Person), so the on-chain space is no longer a legal vacuum, and regulatory agencies can use this as a breakthrough to regulate on-chain DAOs, DeFi, and DEX projects; (2) on-chain DAOs are defined by the CFTC as “unincorporated associations,” which is accepted by the court, meaning that members participating in DAO governance may bear joint legal liability for DAO.
2. Details on the Ooki Case
The bZx protocol is a blockchain-based decentralized finance (DeFi) protocol that allows users to provide virtual assets as collateral to establish leveraged positions for trading. The value of the trade is determined by the price difference between two virtual assets, and does not involve the actual sale of virtual assets.
Initially developed and maintained by bZeroX LLC and its founders, the control of the bZx protocol was transferred to bZx DAO (renamed Ooki DAO on November 18, 2021) on August 23, 2021, and since then, Ooki DAO can only be governed by the votes of OOKI Token holders. The CFTC cited one of the bZx protocol founders’ statement at the time: “Transitioning to a DAO will protect the bZx protocol from legal regulation and accountability.” Obviously, the CFTC does not agree.
On September 22, 2022, the CFTC took two enforcement actions against Ooki DAO: (1) penalties against bZeroX LLC and bZx protocol founders, ultimately settling the case; and (2) lawsuit against Ooki DAO, alleging that Ooki DAO (i) illegally provided off-exchange margin and retail commodity transactions; (ii) engaged in futures trading (FCM) without registration; and (iii) failed to perform KYC verification and customer identification procedures (CIP) in accordance with FCM requirements under the Bank Secrecy Act. The court subsequently approved the notice and subpoena to Ooki DAO and DAO members through forum chatbot and forum post notices.
Subsequently, Blockingradigm, a16z, DeFi Education Fund (UniSwap support), and LeXpunK_Army (Yearn, Curve & Lido support) have all submitted amicus briefs to the court in support of Ooki DAO, stating that demanding DAO members/token holders to bear the responsibility of the DAO solely through governance voting is unreasonable. Miles Jennings, general counsel for a16z, further stated that the focus should be on those members who vote for illegal conduct of the DAO rather than the entire DAO.
After Ooki DAO missed the final deadline for response in January 2023, the CFTC began applying for a “non-response judgment” in the case, which means that Ooki DAO did not defend itself in court and may be a “strategic” abandonment, obviously no DAO members are willing to bear the responsibility of the CFTC.
On June 8, 2023, a California judge issued a final “default judgment” against CFTC, which means that CFTC does not need to prove its reasons for accusing Ooki DAO. Despite widespread support for Ooki DAO, the lack of response has set a bad precedent for regulatory agencies overseeing DAOs.
CFTC Chairman Rostin Behnam believes that Ooki DAO is a clear case of fraud, with organizers attempting to evade CFTC oversight and illegally offering leveraged and margined digital asset derivatives trading to US retail customers. He described DAOs as unique technology, but this does not exempt them from state or federal regulatory frameworks.
Three, the impact and consequences of CFTC’s victory
Since Ooki DAO did not respond, the California judge largely agreed to all of CFTC’s claims, and CFTC does not need to explain its claims. Because the United States is a common law country, this ruling will inevitably have a huge impact on the crypto world: DAOs are defined as sue-able entities, and the on-chain is no longer a legal vacuum. Regulatory enforcement agencies can use this case as a breakthrough to regulate DAOs, DeFi, and DEX projects. At the same time, members participating in DAO governance may bear joint legal responsibility for the DAO.
3.1 On-chain DAO is no longer a legal vacuum
On the CFTC official website’s Digital Assets column, all virtual assets, including all virtual currencies, are classified as “commodities”, which will enable CFTC to regulate the derivatives trading of virtual assets in the futures market, as well as fraud and market manipulation in the spot market of virtual assets. However, CFTC has no authority to regulate virtual asset transactions in the spot market that do not involve margin, leverage, or financing.
Before bZeroX LLC became a DAO, bZeroX and its founders were undoubtedly responsible for any violations. It is worth noting that the California judge agreed that CFTC defined Ooki DAO as an “unincorporated association”, which is a sue-able entity under the Commodity Exchange Act and can be sued as a defendant.
This means that after this case, the CFTC will have the power to regulate DAOs, DeFi, and other projects engaged in virtual asset futures derivatives markets and file lawsuits against them. Are dYdX, Synthetix, and other decentralized derivative exchanges trembling? Even more frightening is whether the SEC can use this ruling to directly enforce administrative law against project parties and decentralized exchanges (DEXs) that the SEC believes are “issuing and selling unregistered securities.”
(https://www.bitstamp.net/learn/web3/what-is-a-decentralized-exchange-dex/)
3.2 DAO members may need to assume joint legal responsibility for DAOs
Although the judge’s sentence is only aimed at Ooki DAO, the CFTC has determined that members of for-profit non-corporate organizations need to assume personal joint liability for the organization’s actions based on federal law and a series of state partnership law precedents. This means that members who participate in Ooki DAO governance may be exposed to the risk of personal joint liability. It is unknown how the CFTC will carry out the enforcement of fines.
This is fatal to DAOs, which are different from legal entities such as LLCs or Corps, which can distinguish between the entity’s legal liability and the personal liability of individuals. The CFTC compares bZeroX LLC and 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 states: once OOKI token holders influence the results of Ooki DAO governance proposals through governance token voting, the OOKI token holder can be deemed to voluntarily participate in Ooki DAO governance and be held personally responsible for DAO’s actions .
3.3 Regulatory thinking for DeFi
Following the US regulatory agency’s sanctions against the mixer DeFi protocol Tonardo Cash in August 2022, the US regulatory agency further expanded the regulatory dimension of on-chain DeFi projects. For Tonardo Cash, the US regulator listed it in the SDN list on the grounds of terrorist money laundering, which means that all US individuals or entities are prohibited from trading with Tonardo Cash or wallet addresses tied to the protocol. Ooki DAO went further and the US regulator directly demanded the relevant server to close the Ooki DAO website and delete online content on the grounds of illegal and irregular DAO business, prohibiting Ooki DAO from conducting any business in the United States.
On April 6, 2023, the US Treasury Department released the 2023 DeFi Illegal Financial Activity Assessment Report, which is the world’s first DeFi-based illegal financial activity assessment report. The report recommends strengthening US AML/CFT supervision and, where possible, strengthening enforcement of virtual asset activities (including DeFi services) to enhance compliance with BSA obligations by virtual asset service providers. It can be seen that US regulation is also following this line of thinking, regulating virtual asset deposit and withdrawal services from the perspective of AML/CTF, controlling the source, and then regulating the compliance of specific project business from the perspective of investor protection.
Four, solution – DAO legal wrapper
Obviously, the CFTC can tear down the barrier of the lawless land on the chain with this case. Therefore, the chain is no longer a lawless land. It is a must, rather than an option, to provide legal packaging (Legal Wrapper) for decentralized DAO and DeFi projects to protect the limited liability of members.
DAO’s legal packaging (Legal Wrapper) is a collection of legal frameworks or legal entities specifically designed for DAOs, which provides DAOs with a recognized legal status under relevant jurisdictions. Its essence is to “package” the DAO in a legal framework, so that the DAO can be linked with the traditional legal system, ensuring compliance with relevant laws and regulations, protecting the limited liability of DAO members, and bridging the gap between DAO and the real world.
Founders and members of unregistered DAOs will face legal risks, especially:
A. Legal liability risks. Just like Ooki DAO, an unregistered DAO can be regarded as a general partnership. Once a DAO is recognized as a general partnership, each member of the DAO may bear joint and several legal liability for all assets and liabilities of the DAO. A registered DAO can function as a separate legal entity, which can meet compliance requirements in the registration location and other jurisdictions, and more importantly, can provide limited liability similar to the organizational form of a company for DAO members.
B. Tax Risks. DAO members may face fines or other penalties if they fail to pay income tax, while a registered DAO can make a series of mature tax declarations based on its organizational form and meet relevant jurisdictional tax compliance requirements.
C. Financial Regulatory Risks. In the anonymous blockchain world, it is possible to absorb funds or engage in economic activities without relevant KYC/AML/CTF verification procedures to check the source of funds, which may involve securities compliance, AML/CTF compliance, financial crime administrative, criminal investigations.
DAO legal entities can be registered as different organizational forms: Foundations, Associations, Non-Profit LLCs, or For-Profit LLCs. The actual choice of organizational form and jurisdiction depends on the DAO type (community/protocol, service, investment), business model, token function, and other factors. When deciding where to establish a DAO, it depends entirely on the DAO’s business model, legal requirements, and preferences, and there are usually three main criteria: (1) Does the DAO want to generate revenue and distribute it to members? (2) The degree of decentralization of DAO; (3) Will the DAO issue tokens in the future?
V. Conclusion
After the US regulatory agency recovered from the FTX incident, it conducted regulatory enforcement activities against many major participants in the crypto world, such as Coinbase, Kraken, Blockingxos, Slivergate Bank, Signature Bank, Justin Sun, and Binance in the first quarter of 2023. In particular, the SEC recently chose to positively challenge Coinbase and Binance, the two major crypto giants, and listed some of the tokens they listed as “securities”, while the CFTC has torn open the barrier of the crypto world behind the scenes, exposing the nearly 12,745 DAO organizations and their $20 billion virtual assets in the crypto chain world to the muzzle of the CFTC.
DAO, DeFi, and DEX project parties need to be particularly alert!
