CFTC Warns DeFi Traders: Exercising Governance Tokens Could Lead to Personal Liability for Illegal DeFi Protocol Activities – Commodities/Derivatives/Exchanges

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Two individuals who voted for governance tokens issued by a decentralized finance (DeFi) protocol have been accused of being “personally responsible” for alleged violations of the Commodity Exchange Act (CEA) and Commodity Futures Trading Commission regulations (CFTC) by an arm’s-length organization that administered the protocol, in an enforcement action brought by the CFTC on September 22, 2022.

The CFTC has charged bZeroX, LLC (bZeroX) – a Delaware company founded, owned and operated by Tom Bean and Kyle Kistner from approximately June 1, 2019 to August 23, 2021 – with various violations of CEA and CFTC regulations for creating and use of the bZx protocol. The bZx protocol constituted a number of smart (i.e. programmable) contracts operating without intermediaries on the Ethereum blockchain. The CFTC alleged that the bZx protocol illegally offered matched virtual currency transactions on a margin or leverage basis to US-based retailers (non-“eligible contract participants”) that were unsuccessful to actual delivery within 28 days – so-called “or margined retail commodity transactions.”

Specifically, the CFTC asserted that bZeroX could only have engaged in leveraged or margined retail commodity trading on a CFTC-approved exchange (i.e. a designated contract market ) and did not; acted as a broker (i.e., futures commission agent (FCM)) when soliciting transactions and holding funds or extending credit to clients without being registered as an FCM; and failed to perform certain anti-money laundering activities (i.e., know your customer activity) required of all FCMs.

Mr. Bean and Mr. Kistner were charged with the same violations as bZeroX for being “controlling persons” of bZeroX.

bZeroX ceded control of the bZx protocol to bZxDAO around August 23, 2021. The bZxDAO (later renamed Ooki DAO) was an autonomous organization that was not a legal entity or owned or operated by natural persons. Instead, Ooki DAO was subject to the exercise of governance tokens (e.g. voting) which were issued to people who deposited certain virtual currencies into the bZx protocol to facilitate trading on the platform . From August 23, 2021 to present, Mr. Bean and Mr. Kistner have owned and exercised governance tokens on Ooki DAO. The CFTC claimed that Ooki DAO was responsible for the same violations of CEA and CFTC regulations as bZeroX.

The CFTC also alleged that Ooki DAO operated as an unincorporated association through its members and that its members were individuals who received and exercised voting rights in the form of governance tokens. Since under the laws of some states each individual member of an unincorporated association is jointly and severally liable with the other members for all debts of an unincorporated association, the CFTC charged, by analogy , Mr. Bean and Mr. Kistner to be personally responsible for all Ooki DAO. violation of CEA and CFTC regulations. The CFTC did not cite any authority within the CEA or CFTC regulations for this extension of liability to Mr. Bean and Mr. Kistner.

bZeroX, Mr. Bean and Mr. Kistner settled all charges brought by the CFTC against them by agreeing to pay a $250,000 fine, among other penalties. In doing so, they neither admitted nor denied any of the findings or conclusions of the CFTC’s order embodying the settlement. The CFTC has filed a separate lawsuit against Ooki DAO which is pending in federal court in California.

Summer Mersinger, a CFTC commissioner, vehemently objected to the CFTC’s order. She noted that while she could not “…tolerate individuals or entities flagrantly violating the CEA or our rules, we cannot arbitrarily decide who is responsible for those violations based on legal theory.” unsubstantiated amounting to regulation by enforcement while federal and state policy develops.” Ms. Mersinger argued against indicting Mr. Bean and Mr. Kistner based on legal theories outside of the regulations of the CEA or the CFTC, especially since she believed there was a provision of the CEA – prohibiting aiding and abetting a violation – that could have been used to hold the two individuals liable for the alleged violations by Ooki DAO.

Settlement order: https://www.cftc.gov/media/7676/enfbzeroxorder092222/download

Pending action: https://www.cftc.gov/media/7681/enfookiccomplaint092222/download

Dissenting Commissioner Mersinger: https://www.cftc.gov/PressRoom/SpeechesTestimony/mersingerstatement092222

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