The Commodity Futures Trading Commission (CFTC) announced yesterday it had both filed and settled charges against three "decentralized finance" operations, Opyn Inc., ZeroEx Inc., and Deridex Inc.
In the agency's own language, the charges included "failing to register as a swap execution facility (SEF) or designated contract market (DCM), failing to register as a futures commission merchant (FCM), and failing to adopt a customer identification program as part of a Bank Secrecy Act compliance program" and "illegally offering leveraged and margined retail commodity transactions in digital assets."
The companies have to pay fines ranging from $100,000 to $250,000 and refrain from further such law violations. The full CFTC press release gives some of the technical details of the sort of decentralized "smart contract" operations the companies performed that the agency insists violated the law. Opyn, CFTC acknowledges, seemed aware it was legally questionable to offer its services to U.S. residents and tried to block them, but not hard enough in CFTC's eyes.
The use of DeFi and smart contracts allows people to make sophisticated financial dealings involving buying, selling, trading, or swapping commodities, crypto, or derivatives more or less automatically without specific human entities having to make decisions and act. CFTC Director of Enforcement Ian McGinley says in the press release that, "somewhere along the way, DeFi operators got the idea that unlawful transactions become lawful when facilitated by smart contracts. They do not. The DeFi space may be novel, complex, and evolving, but the Division of Enforcement will continue to evolve with it and aggressively pursue those who operate unregistered platforms that allow U.S. persons to trade digital asset derivatives."
In an intriguing Twitter thread yesterday, Delphi Labs general counsel Gabriel Shapiro, said this CFTC action ratifies what he's long believed: DeFi is likely to be judged illegal in nearly all contexts interacting with U.S. citizens.
Shapiro advises that "if you run any kind of interface etc. for a DeFi credit protocol, block the U.S.," adding, "I also always told you the CFTC would be an even worse regulator for crypto than the SEC."
The underlying theory of this enforcement action, Shapiro says, is inherently anti-DeFi: "The purpose of DeFi is disintermediation. There is no way of making DeFi 'comply' with a mandatory intermediation regime—then it would not be DeFi, just intermediaries who use permissioned, KYC-gated etc. smart contracts as part of their tech stack."
One CFTC commissioner, Summer K. Mersinger, filed a dissent to his agency's actions. Among his complaints were that "we are asked [in this action] to find liability and impose sanctions based on a novel technology that was decentralized in conception and operation—an area that has not previously been the subject of a CFTC enforcement action." Mersinger points out that "the Commission's Orders in these cases give no indication that customer funds have been misappropriated or that any market participants have been victimized by the DeFi protocols on which the Commission has unleashed its enforcement powers."
He thinks this represents a shift from a previous CFTC vow to use more "stakeholder engagement" and less out-of-the-blue enforcement actions in the DeFi space. "Yet, today's actions do not promote responsible innovation—they shut it down, banishing innovation from U.S. shores."
Mersinger points out that it would be often difficult or impossible for DeFi operations to legally register under CFTC rules as those rules "were written for centralized entities—are they fit for purpose if FCM activity can be performed in a decentralized manner?" He also asks, relevant to some of the specific charges at issue this week: "If a DeFi protocol is developed for lawful purposes but is used for purposes that violate the CEA [Commodities Exchange Act], should the developer be held liable? Must the deployment and the illegal use be close in time, or is the developer of a DeFi protocol forever liable if its technology is used for illegal purposes by others?"
Overall Mersinger thinks these sort of enforcements "creates an impossible environment for those who want to comply with the law, forcing them to either shut down or shut out U.S. participants."
As I wrote back in Reason's January issue, "DeFi's ability to move value and make investment decisions via automatic, unregulated programming makes it harder for the government to rely on the old system whereby it drafts financial intermediators such as banks and brokers to spy on their customers." The CFTC is acting on the eternal state imperative to crack down on anything that widens spaces where citizens can act without government knowledge and supervision.