With a Little Help From My Friends — Amicus Briefs in CFTC vs. Ooki DAO
A Day To Remember
September 22, 2022 is a date the web3 community will long remember. On the last day of the Northern Hemisphere’s astronomical summer, the Commodity Futures Trading Commission (CFTC) filed a federal civil lawsuit in a California court that foreshadowed that winter indeed might be coming soon for decentralized autonomous organizations. In what is probably the first government action against a DAO, the CFTC brought out the big guns to take down Ooki DAO, which ran a crypto margin trading platform, and to impose joint and several liability on Ooki token holders who had voted on governance proposals.
Ooki Protocol
The Ooki Protocol used smart contracts to allow its users to create leveraged positions to bet on the increase (long position) or decrease (short position) of popular cryptoassets (e.g. ETH) against DAI (a crypto collateralized stablecoin pegged to USD). If a trader believes ETH will appreciate against DAI, the trader may open a leveraged (say 5x) long position worth five times the increase in the price of ETH relative to DAI from the time the position was opened until it was closed. If correct, and ETH rose in the relevant period by $10, the trader could cash in on their bet $50 on each ETH invested. Leveraged trading comes at a price though, amplifying betting off the mark. If the trader was wrong, and ETH depreciated, their collateral would be eaten up to cover the loss. To take advantage of the protocol, the traders have to pay some fees that ultimately become profits of the protocol and interest for the lenders providing funds to allow leveraged trading.
Crime and Punishment
Neither the Ooki Protocol nor the DAO behind it have properly registered with the CFTC. Traders using the protocol do not have to go through any screening process. Also, they do not need to reveal any personal data allowing for identification. After all, the Ooki Protocol is just a piece of code that allows anyone with an Ethereum wallet to participate. Isn’t that what DeFi is all about? Free access, no restraints, publicly available open-source code running the protocol? Apparently not, at least as far as the CFTC is concerned.
The CFTC is a U.S.government agency that regulates derivatives markets, including futures, swaps, and certain kinds of options. Within its mandate, the CFTC is authorized to track down non-compliant actors and bring them to justice to face sanctions. In its complaint, the CFTC alleges that Ooki DAO facilitated retail commodity transactions by enabling leveraged trading in crypto through its platform. Such activity, the CFTC argues, may only be run by registered future commission merchants (FCM). FCMs need to have a customer identification program (CIP) in place and subject traders to Anti-Money-Laundering/Know-Your-Customer procedures. By running the Ooki Platform without registration and without CIP — the CFTC concludes — Ooki DAO violated the Commodity Exchange Act and Commission Regulations. Since such violations cannot go unpunished, the CFTC requested the court to stop the Ooki Platform from functioning. Abstracting away its feasibility given the nature of smart contracts, that seems like a reasonable request to make. However, the CFTC goes further and calls for the court to prevent not only Ooki DAO, but also its token holders from ever registering with the CFTC to run a lawful commodity trading platform. Then the CFTC moves in for the kill and asks the court to prohibit the token holders trading in commodity interests on any registered entity.
Needle in the Haystack
Delivering a document to a DAO, not to mention an official legal complaint, is anything but easy. Where to deliver, how to deliver, who to deliver it to — these are just a few obstacles on the way. But are they insurmountable for a powerful governmental agency equipped with legal means and considerable resources? It can for instance trace the wallet addresses of the token holders back to the place where they first onramped fiat into crypto and force the concerned exchange to reveal the identity of the user who transferred the purchased crypto to the wallet. Knowing the identity of a token holder, it is possible to pin down an address, e-mail, social media profile, or other means of communication to allow for delivery of information to the token holder.
Is that what the CFTC did to serve the complaint on Ooki DAO token holders? Not quite. The CFTC took a shortcut. First, the agency searched to no avail on the Ooki Platform’s website for any contact details. Then they checked law enforcement databases and business registers in all 50 states looking for Ooki DAO (formerly bZx DAO), to no avail. The CFTC decided to provide Ooki DAO with the complaint via the Ooki DAO’S help chat box and posted on the DAO’s online forum that the complaint had been delivered. To legitimize this way of service, the CFTC filed a motion with the court, with which the court concurred. Thereby Ooki DAO and all its token holders who ever voted on a governance proposal had supposedly been duly informed of the imminent litigation and given the opportunity to defend themselves.
Friend in Need Is a Friend Indeed
And here’s where the web3 community’s resilience takes the stage. Two eminent web3 advocacy groups, the Defi Education Fund (DEF) and LeXpunK, filed with the court amicus briefs to quash the CFTC’s controversial service of the complaint on Ooki DAO and its token holders. Amicus curiae briefs (literally translated from Latin “friend of the court”) are intended to draw the court’s attention to law that escaped consideration. Those are interventions from non-parties concerning legal issues that have potential ramifications beyond the parties directly involved, which are not brought up by any party to the litigation. The court hearing a case is generally free to decide whether to allow an amicus brief to be filed and deliberated upon.
It is noteworthy that each of the proponents is represented by a white-shoe law firm in their amicus interventions. In their brief, DEF argued that Ooki DAO is not necessarily an “unincorporated association of Ooki token holders” as asserted by the CFTC in its complaint. Not being an association (a category included in the umbrella term “person” under the Commodity Exchange Act), it cannot act as a defendant in an enforcement action. In addition, DEF contends that the CFTC’s chosen method of service (i.e. through a chat-box) is not reasonably calculated to reach Ooki DAO’s token holders. DEF emphasized that the CFTC did not use its vast resources to identify individual token holders believed to bear joint and several liability for the Ooki DAO’s alleged wrongdoings and serve the complaints on them through ordinary channels. DEF noted that the CFTC had already reached a settlement with two individual Ooki token holders establishing their joint and several liability and ensuring full recovery.
Arguments presented in the LeXpunK brief are similar to those in the DEF’s brief, although their brief is a bit more concise (to be fair, the LeXpunK’s brief was filed one day earlier). LeXpunK also argued that the CFTC sought judgments against unknown individual Ooki token holders without providing them with constitutionally required notice. As LeXpunK rightly observed, without being properly noticed, defendants are unable to defend themselves and lose the opportunity to be heard. LeXpunK makes a clever observation that since the CFTC has no knowledge where Ooki DAO operates (as it states in the complaint) it is incoherent to assert that the DAO runs its business in the court’s district, which would justify the court’s jurisdiction over the case. Moreover, LeXpunK pointed out that the CFTC’s motion for alternative service through the mentioned chat-box does not qualify for expedited resolution since it does not satisfy the applicable requirements. Lastly, LeXpunK noted that the CFTC’s motion exceeded a 5-page limit for motions of this kind.
Paradigm, a crypto venture capital firm, also submitted an amicus brief that, for the most part, echoed the arguments in the two other briefs. Paradigm also touched on the notion of decentralization arguing that a token holder cannot really control a DAO and be liable for its wrongdoings unless the token holder owns a sufficient number of tokens and thereby voting power. The CFTC had failed to indicate any such token holders in its complaint, Paradigm concluded.
Both DEF and LeXPunK will be allowed to present their arguments against the CFTC’s service of process at a hearing scheduled for November 30, 2022. As of this writing, Paradigm’s motion to have its brief admitted had not yet been resolved.
Way Forward
September 22 marks a day of transition. In the north, transition into cloudy, windy, gloomy days of autumn; in the south, into warm, hopeful, blooming days of spring. Unlike the change of seasons, the direction of governmental regulations and enforcement policy are far less deterministic. They may be influenced by many different factors, including the strength of the community, which the regulations target, in voicing concern. Luckily, the web3 community — although so diverse and decentralized — stands ready when a friend’s house is on fire. If not extinguished on time, it may soon sweep through the whole decentralized community. Yet an ounce of prevention is worth a pound of cure. Hence the need for a dialogue between web3 community, lawmakers, and regulators to figure out what can be done to strike the right balance between consumer protection, reasonable compliance requirements, and, most of all, freedom to pursue innovation in the web3 space.
Jay Figurski is a tech-savvy attorney-at-law from Poland specializing in tax and corporate matters. He has 10 years of professional experience in the legal and consulting industry gained both in Poland and abroad. Member of the Blockchain Lawyers Group and International Fiscal Association. Contributor of BanklessDAO Legal Guild, advisor to WeavrDAO.
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