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On September 7, 2023, the Commodity Futures Buying and selling Fee (CFTC) introduced the settlement of three separate enforcement actions within the decentralized finance (DeFi) house: particularly, regarding the Opyn protocol and its Squeeth energy perpetual merchandise;1 the Deridex protocol, an on-chain perpetual contract buying and selling platform;2 and the 0x protocol, Matcha (its person interface), and its use as a decentralized change (DEX) and DEX aggregator supporting buying and selling in sure third-party leverage tokens.3
Though the three enforcement actions have been introduced in a single press launch and grouped collectively as DeFi circumstances by the CFTC, they’ve essential variations and particularities. On this shopper alert, we establish potential classes and key takeaways for DeFi individuals each inside and outdoors the US and supply a abstract of the factual background, the precise nature of the alleged regulatory violations, and the penalties imposed in every of the three enforcement actions. On condition that it’s at present not possible for many DeFi protocols to register with the CFTC as a swap execution facility (SEF), designated contract market (DCM), or futures fee service provider (FCM) — not to mention to register in a number of such capacities concurrently — the elemental takeaway from these enforcement actions is that it’s crucial for DeFi groups to be fastidious and take all steps potential to exclude US customers if their protocol could facilitate buying and selling in derivatives or on a leveraged or margined foundation.
On this regard, it’s noteworthy that these enforcement actions drew a strongly worded dissent from CFTC Commissioner Summer time Okay. Mersinger, who lamented these circumstances as creating “an unimaginable setting for many who wish to adjust to the regulation, forcing them to both shut down or shut out US individuals.” Commissioner Mersinger additionally famous that there was no indication in any of those three circumstances that buyer funds had been misappropriated or that any market individuals had been victimized. Certainly, the CFTC’s personal press launch acknowledged the substantive cooperation of every of the protocols in query. Towards this backdrop, many trade voices have warned that these CFTC enforcement actions will proceed to drive DeFi out of the US and stunt innovation.
Notable Takeaways
- The CFTC has well-established jurisdiction with respect to derivatives resembling swaps and sure types of leveraged or margined transactions in commodities (together with digital property that represent commodities). The CFTC can apply these established features of its jurisdiction in novel contexts, together with within the DeFi house. Sure actions with respect to such CFTC-regulated transactions require registration, which is at present not possible for DeFi protocols.
- Whereas every of the protocols in query in these enforcement actions was related to a US entity or place of job, offshore groups ought to take word and thoroughly scrutinize their US nexus. Within the absence of a path to registration with the CFTC, DeFi protocols which will facilitate buying and selling in derivatives or on a leveraged or financed foundation ought to prohibit US customers in an effort to mitigate their U.S. regulatory danger.
- Nevertheless, because the Opyn enforcement motion particularly makes clear, merely blocking protocol entry for customers with US-based IP addresses is not going to suffice. Though imperfect and under no circumstances infallible, different danger mitigants could embody (i) strong prohibitions on U.S. customers in protocol phrases of use, (ii) acquiring affirmative non-U.S. particular person standing representations upon pockets connection or with a signed pockets message, and (iii) probably even blocking U.S.-based IP addresses from viewing any protocol-controlled web site that promotes or advertises the DeFi protocol (i.e. past simply geo-blocking pockets connections themselves).
- Sadly, whereas acknowledging subsequent remedial efforts made by Opyn, the CFTC didn’t present any significant helpful steerage on what different steps DeFi protocols can or ought to take to stop entry by US customers.
- The Matcha enforcement motion warrants specific consideration for all DEXes, DEX aggregators, and different DeFi protocols, particularly those who permit the permissionless addition of third-party tokens and buying and selling pairs.
- Merely supporting buying and selling in leverage tokens or tokenized derivatives designed and issued by a 3rd social gathering could also be adequate to run afoul of the CFTC’s registration expectations. That is the case even when, as within the Matcha enforcement motion, the protocol in query was not particularly designed or marketed for buying and selling in derivatives or on a leveraged or margined foundation and would sometimes be considered as a venue for spot or money market buying and selling of digital property.
- Whereas antithetical to the DeFi ethos and never possible for permissionless protocols, DeFi protocols which can be in a position and keen to take action ought to take into account limiting use of their protocols for identified leverage tokens or tokenized derivatives devices (e.g., through allowlisting and blocklisting tokens). Certainly, the Matcha enforcement motion referenced remedial efforts by the protocol to stop buying and selling in leverage tokens going ahead.
- Notably, the Matcha enforcement motion stands in stark distinction to the current dismissal of a category motion filed within the Southern District of New York towards Uniswap and sure of its enterprise capital backers4, which sought to impose legal responsibility for losses related to sure third-party rip-off tokens that have been traded by means of Uniswap’s sensible contracts. Albeit within the completely different context of securities regulation–based mostly claims, District Choose Katherine Polk Failla questioned the logic of holding the drafter of a software program platform or protocol accountable for a 3rd social gathering’s misuse of that platform.
The Opyn Enforcement Motion
As alleged by the CFTC, Opyn, Inc. (Opyn), a Delaware company with a principal place of job in California, developed and operated a digital asset buying and selling platform that allowed for buying and selling in energy perpetuals. These devices allowed customers to enter into lengthy and brief positions the worth of which have been based mostly on the worth of a specific digital asset squared (i.e., to the ability of two) relative to the stablecoin USDC. For instance, customers of the Opyn protocol might enter into an extended place by shopping for the ERC-20 token often called oSQTH to acquire publicity to an index that tracked the worth of ETH squared. Customers might additionally set up brief positions by minting after which promoting oSQTH, topic to sustaining a specific collateralization ratio with adequate property locked within the Opyn protocol’s sensible contracts. The CFTC alleged that though Opyn took sure steps to exclude US individuals from accessing the Opyn protocol, these steps have been “not adequate” to truly block US customers from such entry.
The Opyn enforcement motion incorporates quite a lot of alleged violations towards Opyn, every starting from the premise that each ETH and stablecoins resembling USDC represent “commodities” for functions of the Commodity Trade Act (CEA) and the laws of the CFTC thereunder (CFTC Guidelines). The CFTC then reasoned that the “energy perpetuals” supported by the Opyn protocols constituted “swaps” for CFTC regulatory functions, a time period that’s broadly outlined within the CEA and CFTC Guidelines to embody nearly any instrument that derives its worth from another underlying commodity.5 As well as, the CFTC reasoned that the buying and selling in oSQTH supported by the Opyn protocol amounted to an providing of leveraged or margined buying and selling in commodities to retail prospects (i.e., noneligible contract individuals, in CFTC parlance). Such transactions are topic to regulation as in the event that they have been futures contracts until they lead to precise supply of the underlying commodity inside 28 days.
From these premises, the CFTC discovered that Opyn had engaged in quite a lot of violations of the CEA and CFTC Guidelines:
- By working a multiple-to-multiple buying and selling platform for executing or buying and selling in swaps (right here, the ability perpetuals), Opyn engaged within the exercise of a SEF with out registering as such (or as a DCM).
- By providing leveraged or margined commodity buying and selling to retail customers, Opyn violated the CEA and CFTC guidelines in that such transactions are topic to regulation as in the event that they have been futures and could also be lawfully supplied solely on a DCM (i.e., a regulated futures change).
- By (i) soliciting and accepting orders for swaps and leveraged or margined transactions and (ii) accepting property to margin or collateralize such trades, Opyn engaged within the exercise of an FCM with out registering as such. As well as, in appearing as an unregistered FCM, Opyn didn’t adjust to the “buyer identification program” obligations relevant to FCMs, that are supposed to facilitate know-your-customer (KYC) diligence.
The settlement of the Opyn enforcement motion in the end supplied for Opyn to pay a civil financial penalty of $250,000.
The Deridex Enforcement Motion
As alleged by the CFTC, Deridex, Inc. (Deridex), a Delaware company with a principal place of job in Charlotte, North Carolina, developed and operated a digital asset buying and selling platform involving a group of sensible contracts deployed on the Algorand blockchain. By accessing the Deridex protocol, any particular person with a digital asset pockets might contribute margin collateral to open a place in a “perpetual contract” that supplied for the change of a number of funds based mostly on the relative worth of STBL2, a stablecoin beneath the Algorand Normal Belongings technical customary, and another digital asset. Such positions might be entered into on a leveraged foundation as much as a most leverage ratio of 15 occasions at place institution, topic to the person depositing collateral of at the least one-fifteenth of the place’s worth. The rest of the leveraged place was financed by means of borrowing from a liquidity pool provided by different Deridex protocol customers, with Deridex and the liquidity suppliers every receiving a portion of the curiosity paid by customers on such leveraged positions. The CFTC alleged that Deridex didn’t take any motion to stop entry by US customers or retail prospects.
The alleged violations within the Deridex enforcement motion mirror these within the Opyn enforcement motion. Starting from the premise that the STBL2 stablecoin and different digital property represent “commodities” for functions of the CEA and CFTC Guidelines, the CFTC reasoned that the perpetual contracts supported by the Deridex protocol constituted each “swaps” and an providing of leveraged or margined buying and selling in commodities to retail prospects. Consequently, the CFTC discovered that Deridex had engaged in quite a lot of violations of the CEA and CFTC Guidelines:
- By providing leveraged or margined commodity buying and selling to U.S. retail customers, Deridex violated the CEA and CFTC Guidelines in that such transactions are topic to regulation as in the event that they have been futures that and could also be lawfully supplied solely on a registered DCM. The CFTC additionally particularly alleged that Deridex carried out an workplace or enterprise within the US for the needs of soliciting, accepting, or in any other case dealing in such transactions.
- By the Deridex protocol and Deridex’s web site, Deridex operated a multiple-to-multiple buying and selling platform for executing or buying and selling in swaps (right here, the perpetual contracts) with out registering as a SEF or DCM.
- By (i) soliciting and accepting orders for swaps and leveraged or margined transactions and (ii) accepting property to margin or collateralize such trades, Deridex engaged within the exercise of an FCM with out registering as such. As well as, in appearing as an unregistered FCM, Deridex didn’t adjust to the “buyer identification program” obligations relevant to FCMs, that are supposed to facilitate KYC diligence.
The settlement of the Deridex enforcement motion in the end supplied for Deridex to pay a civil financial penalty of $100,000, with the CFTC emphasizing that Deridex took immediate remedial motion upon the Division of Enforcement’s inquiry. Particularly, Deridex took steps to put the Deridex protocol into wind-down mode in order that no new deposits or positions might be established.
The Matcha Enforcement Motion – Considered one of These Three Is Not Just like the Others …
As alleged by the CFTC, ZeroEx, Inc. (ZeroEx), a Delaware company with a principal place of job in San Francisco, developed and deployed the 0x protocol and its associated front-end person interface, Matcha. Collectively, the 0x protocol and Matcha might be used as a DEX to purchase or promote one digital asset for one more digital asset. The 0x protocol and Matcha interface additionally functioned as a DEX aggregator, compiling value information from a number of different DEXes. Thus, by interacting with the 0x protocol and the Matcha interface, customers might commerce in digital property from a number of sources of liquidity for 1000’s of various digital asset buying and selling pairs.
Among the many 1000’s of buying and selling pairs that customers might commerce by means of the 0x protocol and Matcha interface, the CFTC centered on sure leveraged tokens developed and issued by a 3rd social gathering unaffiliated with ZeroEx. Particularly, the CFTC referenced tokens issued on each the Ethereum and Polygon networks offering leveraged publicity that was twice the worth of BTC and ETH and that might be purchased and bought by means of the 0x protocol and Matcha interface. The CFTC recited that Matcha customers transacted roughly $117 million in commerce quantity in such leveraged tokens, however acknowledged that ZeroEx did not cost buying and selling charges on such transactions.
Specializing in these leverage tokens, the CFTC alleged that ZeroEx had carried out an workplace or enterprise within the US for the aim of soliciting or accepting orders for off-exchange leveraged or margined commodity transactions from retail customers (i.e., noneligible contract individuals). Below the CEA and CFTC Guidelines, absent precise supply of the related commodity inside 28 days, such transactions are regulated as in the event that they have been futures contracts and could also be lawfully supplied solely on or pursuant to the principles of a DCM (i.e., on a regulated futures change).
Considerably, the CFTC discovered ZeroEx to be in violation of the CEA and CFTC Guidelines however that the leverage tokens in query have been designed and issued by an unaffiliated third social gathering. On this regard, the CFTC referenced its personal prior interpretive steerage that the “offeror” of such transactions consists of individuals who current, solicit, or facilitate the usage of margin, leverage, or financing preparations. The CFTC concluded that by deploying a decentralized protocol (i.e., the 0x protocol) and working a front-end person interface (i.e., the Matcha interface), ZeroEx facilitated and supplied a purchaser with the flexibility to supply financing or leverage from different customers or third events.
The settlement of the Matcha enforcement motion in the end supplied for ZeroEx to pay a civil financial penalty of $200,000.
[1] In re Opyn, Inc., CFTC No. 23-40 (Sept. 7, 2023), accessible at https://www.cftc.gov/media/9211/enfopynorder090723/download.
[2] In re Deridex, Inc., CFTC No. 23-42 (Sept. 7, 2023), accessible at https://www.cftc.gov/media/9221/enfderidexorder090723/download.
[3] In re ZeroEx, Inc., CFTC No. 23-41 (Sept. 7, 2023), accessible at https://www.cftc.gov/media/9216/enfzeroexorder090723/download.
[4] Risley v. Common Navigation Inc. dba Uniswap Labs et al., No. 1:22-cv-02780 (S.D.N.Y. Aug. 29, 2023).
[5] T7 U.S.C. § 1a(47).
[6] Retail Commodity Transactions Involving Sure Digital Belongings, 85 Fed. Reg. at 37,737 n.63, 37,736 n.164.
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