What does it mean to “facilitate” leveraged trading? The CFTC’s novel theory in ZeroEx and Uniswap Labs

On September 7, 2023, the CFTC announced a trio of enforcement actions against the operators of three DeFi protocols for offering trading in digital asset derivatives without being licensed: Opyn, Inc., Deridex, Inc., and ZeroEx, Inc. [Fn1]. In our view, the CFTC’s action against ZeroEx was the most noteworthy and the most problematic. In the order, the CFTC announced a new theory of liability for “facilitating” the use of margin, leverage, or financing in the trading of digital asset commodities. In yesterday’s (9/4/2024) action against Uniswap Labs [FN2], the CFTC again relied on this novel theory. We think that this theory is unmoored from the statutory text and raises questions about which other blockchain infrastructure providers could find themselves on the receiving end of an enforcement action, even if they had no intention of offering derivatives or leveraged trading to U.S. users.

First, some background. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 amended the Commodity Exchange Act (“CEA”) and extended it to commodity transactions offered on a leveraged or margined basis “as if” they were futures trades. Such products are called “Retail Commodity Transactions,” and are prohibited by the relevant CEA section 7 U.S.C. § 2(c)(2)(D) to be offered or sold to U.S. retail investors off of a regulated exchange absent narrow exceptions. This provision was added for good reason. The CFTC has years of experience demonstrating the harm that unscrupulous bucket-shop operators and other unregistered and unregulated actors can cause when offering leverage (usually involving precious metals) to unsophisticated mom-and-pop traders.

In 2016, the CFTC’s Division of Enforcement brought its first case under Section 2(c)(2)(D), suing Bitfinex for offering leveraged trading in Bitcoin. [FN3] Since then, the CFTC has used this authority to go after all manner of both centralized exchanges and DeFi offering leverage to U.S. users, including settling or litigating cases against Kraken, Ooki DAO, and others. [FN4].

Those earlier cases, we would argue, largely hewed to the statutory language. Retail Commodity Transactions are defined as “any agreement, contract, or transaction in any commodity” (of which most digital assets are), that is entered into with a non-ECP (i.e. non-retail) person, and is:

“entered into, or offered (even if not entered into), on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis.”

Was Kraken or Bitfinex “entering into” or “offering” leveraged trading? Surely they were. Same goes for other decentralized marketplaces designed to permit retail users to speculate on leverage. But what about ZeroEx and Uniswap?

Neither ZeroEx nor Uniswap was designed to allow traders to speculate on leverage. The defendant in the first case was ZeroEx, Inc., a company that “developed and deployed a blockchain-based digital asset protocol” which the CFTC called the “0x Protocol.” It also operated a front-end called “Matcha,” which was marketed as a DEX and a DEX aggregator, which enabled users to trade “thousands” of different tokens on a peer-to-peer basis. A tiny share of the tokens being traded through the 0x Protocol were “Leveraged Tokens,” which provided traders 2:1 leveraged exposure to digital assets such as ether and bitcoin.

The 0x Protocol is product agnostic blockchain infrastructure project designed to enable peer-to-peer token swaps; it was not built as a derivatives platform. There were no allegations in the Order that ZeroEx affirmatively sold, offered, or even marketed the Leveraged Tokens to anyone. Rather, some unknown party listed the Leveraged Tokens and made them available for traders — ZeroEx was not accused of having anything to do with it. The CFTC did not claim that ZeroEx was in cahoots with the developers (or listers) of the Leveraged Tokens in any way. Rather, those unknown folks merely used the token-agnostic blockchain infrastructure that ZeroEx had developed. The facts as they concerned Uniswap were strikingly similar.

To turn back to the statutory language, did ZeroEx “enter into” any “agreement, contract, or transaction” involving the Leveraged Tokens? Nope, and the CFTC does not allege that they did. Did Uniswap Labs directly “offer” trading in Leveraged Tokens? No, there was no evidence of that, either. There are no facts to support the claim that either respondent promoted the Leveraged Tokens to U.S. retail users, or took any affirmative steps to cause them to be offered. Did ZeroX “act in concert” with those individuals offering Leveraged Tokens? There are no facts to support that, either. No one at ZeroEx ever met them. Rather, some unknown third party had used the swap protocol to list certain “Leveraged Tokens,” which the CFTC found embodied retail commodity transactions as discussed above.

The reader has to scour the footnotes to uncover what the CFTC’s real theory is. Footnote 8 of the ZeroEx Order states: “By deploying a decentralized protocol (the 0x Protocol) and operating a front-end user interface (Matcha) that ‘facilitated’ and ‘provide[d] a purchaser with the ability to source financing or leverage from other users or third parties,’” ZeroEx fell within their broad definition of “offeror,” per the CFTC. A near-identical footnote appears in the Uniswap order: “By operating a front-end user interface (the Interface) that ‘facilitated’ and ‘provide[d] a purchaser with the ability to source financing or leverage from other users or third parties,’ Respondent’s conduct met this standard.”

So, the theory of these cases is that developing technology that enables or “facilitates” others in trading tokens that embody “retail commodity transactions” counts as “offering” those transactions.

The word “facilitate” is not in Section 2(c)(2)(D) of the CEA, of course. For this point, the CFTC cited its 2020 Interpretive Guidance on Actual Delivery for Digital Assets (the “2020 Interpretive Guidance”). [FN4]. Keep in mind that the Interpretive Guidance is not law; it is the CFTC’s own view on the applicability of this section to certain aspects of blockchain technology. In both the ZeroEx and Uniswap orders, the CFTC points to three footnotes in the 2020 Interpretive Guidance. See 85 Fed. Reg. 37,734–01, at 37,737 n.63, 37,742 n.164 (June 24, 2020).

In the 2020 Interpretive Guidance, the CFTC says that when evaluating potential retail commodity transactions, it would view the word “offeror” broadly to include “any persons presenting, soliciting, or otherwise facilitating ‘retail commodity transactions,’ including by way of a participation interest in a foundation, consensus, or other collective that controls operational decisions on the protocol.” Id. at fn. 63 (emphasis added); see also id. at fn 164 (similar language)). Later in the guidance, the CFTC wrote:

“The Commission recognizes that the offeror of the transaction and the ultimate counterparty may be two separate entities or may be the same. For example, the Commission would consider as the offeror of the transaction a virtual currency execution venue that makes the transaction available to the retail customer or otherwise facilitates the transaction. That virtual currency execution venue could also be considered a counterparty to the transaction if, for example, the platform itself took the opposite side of the transaction or the purchaser of the virtual currency enjoyed privity of contract solely with the platform rather than the seller. Additionally, the Commission recognizes that some virtual currency execution venues may provide a purchaser with the ability to source financing or leverage from other users or third parties. The Commission would consider such third parties or other users to be acting in concert with the offeror or counterparty seller on a similar basis.” (Id. at fn. 165).

In our view, applying this reasoning to a blockchain project that was specifically designed and marketed to enable leveraged trading (i.e. Ooki DAO) could be justified. But applying it to a token-agnostic piece of blockchain infrastructure like 0x or Uniswap is misguided, and strays too far from the statutory language. It is quite a stretch to say that Uniswap Labs was “facilitating” leveraged trading when there are no facts to support that it had any intent or involvement in those products being offered.

The theory also leads to problematic questions about line-drawing. Per the CFTC, Uniswap was guilty as a technology that “provide[d] a purchaser with the ability to source financing or leverage from other users.” Couldn’t the same be said for Ethereum itself? The concern raised by the case is that any manner of blockchain infrastructure providers could find themselves being sued based on activities their users are doing, for which they had no specific intention to offer or encourage.

In our view, the CFTC should focus its efforts first on the scammers, the fraudsters and the con artists bilking U.S. users with false promises related to derivatives or leverage. Second, the CFTC should focus its efforts on unregistered entities affirmatively and directly offering leveraged trading to U.S. users — there are plenty of those. It should leave general-purpose core blockchain infrastructure providers like Uniswap alone. Especially when they’re among the “good actors” in the space, as eloquently pointed out by Commissioner Mersigner in her dissent. [FN5]

FN1: See CFTC Issues Orders Against Operators of Three DeFi Protocols for Offering Illegal Digital Asset Derivatives Trading, Release №8774–23, available at https://www.cftc.gov/PressRoom/PressReleases/8774-23.

FN2: https://www.cftc.gov/PressRoom/PressReleases/8961-24

FN3: https://www.cftc.gov/PressRoom/PressReleases/7380-16

FN4: https://www.cftc.gov/PressRoom/PressReleases/8139-20

FN4: https://www.cftc.gov/PressRoom/PressReleases/8433-21; https://www.cftc.gov/PressRoom/PressReleases/8590-22

FN5: https://www.cftc.gov/PressRoom/SpeechesTestimony/mersingerstatement090424