Wednesday, November 02, 2022

CFTC rulemaking petition seeks clarity on DAOs

By Mark S. Nelson, J.D.

Haun Ventures announced that it plans to submit a rulemaking petition to the CFTC in which it urges the agency to issue rules or guidance clarifying the status of decentralized autonomous organizations (DAOs) and the status of persons who participate in such entities. One of the few prior times that a federal agency issued guidance on DAOs was in 2017 when the SEC issued its DAO Report, ostensibly providing guidance for all types of digital asset securities or, as the SEC currently calls them, crypto asset securities. Haun Ventures’ rulemaking petition cites the CFTC’s recent Ooki DAO/bZeroX enforcement action as the primary reason for seeking regulatory clarity.

Ooki DAO/bZeroX. Ooki DAO was the resulting entity created after bZeroX transferred its bZx protocol to bZx DAO, a decentralized entity that was then renamed Ooki DAO. According to the CFTC’s federal court complaint filed against Ooki DAO and a settled administrative order against bZeroX, the bZx protocol enabled margined and leverage retail commodity trading based on the difference between two virtual currencies.

The CFTC’s complaint and administrative order alleged similar facts based on violations of the CEA and a related regulation. The CFTC first charged that Ooki DAO/bZeroX engaged in unlawful off-exchange leverage and margined retail commodity trading, including activities that could only be lawfully undertaken by a registered designated contract market (DCM). The CFTC also charged that Ooki DAO/bZeroX unlawfully engaged in the activities of a registered futures commission merchant (FCM). Lastly, the CFTC charged that Ooki DAO/bZeroX failed to have procedures in place regarding anti-money laundering and know-your-customer requirements. bZeroX and two individuals settled the administrative charges brought against them for $250,000. bZeroX and the individuals agreed to cease and desist from the offending activities, while agreeing to the settlement without admitting or denying the CFTC’s charges.

CFTC Commissioner Summer K. Mersinger dissented from the CFTC’s enforcement action against Ooki DAO. Her central thesis was the following: “While I do not condone individuals or entities blatantly violating the CEA or our rules, we cannot arbitrarily decide who is accountable for those violations based on an unsupported legal theory amounting to regulation by enforcement while federal and state policy is developing.”

Specifically, Mersinger objected to the CFTC’s use of state law principles primarily used in private transactions to define those who vote DAO tokens to be members of an unincorporated association who are then personally liable for the actions of the DAO. Mersinger posited that this approach may chill technological development. According to Mersinger, the CFTC instead could have held the two individual respondents liable under a theory of aiding and abetting.

Haun Venture’s rulemaking petition is based largely on Mersinger’s dissent, albeit with some more details of how Haun Venture would like to see commodities law develop with respect to DAOs.

“Shockwaves” in web3 community. Haun Ventures, a $1.5 billion venture capital firm with portfolio projects emphasizing web3 and DAOs, conceded its interest in having the CFTC adopt a regulation that would benefit itself and similar investors in DAOs. Haun Ventures’ main concern regarding the Ooki DAO matter is that, in its view, too many people who hold or vote DAO tokens could be held personally liable for the actions of a DAO under the CFTC’s current approach to blockchain enforcement. Haun Ventures’ rulemaking petition noted that DAOs are a key piece of web3 development and the CFTC’s approach had sent “shockwaves” through the web3 community and could chill participation in DAOs.

According to Haun Ventures, the CFTC should engage in rulemaking to amend an existing regulation and to adopt a new rule specific to the DAO setting. For example, existing rules should be amended to include a definition of “DAO.” Second, the CFTC should add a rule aimed at limiting the circumstances in which individuals could be held personally liable for the actions of a DAO.

To achieve the second goal, Haun Ventures suggested a rule that would penalize willful conduct that causes a DAO to take unlawful actions, or which involves aiding and abetting such actions, or which involves acting in concert with others to cause a DAO to violate the law. A key theme connecting most, but not all, of the examples the rulemaking petition would have written into CFTC regulations would especially favor passive investors or passive holders of DAO tokens. In other words, DAO participants who do not vote their tokens or who vote their tokens on actions unrelated to a DAO’s unlawful actions would not be held personally liable.