DeFi "Illegal Under CFTC's View Of US Law"

Yesterday the CFTC settled charges against three DeFi organizations: Opyn, Inc., ZeroEx, Inc., and Deridex, Inc., all Delaware companies based in California or North Carolina.

All three were charged with illegally offering leveraged and margin retail commodity transactions in digital assets. Deridex and Opyn were also charged with 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, which is required of FCMs.

Civil penalties of $250,000 were imposed on Opyn, $200,000 on ZeroEx, and $100,000 on Deridex. The services were required to "cease and desist" from violating the Commodity Exchange Act (CEA) and CFTC regulations.

The CFTC's Director of Enforcement, Ian McGinley, commented: "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."

Square Peg, Round Hole

The CFTC's position appears to make any form of compliance for true DeFi protocols of this nature (e.g. leverage trading) impossible. Their compliance model is based on the existence of intermediaries who can collect KYC information. These intermediaries simply do not exist in the DeFi world, where it is possible (and preferred) to interact directly with the protocol at the smart contract level.

Frontend providers are therefore likely to come under fire if they facilitate access to such a service without registering and collecting the required information.

Geo-blocking for the US on the frontend is not enough. VPNs will also need to be blocked. It additionally appears that the CFTC may have required Opyn to enforce greater compliance through their provided software.

In practice, this kills off a whole subset of DeFi protocols within the US. American companies cannot serve American users. US users, meanwhile, can only engage with non-US DeFi services.

The only services that the CFTC would allow would be based on permissioned chains, gated via KYC providers—in effect, little different from existing TradFi services, but leveraging blockchain infrastructure for greater speed and transparency.

Additionally, as one Twitter user warns, this is likely to lead to a concerning increase in data collection for all users who do use official frontends.

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