The Breakdown - The CFTC Goes After a DAO

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com. And produced and distributed by CoinDex. What's going on, guys? It is Friday, September 23rd. And today we're talking about the jostling over the stable coin bill and a CFTC action against a Dow. Before we get into that, however, if you are in, enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to

Starting point is 00:00:39 dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. All right, folks, we have been heavy macro this week, and obviously there's been good reasons why. The housing market is shifting in front of our eyes, giving us perhaps an indication of where other industries might go as they adapt to new Titan financial conditions. And on top of that, we had the Federal Open Markets Committee meeting and a fresh 75 basis point hike. As you heard yesterday, with that meeting came a huge amount of new information about how long the Fed expects to continue to raise rates and keep them elevated.

Starting point is 00:01:23 However, for this Friday, I wanted to close out the calendar week with another update on the crypto scene. And as seems to be the case every week, a huge chunk of the big important news is around the regulatory sphere. To me, this makes sense. It remains my number one prediction for a catalyst for crypto markets outside of a massive macro shift, in other words, successfully getting through this regulation phase and that opening up new pockets of buyers. But it's also, even if it turns out very poorly for us, in its endgame. In particular, the U.S. government is no longer kicking the can down the road. And with that in mind, one of the big things this week was the circulation of a draft bill on stablecoins. Now, this has long seemed like the legislation most likely

Starting point is 00:02:07 to be passed this year. If you think about it, of course, stablecoins make sense as the place where Congress would initially focus, given that they are the thing that looks the most like the old system, aka they are approximations of digital dollars. There had been much movement in the House Financial Services Committee towards the goal of a stable coin bill, but over the summer, Democratic chairwoman Maxine Waters said that the bill was delayed until at least after the August recess. And it seemed like there were some pretty serious sticking points between Republicans and Democrats. However, this week apparently a draft of the House bill began circulating, and there are a few notable features. The one that has got perhaps the most mainstream discussion is a

Starting point is 00:02:45 potential ban on algorithmic stablecoins. According to Bloomberg, the draft circulating would place a two-year ban on what the bill calls, quote, indogynously collateralized stablecoins. Or, as Bloomberg describes it, quote, the definition would kick in for stable coins marketed as being able to be converted, redeemed, or repurchased for a fixed amount of monetary value, and that rely solely on the value of another digital asset from the same creator to maintain their fixed price. So basically, no Terra. If this part makes it to the final bill, it would seem to validate a recent tweet by Jake Trevinsky, the head of policy at the Blockchain Association. He recently wrote, it's hard to overstate the damage that Terra has done to the perception of

Starting point is 00:03:24 crypto in D.C. Many policymakers already disliked the notion of a permissionless digital marketplace and wanted to put all of crypto into a well-sealed box. Terra gave them unjust cause to push forward. Last week's report and response to the president's crypto E.O. were pretty grim. They almost read like a rejection of the idea of decentralization itself. A lot of crypto policy people think those reports could have looked very different if not for Terra and its ensuing follow. Those well-educated on crypto understand that Terra doesn't represent all stable coins. Celsius was in Defi, Three Arrow's Capital had nothing to do with the technology, etc. But as in all things, it's a lot harder to engage with those nuances than to simply say, crypto bad, regulate it to death.

Starting point is 00:04:05 In addition to the two-year ban, this draft legislation would mandate that the Treasury Department, Federal Reserve, FDIC, SEC, and OCC all do a joint study on these types of tokens. Now, not everyone is upset about this potential ban. Hasu wrote, the market empirically fails at regulating schemes that have a near 100% chance to fail, but it's hard for most investors to understand why. This is where we need actual regulators to step in. The correct term for endogenously collateralized is insolvent. There are other aspects to the bill as well. The bill would allow both banks and non-banks to issue stable coins. Bank issuers would apply for approval from the regulators they already work with, such as the Office of the Comptroller of the Currency. non-bank issuers would be subject to an as-yet uncreated process that the Federal Reserve would be in charge of establishing.

Starting point is 00:04:53 Alternatively, non-bank issuers who are approved at the state level and who then registered with the Fed within 180 days of that approval would also be able to operate. Now, an important caveat on the bill circulating is that it's not clear if this actually represents a compromise bill between the two chief negotiators, the HFSC chairwoman Maxine Waters and ranking Republican Patrick McHenry. The question specifically is whether McHenry's office has approved this latest draft. What's more, it sounds like from at least one representative, the date for actually trying to push this thing through hasn't yet been decided. The political realities of an election year complicate the likelihood of anything getting done. As Coin Desk puts it, the lawmakers negotiating the legislation are close to releasing the language that will be considered by the House Financial Services Committee in a markup as soon as next week, according to people pouring over draft language circulated this week. While a committee-approved bill would be hard-pressed at this late stage to clear the further hurdles required,

Starting point is 00:05:45 passage in the full House of Representatives and then Senate approval, some of the compromises made in this version could survive if the bill is negotiated again in next year's congressional session. Jared Seberg, an analyst with Cohen, wrote in a note on Wednesday, we do not see a path for Congress to enact Stablecoin legislation this year, as the Senate is far behind the House on this issue. If the House votes, it will create a foundation for early action next year in the House, regardless of which party controls the chamber. So that's the latest on stablecoin legislation,

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Starting point is 00:08:06 Crypto Twitter exploded on Thursday night when the CFTC brought the first ever regulatory action against the Dow. One of the big reckonings that crypto is going through overall is government putting to the industry the question of, well, just how decentralized is it really? That was sort of the gist of OFAC sanctions on tornado cash, and it's certainly a part of this case as well. Miller White House Levine from the Defyye Education Fund sums up with quotes from the CFTC's complaint. Defendant Okie Dow is an unincorporated association comprised of holders of Okie tokens who have voted those tokens to govern the Okie profile. By the way, guys, I apologize, I have no idea if it's Uki or Okie, so if it's the other one, my apologies. Miller goes on with his quotes.

Starting point is 00:08:46 By transferring control to a Dow, B0X's founders touted to B0X community members, the operations would be enforcement proof, allowing the Oki Dow to violate the CEA and CFTC regulations with impunity, as alleged in the federal court action. These actions are part of the CFTC's broader efforts to protect U.S. customers in a rapidly evolving decentralized finance, said acting director of enforcement low. These requirements apply equally to entities with more traditional business structures as well as to DAOs. Miller goes on. The press release includes two actions. Settlement with B0X quote for illegally offering leveraged and margin retail commodity transactions and digital assets, and two, charging the Dow with violating those same laws. Lawyer Drew Hinkies also tweeted about this.

Starting point is 00:09:30 He writes, allegations in claim against Okie Dow characterize it as an unincorporated association comprised of holders of Okie tokens and legacy BZRX tokens who have voted those tokens to govern, e.g. to modify, operate, market, and take actions with regard to the Oki protocol. This is a huge distinction. While the Dow itself is a named party, it is unincorporated, which leads to all sorts of material questions about who can be sued for what. In this case, the complaint makes clear that the Dow is those who, A, have tokens, and B, have voted to govern. So, the Dow is in every passive token holder. It's comprised of the humans and entities that use their tokens to vote. The complaint further alleges that the Dow itself controlled and operated the BZX protocol as B0X had done

Starting point is 00:10:11 prior to turning control over to the Okie Dow. Complaint seeks a bar of all token holders who voted as part of the Dow from the commodities markets. Big picture themes to take away. One, how much control does a Dow have? If it's too much, maybe the counterparty to the transactions offered by the protocol. Maybe decentralization of control over the protocol, not overvoting to control the protocol is what matters. Two, maybe this isn't the death of all Dow's, but a strong reminder that you shouldn't offer regulated transactions to U.S. persons if you're not complying with the regulations. Preston Byrne put a finer point on this. He writes, Looks like voting governance tokens on an illegal protocol is a bad idea. Going to do a bit of a

Starting point is 00:10:49 victory lap here, albeit one I take no joy in, but Stefan Paley suggested DAWs would likely be found to be unincorporated associations back in March 2016. I wasn't too far behind him in my critique of the original Big Dow when it blew up a month and a half later. I wrote then, it is possible that a partnership less likely or unincorporated association more likely will be deemed to exist between its members. Caviot, these are claims as yet unproven. A court may not find in the CFTC's favor. But the unincorporated association point is something crypto-law Dow boosters have glossed over

Starting point is 00:11:18 or poo-poohed for years. And look where we are now. Big question, whether SEC and FinC try it too. Punk 6529 threaded about this as well. He writes, The CFTC BZX Oki enforcement action is interesting because of the last paragraph, namely that the CFTC just looked through the Dow and said it is an unincorporated association and the individuals are responsible. This is something I worry about on behalf of

Starting point is 00:11:42 waves hands some of you. Dow used to mean decentralized autonomous organization, or basically a smart contract. That is not what anyone is doing these days. What people are doing is getting token holders to vote on things. This is not decentralized and not autonomous, and in absence of a legal structure, what regulatory authorities are going to do is exactly what is written below. go after some of the individuals in the Dow, in this case the organizers. The takeaway is that you should look at the substance of your actions. Calling your Discord group a Dow and voting your tokens does not reduce your legal liability. In some ways, it might increase it. Be careful out there.

Starting point is 00:12:16 Investor Adam Cochran writes, holy f***, the CFTC has gone after them saying the protocol itself was a futures violation and that the Dow governance didn't matter. It was still an unincorporated entity. This is bad. This kind of ruling will impact so many projects, collateral margin and future settlement Dow passed through. Horrible precedent. Still, not everyone is quite as freaked out. Bill Hughes from Consensus writes, a court has to agree with the CFTC

Starting point is 00:12:41 for these theories about die liability for a token to be meaningful. That's not going to be easy for the CFTC. Chill out, everybody. The world hasn't ended. What's more, as many of these folks pointed out, there was a strong dissenting statement from Commissioner Summer Kay Mercinger.

Starting point is 00:12:56 She wrote, Today the commission is called upon to consider novel and complex questions about how our governing statute, the Commodity Exchange Act, applies in a world of digital assets, blockchain technology, and decentralized autonomous organizations. Technology that did not exist when the statute was enacted in 1974, and that has just started to develop since Congress last amended the statute

Starting point is 00:13:15 as part of the Dodd-Frank Act in 2010. Unfortunately, I cannot support the Commission's approach to this particular matter. 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. In the dissent, she gets specific. I cannot agree with the Commission's approach of determining liability for Dow token holders based on their participation in governance voting for a number of reasons. First, not only does this approach fail to rely on any legal authority in the CEA, it also does not rely on any case law relevant to this type of action.

Starting point is 00:13:53 Instead, the commission's approach imposes governmental sanctions for violations of the CEA and CFTC rules based on an inapplicable state law legal theory developed for contract and tort disputes between private parties. Additionally, this approach arbitrarily defines the Okie Dow Unincorporated Association in a manner that unfairly picks winners and losers and undermines the public interest by disincentivizing good governance in this new crypto environment. This approach constitutes blatant regulation by enforcement by setting policy based on new definitions and standards never before our articulated by the commission, or its staff, nor put out for public comment. And finally, the commission ignores an alternative, well-established basis for imposing liability for the Okie-Dow's violation of the CEA and CFTC rules in this case, i.e. aiding and abetting

Starting point is 00:14:36 liability. That is specifically authorized by Congress, and that would solve all of these problems. Jake Trevinsky writes, The CFTC's BZX enforcement action may be the most egregious example of regulation by enforcement in the history of crypto. We've complained at length about the SEC abusing this tactic, but the CFTC has put them to shame. It's deeply disappointing to see the CFTC damage its own reputation like this among those who care about the future of crypto in the United States, especially at a critical moment while it pitches itself to Congress as the right agency to regulate digital commodity trades. Still, I think the best and most sober review comes from Chairman Burr-Bernacki

Starting point is 00:15:13 at Bone Condor on Twitter. She writes, having been in traditional finance and having been heavily involved in compliance, I've seen the CFTC be reasonable. They're an agency that usually doesn't tend to overreach or create policy from nowhere. That said, I think this one missed the mark in a number of ways. The Mercinger dissent is spot on. Her main points, one, this has far-reaching policy implications, and it is regulation creation by enforcement. Two, this is an arbitrary definition that the CFTC themselves has never used. Three, existing law could have already gotten who they want to get. None of this should be taken to mean regulation is bad or Bean and Kistner did nothing wrong. They absolutely did, and they should be charged for their wrongdoing. What it does, though, is

Starting point is 00:15:52 disincentivize voting with your governance tokens. What does that mean? The complaint defines the Dow not as any token holder, but as anyone who voted during a time period. This means you can be in the Dow by being a token holder, but if you vote for anything, higher interest rate, then, and only then, are you liable? That's problematic, but the complaint then says that since the Dow is equal to what came before it, the Dow is liable for all previous crimes. So if you bought the token and voted on a ribbon vault, you're liable for offering an illegal asset by virtue of having bought it. The CFTC themselves has never defined a DAO this way. This is the first instance even Mercinger can find of this definition. I don't think this is how the law should work. This is an admission that you can be charged

Starting point is 00:16:30 with a crime that's only defined when you're charged. There's a place for regulation of DAWs, and honestly, I agree with the CFTC in their attempt to explain that just because you're a Dow doesn't mean you're immune to regulation and compliance. That's entirely fair, and there's more work to be done on defining that area of law. It's good to reduce the amount of bad actors in the space. It's not good to do it via new policy creation without legal authority notice or public input. I hope the CFTC is more thoughtful going forward and that they work with crypto communities to create careful, good rules. Now, as I've been reading all of this, I was reminded of another recent thread from Jake Trevinsky again. It serves as sort of, if not a

Starting point is 00:17:06 warning, a level setting and expectation setting on what might come out of this regulatory process. He writes, policymaking behind the scenes is a hugely complex negotiation among many parties with different goals. As with most negotiations, striking a deal involves some compromise. and leaves most parties feeling less than fully satisfied. This is how crypto legislation will happen, too. If you imagine a scale from 1 to 10 where 1 is absolute crypto pessimism and 10 is absolute crypto-idealism, you should expect legislation to fall somewhere between 4 and 6. That's how it always works. Getting to 3 or 7 means one side wields way more power than the other, and that's rare. Bear in mind that we, the community, the industry, don't have a seat at that table, only members of Congress do.

Starting point is 00:17:48 We can help them understand crypto's promise and the policies that would most benefit benefit the country. We can make sure they hear the desires of the people they represent. We can support them when they take positions that promote responsible innovation. We can oppose them when they defend the status quo against progress. We can enforce the law in the courts if they fail to respect our constitutional rights or their own processes. We can vote. I think that all these commenters are right that Dow's running into the law was inevitable. I think it's encouraging that there's such clear dissent and discouraging that that dissent seems to so have been glossed over. But at the end of the day, I think there's a lot more like this coming.

Starting point is 00:18:22 And as much as it seems like it's a nonstop barrage, now is definitely the time to keep paying attention, stay informed, and stay engaged. For now, I want to say thanks again to my sponsors, nexus.com. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital enterprises and asset summit or ideas. The event facilitates capital flow and market growth. by connecting the digital economy with traditional finance.

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The Breakdown - The CFTC Goes After a DAO

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