CFTC Wades Into DeFi Enforcement Again – Fin Tech

Last month, the Commodity Futures Trading Commission (CFTC) announced settled charges against three
decentralized finance (DeFi) protocols for various registration and
related violations under the Commodity Exchange Act (CEA) during
the relevant period of investigation. As a result, each entity paid
a civil monetary penalty and agreed to cease violations of the CEA.
According to a statement by Commissioner Kristin N. Johnson,
these latest settlements are the first time the CFTC charged a DeFi
operator (e.g., Opyn, Inc. and Deridex, Inc.) with failing to
register as a swap execution facility (SEF) or designated contract
market (DCM). Moreover, these latest enforcements against DeFi
entities arrive soon after the CFTC’s successful enforcement and default judgment
against Ooki DAO, which the CFTC alleged was operating a
decentralized blockchain-based software protocol that functioned in
a manner similar to a trading platform and was violating the CEA
(prior coverage of the Ooki DAO enforcement can be found here).

As defined by the CFTC’s Enforcement Director in
recent remarks, DeFi protocols are “collections of smart
contracts on blockchains that replicate traditional commodity
derivatives and spot markets in a purportedly decentralized and
permissionless way.” Specifically, in its latest round of
enforcement, the CFTC issued orders against several entities:

• Opyn, Inc. (“Opyn”), a DeFi options trading protocol,
  offered trading of a digital asset derivatives token called oSQTH,
  the value of which was based in part on the price of ether (which
  the CFTC considers a “commodity” for purposes of the
  CEA). The order found that oSQTH tokens are swaps and
  leveraged or margined retail commodity transactions and therefore
  could be offered to retail users who do not qualify as an eligible
  contract participant only on a registered exchange. The CFTC
  concluded that Opyn operated as an unregistered SEF. In addition,
  Opyn allegedly engaged in certain margined retail commodity
  transactions that could only lawfully be performed by a registered
  futures commission merchants (FCM). Opyn was also charged with
  failing to adopt a KYC program as part of a Bank Secrecy Act
  compliance program, as required of FCMs, and for also failing to
  effectively block U.S. users from accessing the Opyn Protocol
  (i.e., Opyn blocked U.S. IP addresses, but the CFTC deemed such a
  step insufficient to block U.S. persons from ultimately accessing
  the Opyn Protocol).




• Deridex, Inc. (“Derididex”), a decentralized on-chain
  derivatives platform, offered trading of “perpetual
  contracts,” which the CFTC described as leveraged derivative
  positions that provided for the exchange of one or more payments
  based on the relative value of the STABL2 stablecoin and another
  virtual currency. Among other things, the order found that these perpetual contracts are
  swaps and leveraged or margined retail commodity transactions and
  therefore could be offered to retail users only on a registered
  exchange. In addition, Deridex allegedly failed to conduct KYC
  diligence on its customers as part of a customer identification
  program, as required of FCMs.

• ZeroEx, Inc. (“ZeroEx”), a decentralized exchange
  (“DEX”), offered users the ability to trade digital
  assets on its platform on a peer-to-peer basis and maintain custody
  of their tokens throughout the transaction process. According to
  the order, such digital assets included
  “certain leveraged tokens, which provided traders
  approximately 2:1 leveraged exposure to digital assets such as
  ether (ETH) and bitcoin (BTC), both commodities.” The order
  found that these leveraged tokens are leveraged or margined retail
  commodity transactions and therefore can be offered to retail
  customers only on a registered exchange.

Recognizing the substantial cooperation of the respondents with
the investigation, the CFTC ordered Opyn, ZeroEx, and Deridex pay
civil monetary penalties of $250,000, $200,000, and $100,000,
respectively, and cease and desist from violating the CEA, as
charged.

In a statement about the DeFi settlements, CFTC
Commissioner Johnson looked down the road and urged Congress and
agencies to work toward more coherent regulation for the growing
digital asset marketplace that brings a “framework that
effectively employs our longstanding body of risk mitigation best
practices.” Commissioner Johnson also noted that Opyn and
Deridex were charged with not maintaining KYC programs, which are
“critical” to the CFTC’s ability to protect customers
and “mitigate the risk of illicit financial
transactions.”

In a dissenting statement, CFTC Commissioner Summer
K. Mersinger stated that “enforcement is inherently ill-suited
to balancing our competing mandates of protecting customers and
promoting responsible innovation” and characterized the
settlements as essentially registration violations but without any
indications of misappropriated customer funds or victimized users
of the DeFi protocols.

The CFTC has brought previous enforcement actions against digital
asset entities (115 actions and counting, as of September 2023,
according to the CFTC). During a recent speech at a Practising Law Institute (PLI)
event, CFTC Enforcement Director McGinley spoke about the
CFTC’s various actions in the derivatives markets for digital
assets and stated, in particular, that DeFi itself is “fraught
with unique risks,” and that such protocols can offer digital
asset derivative transactions, which, in his opinion, must,
“in many cases, be offered on a CFTC-registered platform and
comply with required core principles designed to protect customers
[including KYC and AML rules and other regulations]”. In
stressing that DeFi is one of the focuses of the agency, McGinley
stated that “the existence of unregulated DeFi exchanges is an
obvious threat to the markets regulated and customers protected by
the CFTC, and it is one we have taken very seriously.”

CFTC Wades Into DeFi Enforcement Again

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