The following is a summary of the regulatory policies and event observations that co-authored Beosin's 2023 annual report. Beosin is the world's leading blockchain security company, with one-stop blockchain security products + services such as project code security audit, operational security risk monitoring, early warning and blocking, virtual currency stolen asset recovery, and security compliance KYT/AML.
This article covers the regulatory dynamics and hot events of the Web3 virtual asset industry in 2023, focusing on the regulatory enforcement and judicial cases of the virtual asset industry in the United States, including the regulatory enforcement of the U.S. Securities and Exchange Commission (SEC) against the exchanges Kraken, Coinbase, Binance, Ripple litigation, Grayscale Bitcoin spot ETF litigation, and the U.S. Commodity Exchange Commission (CFTC) against DeFi Regulatory enforcement of protocols, class action lawsuits by Uniswap, etc. These cases have tremendous guiding significance for the virtual asset industry, and are expected to shape the future regulatory landscape of the U.S. and even the global virtual asset industry.
Although the SEC's claims against Ripple were not supported by the majority of the courts, the decision of each case did not prevent the SEC from filing a lawsuit against the three largest exchanges, Kraken, Coinbase, and Binance. As a result, the SEC directly raised the most controversial and ultimate question in the industry to the U.S. judiciary and legislature - "what kind of virtual assets are securities?". It is believed that this question will be answered in the 2024 US election year.
At the same time, the CFTC has also turned its attention to DeFi after a previous regulatory exploration. In this context, the SEC will aim at CeFi, the CFTC will aim at DeFi, and the FinCEN/OFAC under the US Treasury will focus on KYC/AML/CTF for global virtual asset circulation, which should be the regulatory landscape of the virtual asset industry before the 2024 US election year.
From the perspective of traditional finance, with the continuous regulation of the market, as well as the clarity of the positioning of Bitcoin commodities and the continuous recognition of value, it is further promoting the entry of Wall Street capital. The traditional financial giants are poised to take off, and when the SEC approves the spot BTC ETF will be a sign of a charge, which is why Grayscale's victory is so compelling.
Before introducing traditional finance, the first thing that needs to be addressed is the biggest uncertainty in the industry – Binance and CZ. As a result, the sky-high settlement of Binance by the U.S. Department of Justice (DOJ), together with CFTC, FinCen, and OFAC, marks the full implementation and compliance of the virtual asset industry. "Any entity that wants to do business in the United States and benefit from a good financial market in the United States should strictly abide by the laws of the United States," was the tough statement of US Treasury Secretary Janet Yellen.
1. The SEC's soul torture: "What kind of virtual assets are securities?"
In the wake of the collapse of FTX in 2022, along with numerous virtual asset platforms, the US SEC has been criticized by the market and members of Congress for failing to regulate this volatile industry in a timely manner. On February 7, 2023, the SEC's review division announced that it would prioritize the review of "Emerging Technologies and Crypto-Assets" [1].
Since then, the SEC has launched a new round of stricter and tougher "Regulation by Enforcement" regulation of the virtual asset industry. The spearhead is the ultimate question of "what kind of virtual assets are securities".
1.1 Kraken's Staking Product Settlements and Securities Litigation
In the SEC's regulatory enforcement, the exchange Kraken is bearing the brunt of it. On February 9, 2023, the SEC issued an announcement announcing that virtual asset exchange Kraken had agreed to pay $30 million to the SEC and cease providing its Staking as a Service to U.S. customers to settle the SEC's allegations against its offering of unregistered securities [2].
"When investors provide assets to such staking services, they lose control of those assets and assume the risks associated with these platforms with little protection," the SEC said. "After getting the KEY of the investor's assets, Kraken will take control of the investor's assets for any purpose (lack of disclosure, the investor is unknown), and finally promise the investor a high return.
SEC Chairman Gary Gensler also took the lead in a video to explain why interest-bearing products like Kraken need to comply with the U.S. Securities Act: "When a company or platform offers you these types of products and promises returns, whether they call their services Lending, Earn Rewards, APY, or Staking, the act of offering an investment contract in exchange for investor funds should be protected by the federal Securities Act...... This enforcement action should make it clear to the market that service providers that provide pledged interest-bearing products must be registered and provide comprehensive, fair and truthful information disclosure and investor protection. ”
The SEC's rationale for determining Kraken's interest-bearing products as "securities" is as follows: first, Kraken receives funds from investors (full control), second, the funds are mixed with pools and used by Kraken for common causes (it is not known what exactly is done), Kraken does promise a return of up to 21% (ETH staking returns on the Ethereum Foundation's website are around 3%-5%), and finally, investors only participate in the investment, through Kraken efforts to achieve returns. This satisfies all the conditions of the Howey test and constitutes an "investment contract", which is a securities transaction.
Related reading: Ethereum, ETH staking (Solo Staking) is not a security, Kraken's ETH staking product is
On November 20, 2023, the SEC applied the logic of the above securities designation to virtual currencies listed on Kraken's exchange, and the SEC accused Kraken of integrating traditional financial services of exchanges, brokers, and clearing institutions with the SEC as required by law to register with the SEC because the trading targets included security tokens (Crypto Asset Securities) [3]. This is in line with Coinbase's accusations, which point to the ultimate question of "what kind of virtual asset is a security?"
1.2 Securities litigation by Coinbase, the largest publicly listed compliant exchange in the United States
The SEC filed a lawsuit on June 6 against Coinbase, the nation's largest digital asset compliance exchange, which became the first virtual asset integrated financial services provider to go public in the U.S. in April 2021. This lawsuit reflects the regulatory challenges and compliance framework of the SEC that all virtual asset exchanges need to face [4].
According to the SEC's allegations [5], Coinbase integrates traditional financial services of exchanges, brokers, and clearing institutions, and is required by law to register with the SEC because the trading subject includes security tokens (Crypto Asset Securities). As a result, Coinbase's violations include (1) unregistered brokers, including soliciting potential investors, handling customer funds and assets, and charging transaction fees, (2) unregistered exchanges, including providing a marketplace that brings together multiple virtual asset buyers, sellers, and order matching and execution, and (3) unregistered clearing institutions, including holding customers' assets in Coinbase-controlled wallets and settling customer transactions via debits.
The SEC also sued Coinbase for offering and selling unregistered securities to its customers through its staking product (Staking-as-a-Service Program). The SEC conducted regulatory enforcement against Kraken in February of this year for the same reason, and in the end Kraken agreed to pay the SEC a $30 million settlement, while Coinbase chose hard steel to the end.
In addition, the SEC also listed 13 tokens on the Coinbase platform as security tokens, including SOL, ADA, MATIC, FIL, SAND, AXS, CHZ, FLOW, ICP, NEAR, VGX, Dash, NEXO, and it is worth noting that the SEC noted that this is a non-exhaustive list.
Web3 小律 Comments：
The SEC's rationale for the lawsuit against Kraken and Coinbase is the same, namely that the trading platform is accused of failing to register with the SEC as an exchange, broker, clearing house because certain tokens on the exchange are identified as "securities." The identification of virtual asset "securities" has always been the ultimate issue that needs to be resolved by U.S. regulators.
While SEC Chairman Gary Gensler has so far avoided answering the question of whether ETH is a security head-on, Judge Katherine Polk Failla directly referred to ETH as a Crypto Commodity in the Uniswap case. Considering that the judge also heard the SEC v. Coinbase case, her response to whether or not virtual assets are "securities": "This case, not by the courts, but by Congress", threw this ultimate question to the U.S. legislature, Congress. However, the process of legislating Congress will be lengthy, and the 2024 election year will be fraught with uncertainty.
However, it is precisely because of this uncertainty that the SEC's regulatory strategy has a lot of room to play. The SEC will try to avoid in-depth treatment of the definition of "security" (as Gary Gensler pretended to be deaf and stupid at the hearing), and instead use the "security" of the project's token as a breakthrough to open a deeper investigation into the project, such as whether there is money laundering, market manipulation, misleading investors, etc. The best case in question is the settlement case between Binance and CZ.
Therefore, it does not matter whether or not a single project token is "securities" (e.g., SEC v. Ripple), the important thing is that when the project party is subject to the SEC's regulatory enforcement, in addition to paying money and accepting penalties, the SEC will also require the project party to implement an internal control procedure, and when this internal control procedure is adopted by more and more project parties, this internal control procedure will naturally become a regulation. This is how Gary Gensler "squeezed out" the regulations when he was previously chairman of the CFTC, which is largely consistent with the current situation at the SEC.
2. Whether Ripple is a "security" or not needs to be further clarified by the court
On July 13, 2023, SEC v. Ripple's three-year, $200 million major litigation case in the virtual asset industry has finally come to an end "briefly". In the 34-page judgment [6], the judge pointed out that Ripple's fundraising with institutional investors is an investment contract and an offering of "securities", and that the sale of tokens through an exchange program algorithm does not constitute an investment contract and does not belong to an offering of "securities".
On December 22, 2020, the SEC filed a lawsuit against Ripple and its founders, alleging that since 2013, Ripple and its founders have repeatedly issued and sold Ripple's token XRP in various ways in exchange for more than $1 billion. However, Ripple and its founders did not register their offering and sale of tokens with the SEC, nor did they obtain any registration exemptions from the SEC, thereby violating Section 5 of the U.S. Securities Act.
The judge in this case deftly avoided the most controversial question of the U.S. regulators – what kind of virtual assets are securities, and instead judged whether the different ways of offering XRP tokens constituted an offering of "securities" by judging the economic substance of the token transaction. The judge held that the underlying subject matter of most investment contracts is only commodities, such as gold and crude oil, which may not meet the definition of "securities". The same applies to Ripple's XRP token.
For XRP's Institutional Sales, due to Ripple's public announcement and promotion and the rational perception of institutional investors, the judge held that this token offering method met the OmniVision test and constituted a "securities" offering. However, the programmatic sales of XRP cannot meet the Howey test and does not constitute a "securities" offering because the way investors in the secondary market expect to make a profit may not be the efforts of the Ripple project team, but more likely based on the judgment of its market macro environment and the use of trading strategies.
For Other Distributions, it includes payments to employees, as well as XRP payments to third parties (ecosystem participants). The judge found that this type of offering did not satisfy the definition of "investment of money" in the OmniVision test, i.e., there was no record of the existence of an investment of money or other tangible consideration against Ripple.
The decision has been a major positive for the market, with several exchanges, including Coinbase, Kraken, Gemini, and Crypto.com, announcing the reopening of XRP trading, which rose by about 75% at one point and has a market capitalization of more than $42.8 billion, ranking fourth in the world. However, it is important to note that the decision is made by the District Court and is not binding.
On August 18, 2023, the SEC filed a motion for interlocutory appeal in the Southern District Court of New York, seeking an interlocutory appeal of summary judgment in the case. The motion was denied by the court, and the relevant grounds of appeal will be debated again in April 2024.
Related Reading: SEC v. The Ripple case further clears the regulatory fog
Web3 小律 Comments：
In this case, it was also seen that the judge's thinking was to dilute the definition of the token itself (e.g., the underlying subject of many investment contracts is a "commodity"), and was more inclined to judge the way in which the token was issued and sold (e.g., solo staking itself does not constitute a "security", but a staking financial product may constitute a "security"). This could be a regulatory idea for the future.
In addition, the judge's determination of Other Distributions is significantly different from the SEC's Framework for "Investment Contract" Analysis of Digital Assets[7], as amended by the SEC on March 8, 2023.
The SEC believes that in addition to the general definition of "money" that we can understand, other definitions of "money" include, but are not limited to: (1) digital currency rewards earned by investors for completing specific tasks (Bounty Program), and (2) digital currency rewards received by investors through air drops. It is believed that this conflict will be more fully debated in appeal cases.
Although the case seems to be able to bring Ripple a short-term "victory", judging from the lawsuits against large exchanges such as Kraken, Coinbase, and Binance, the SEC is no longer limited to the "security" determination of a single token, and the SEC wants to seek an all-in-one answer from Congress.
3. How far is Grayscale winning the SEC, Bitcoin spot ETFs?
On August 29, 2023, a ruling in a U.S. federal court gave Grayscale the victory in a lawsuit against the SEC for refusing to apply for a Bitcoin spot ETF [8]. The move could accelerate the process of traditional financial giants such as Blackrock and Fidelity applying for Bitcoin spot ETFs over the past few months.
In October 2021, Grayscale first applied to convert its closed-end Bitcoin trust, GBTC, into a Bitcoin ETF exchange fund. However, it was later rejected by the SEC, which said Grayscale had failed to answer questions about preventing fraud and manipulation in the market. Last year, Grayscale filed a lawsuit with the SEC, asking the court to re-examine the SEC's administrative actions.
The SEC previously allowed trading in Bitcoin futures ETFs for the first time in 2021 and said: futures products are more difficult to manipulate because the market is based on futures prices on the Chicago Mercantile Exchange (CME), which is regulated by the CFTC.
In the proceedings, the judge stated that it is a basic principle of administrative law that administrative acts taken by administrative organs must be treated equally. The SEC recently approved two Bitcoin futures ETFs and allowed them to be traded on exchanges, but refused to approve Grayscale's Bitcoin spot ETFs. The SEC's rejection of Grayscale's application was arbitrary and unfounded, as the SEC failed to explain how it treated similar ETF products differently. Accordingly, the court found that this discriminatory administrative action violated administrative law, agreed to Grayscale's request, and quashed the SEC's denial of the application.
Related Reading: Grayscale Wins a Win Over the Future, How Far Is the SEC's Bitcoin Spot ETF?
Web3 小律 Comments：
At this time, the court has not ordered the SEC to approve Grayscale's ETF application. The adjudication document simply says that the SEC's analysis of the issue of "fraud and manipulation" was wrong. So what will the SEC do?
One possibility is that the SEC will choose to continue to deny Grayscale's application on a different reason and force it to pursue a longer and more expensive lawsuit. It's entirely possible, but it depends on whether the SEC can swallow the bitter pills of this defeat and Gary Gensler's determination to continue the fight against the virtual asset industry. Another possibility: the SEC uses the court's decision as a step for its graceful exit against Bitcoin spot ETFs. In its press release, the SEC could read: "While we disagree with the court's decision, we must abide by the law and uphold justice." ”
While we have seen negative news that the SEC has delayed the approval of Bitcoin spot ETFs several times, and we have seen positive news that the SEC has actively coordinated with the applicants, in an interview with CNBC on December 15 [9], Gary Gensler responded positively to the Bitcoin spot ETF for the first time: "The SEC will revisit the ETF approval if the court has a different view on the SEC's refusal to approve the Bitcoin spot ETF." You can see that this is at least a change in attitude for Gary Gensler. The next ETF approval window is January 10, 2024.
Fourth, the ins and outs of Binance's sky-high settlement with CZ
U.S. regulators have been paying attention to Binance for a long time, and we can see almost all U.S. regulators from Binance's regulatory enforcement, covering the stablecoin regulatory perspective of financial regulation in New York State, the securities compliance perspective of the SEC, the derivatives compliance perspective of the CFTC, the customer identification (KYC), anti-money laundering (AML) perspective of FinCen, the counter-terrorist financing (CTF) perspective of OFAC, and the DOJ It can be described as a textbook-level regulatory compliance case.
4.1 New York financial regulators have asked Paxos to stop minting its stablecoin, BUSD
On February 13, 2023, Binance CZ issued a statement: The New York State Department of Financial Services (NYDFS) instructed stablecoin issuer Paxos to stop minting new BUSD. At the same time, Paxos confirmed that it has been notified by the SEC of potential allegations related to its BUSD products.
Paxos is a New York State registered stablecoin issuer that holds a New York State Bitlicense virtual asset operation license, is directly regulated by NYDFS, and its BUSD product is built on the Ethereum blockchain and is fully reserved in accordance with the requirements of the USD Stablecoin Issuance Guidelines[10] issued by NYDFS in June 2022[10].
NYDFS reserves the right to require Paxos to stop issuing BUSD or directly suspend Paxos' Bitlicense license on the grounds that it has not completed its regular risk assessment and due diligence commitments to prevent undesirable practices (such as money laundering). According to NYDFS, this regulatory move is intended to clarify the unresolved complex issues between Paxos and Binance. Paxos responded to NYDFS's regulatory move through its official website, stating that as of February 21, Paxos will cease issuing new BUSD tokens as directed by NYDFS and in close cooperation with it, and will end its partnership with Binance regarding BUSD.
4.2 The CFTC alleges Binance and CZ of knowingly evading U.S. law and illegally operating virtual asset derivatives businesses
On March 27, 2023, the CFTC announced that it had filed a civil lawsuit in a U.S. court alleging that CZ and the three entities operating its Binance platform repeatedly violated the Commodity Exchange Act (CEA) and CFTC regulations [11]. According to the indictment, from July 2019 to the present, Binance has offered and executed virtual asset derivatives transactions to U.S. citizens (albeit masking U.S. IP addresses), and under CZ's guidance, Binance instructed its employees and customers to deliberately evade U.S. law and conduct business in a non-transparent manner by circumventing compliance controls (including through VPNs, setting up shell companies, etc.), conducting business in a non-transparent manner, ignoring CEA and CFTC regulations, and systematically engaging in regulatory arbitrage for commercial gain [12]. ]。
The CFTC alleges that entities such as Binance, which provides virtual asset derivatives services in the United States, should register with the CFTC and undertake compliance obligations such as KYC to implement basic compliance requirements designed to prevent and detect terrorist financing and money laundering. Binance, on the other hand, has never made any registration with the CFTC.
As a result, the CFTC sought civil penalties and permanent trading and registration injunctions against CZ and its affiliates through civil lawsuits alleging that CZ and its affiliates had violated relevant laws and regulations on futures trading, and had neglected supervision, failed to implement KYC or anti-money laundering procedures, and developed unqualified compliance programs.
(from CFTC v. Zhao et al, Binance 前首席合规官 Samuel Lim 给出的法律意见)
"Today's enforcement action shows that no region, or region claiming to have no jurisdiction, can prevent the CFTC from protecting U.S. investors," CFTC Chair Rostin Behnam said. The CFTC will continue to use all of its powers to detect and stop misconduct in the volatile and high-stakes virtual asset industry...... Over the years, Binance has been actively working to keep money flowing and avoid compliance knowing that they have violated CFTC regulations. This should be a warning to everyone in the virtual asset industry that the CFTC will not tolerate deliberate circumvention of U.S. law. ”
4.3 The SEC filed 13 charges against Binance and its founder, CZ, including Binance
On June 5, 2023, the SEC filed 13 charges against Binance and other entities, as well as its founder, CZ, including operating unregistered exchanges, broker-dealers, and clearing institutions, conducting false transactions and ineffective regulation of Binance US, and issuing and selling unregistered securities [13].
In the 136-page indictment [14], the SEC charged CZ and Binance from multiple dimensions as follows: Binance illegally solicited U.S. investors to buy, sell, and trade virtual currencies, without restricting U.S. investors' access to Binance .com; Binance issued and sold securities without registration, including BNB, BUSD, and loan products known as "Simple Earn" and "BNB Vault," as well as in The so-called staking investment program offered on Binance, the SEC also noted that Binance secretly controlled assets pledged by U.S. customers in the BAM staking program, and that several entities, including Binance, repeatedly misled investors by allowing them to mix customer assets or transfer customer assets at will, including to Merit Peak Limited entities under CZ's de facto control, echoing similar allegations by FTX and its founder Sam; and other entities that should have been registered as stock exchanges, broker-dealers, and clearing houses operating without registering, Binance.US lying about preventing market manipulation and allowing washing trading by an undisclosed "market maker" trading firm, Sigma Chain, which is also owned by CZ.
SEC Chairman Gary Gensler slammed CZ, as well as Binance, and several other entities for "building a network of massive deception, conflicts of interest, lack of disclosure, and intentional evasion of the law." "As alleged, CZ, as well as Binance, and multiple entities, misled investors about their risk controls and false trading volumes, while actively concealing platform operators, manipulating their affiliated market makers to trade, and even using funds held by investors," Gensler said in a press release. The public should beware of investing any of their hard-earned assets in these illegal platforms. ”
4.4 Binance's sky-high settlement with CZ
On November 22, 2023, Binance admitted that it had violated the Bank Secrecy Act, the Economic Sanctions Act, and other relevant anti-money laundering and business compliance regulations, and announced a sky-high $4.3 billion settlement with the U.S. Department of Justice (DOJ), the U.S. Commodity Futures Trading Commission (CFTC), the Office of Foreign Assets Control (OFAC), and the Financial Crimes Enforcement Network (FinCEN) [15].
In the press release: Binance's biggest problem is that the KYC/AML/Counter-Terrorism Financing (CTF) regulations were not strictly implemented in the early stages of customer development. Binance's laissez-faire inaction, which prioritizes profit over compliance, has led to a huge amount of money flowing into the hands of terrorists, cyber hackers, and other criminals.
Although Binance blocked U.S. customers for failing to register in the U.S., the CFTC allegations that it still provided key U.S. customers with measures to circumvent KYC/AML/CTF, violating the relevant regulations required to do business in the U.S. This behavior allows clients subject to U.S. sanctions to access the U.S. financial market through Binance, seriously jeopardizing the stability of the financial market and national security. Note that this is National Security, so the Office of Foreign Assets (OFAC) is also deeply involved.
U.S. Treasury Secretary Janet Yellen said: "This historic settlement is a historic moment for the virtual asset market, and anyone who wants to do business in the U.S. and benefit from the U.S. financial market should strictly abide by U.S. laws." As part of the settlement, Binance will completely withdraw from the U.S. and appoint a five-year overseer to oversee the exchange's sanctions compliance program, according to a U.S. Treasury Department announcement. During this time, the U.S. Treasury will have access to Binance's records and systems.
Web3 小律 Comments：
After years of investigation by U.S. regulators, there was no mention of Binance's misappropriation of customer funds, such as serious fraud similar to FTX, in the settlement, which is a good thing. More importantly, this settlement has opened the green light for Binance's future business in the United States, which means that this settlement has "whitewashed" Binance's previous bad behavior, which is a positive for Binance in the long run.
Of course, it is not easy to re-establish a high-rise building in the United States through the "shell" Binane US, how to operate in the United States compliantly, set up a controlling entity, and apply for a license It will take time, and it may be more suitable for Binance, which has deep pockets.
It is important to note that this settlement has nothing to do with the SEC, and the previous SEC lawsuit against Binance still exists.
5. U.S. regulators are actively exploring ways to regulate DeFi
On April 6, 2023, the U.S. Department of the Treasury released the 2023 DeFi Illicit Financial Activity Assessment Report [16], the world's first DeFi-based Illicit Financial Activity Assessment Report and a response to the virtual asset regulatory framework released by the White House in March 2022.
Under the guidance of this report, U.S. regulators have gradually formed a regulatory framework for DeFi through judicial practice, including the CFTC's regulatory guidance on DeFi protocols from the business compliance level, FinCEN, which is responsible for preventing and punishing domestic and foreign money laundering activities, combating terrorist financing and other financial crimes, and collecting and analyzing financial transaction information, and tracking suspicious persons and activities by studying mandatory disclosures of financial institutions, and OFAC It is responsible for administering and enforcing all economic and trade sanctions based on U.S. national security and foreign policy, as well as the DOJ's disciplinary actions against offenders.
The financial stability of DeFi, the opacity of data anonymity, the lack of integrity in the market, and the cybersecurity of hackers all pose challenges to the current regulatory framework. How to determine the responsible entity of DeFi projects, how to solve the abuse of projects, regulatory arbitrage, and other issues are all urgent responses for regulators.
Since August 2022, OFAC has further expanded the regulatory dimension of on-chain DeFi projects in its victory against Ooki DAO [17] after the OFAC imposed economic sanctions on Tonardo Cash, a coin mixer DeFi protocol, from an AML/CTF perspective. The CFTC directly defined the on-chain DAO as an unincorporated organization on the grounds that the Ooki DAO business violated laws and regulations, setting a precedent that the on-chain DAO could bear legal liability as the subject of the lawsuit, and what is even more terrifying is that all members participating in the governance may bear joint and several liability of the DAO. After the DAO can be sued, the on-chain is no longer an extralegal place, and regulatory and law enforcement agencies can use this as a breakthrough to supervise on-chain DAO, DeFi, and DEX projects.
5.1 The U.S. Department of Justice has filed criminal charges against the founder of Tornado Cash
On August 23, 2023, the DOJ filed criminal charges against Tornado Cash founders, Roman Storm and Roman Semenov, alleging conspiracy to launder money, breach sanctions, and operating an unlicensed money transfer business during Tornado Cash's operations [18].
Tornado Cash is once a well-known coin mixing application on Ethereum, which aims to provide users with privacy protection for transactions, and it achieves private and anonymous transactions by obfuscating the source, destination, and counterparty of virtual currency transactions. On August 8, 2022, Tornado Cash was sanctioned by OFAC, and some on-chain addresses related to Tornado Cash were included in the SDN list, and any interaction between any entity or individual and the on-chain addresses in the SDN list is illegal.
OFAC claims that since 2019, more than $7 billion has been used to launder money through Tornado Cash, which provides substantial assistance, sponsorship, or financial and technical support for illicit cyber activities within and outside the United States, which could pose a significant threat to U.S. national security, foreign policy, economic health, and financial stability, and is therefore sanctioned by OFAC.
In an Aug. 23 press release, the DOJ said: "The defendants and their co-conspirators created the core features of the Tornado Cash Service, paid for the operating expenses of critical infrastructure to promote the service, and received millions of dollars in rewards from it. The defendant chose not to comply with the KYC/AML compliance measures required by law, knowing the illegality of the transaction.
Web3 小律 Comments：
It is understandable that the DOJ and OFAC have imposed sanctions on DeFi protocols and developers that threaten national security, but in the absence of a threat to national security, it remains an open question whether developers of decentralized protocols should be held accountable for bad third parties or for decisions resulting from loose community voting.
The courts gave different answers in the Uniswap case, as well as in the CFTC's settlement of the three DeFi protocols.
Related Reading: The Death of DeFi Regulation, Uniswap in Heaven, Tornado Cash in Hell
5.2 Uniswap Wins Investor – First Referee in the Context of Decentralized Smart Contracts
In April 2022, a group of investors took Uniswap's developers and investors to court en masse, accusing the defendants of failing to register under the U.S. federal securities laws and illegally listing "fraudulent tokens" for damages caused to investors [19].
Presiding Judge Katherine Polk Failla said that the real defendant in the case should be the issuer of the "scam token" and not the developer and investor of the Uniswap protocol. Due to the decentralized nature of the protocol, the identity of the fraudulent token issuer is unknown to the plaintiff (and the defendant is also unknown). The plaintiff can only sue the defendant in the hope that the court can transfer its recourse to the defendant. The reason for the lawsuit is that the defendant provided the issuer of the fraudulent token with the convenience of the issuance and trading platform in exchange for the transaction fees.
Taken together, the judge dismissed the plaintiff's lawsuit because the current virtual asset regulatory regime did not provide a basis for the plaintiff's claim, and that the developers and investors of Uniswap should not be liable for any damages caused by the use of the protocol by a third party under current U.S. securities laws.
Web3 小律 Comments：
The judge acknowledged the lack of judicial precedents related to DeFi protocols, the fact that no court has made a decision in the context of smart contracts of decentralized protocols, and that no way to pursue the legal liability of defendants under securities laws has not been found.
Section 12(a)(1) of the Securities Act gives investors the right to sue for damages arising from seller's violation of Section 5 of the Securities Act, Registration and Exemption of Securities. Since the petition was based on the regulatory dilemma of whether virtual assets were "securities," the judge said: "This is not a matter for the courts to decide, but for Congress." The court refused to extend the Securities Act to the conduct alleged by the plaintiffs, and concluded that "investor concerns are better raised with Congress than with this court, citing a lack of relevant regulatory basis." ”
In any case, while laws are currently being worked on around DeFi, regulators may one day address this gray area. However, the Uniswap case does provide a sample for the virtual asset industry to deal with regulation, i.e., decentralized exchange DEXs cannot be held responsible for losses incurred by users due to third-party issued tokens. This is actually a bigger impact than the Ripple case, which is good for the industry.
5.3 The CFTC has turned its attention to DeFi and may be an even more feared regulator than the SEC
On September 7, 2023, the CFTC once again focused its regulatory enforcement on DeFi and imposed penalties on three U.S.-based blockchain companies, Opyn, Inc., ZeroEx, Inc., and Deridex, Inc., which eventually settled [20].
In the press release: Opyn and Deridex have developed and deployed a DeFi protocol and a website respectively to provide token derivatives trading and perpetual contract trading, respectively, and ZeroEx has developed and deployed a protocol (0 x Protocol) and DEX applications, and there are some leveraged/margined tokens deployed by unaffiliated third parties on the DEX for investors to trade. These transactions can only be offered to retail users on registered exchanges that comply with the U.S. Commodity Exchange Act (CEA) and CFTC regulations, and all three of them have never been registered to provide services illegally and have not fulfilled the KYC required by bank secrecy laws.
According to the allegations, the CFTC demanded civil fines from three developer-operated companies, Opyn, ZeroEx, and Deridex, and asked them to stop the violations. Ian McGinley, Director of Enforcement at CFTC, said: "Once upon a time, there was an inherent belief on DeFi projects that on-chain was a place outside the law. However, this is not the case. The DeFi industry may be innovative, complex, and evolving, but law enforcement will also keep pace with the times and aggressively pursue those non-compliant unregistered platforms that allow U.S. users to trade derivatives. ”
Related Reading: CFTC Enforcement of Three DeFi Protocols, Ringing Alarm Bells for All Derivatives Trading Platforms
Web3 小律 Comments：
In a statement of dissenting opinions, the CFTC committee raised the question of who should be held liable if a DeFi protocol is developed and deployed for a legitimate purpose, but is used by an unrelated third party for a purpose that violates CEA and CFTC regulations, and whether the developer of the DeFi protocol will always be held liable The precedents have been answered, and the court tells us from the judicial perspective that the developers and investors of Uniswap should not be liable for any damage caused by the use of the protocol by a third party, because the underlying smart contract of Uniswap and the token contract deployed by a third party are completely different.
There is a huge space for discussion and debate. Most lawyers' views on this issue are the same as those of the judges in the Uniswap case, that is, the responsibility for the damage caused is the responsibility of the third party who committed the abuse, not the developers who have no control over the third party who committed the abuse, and the developers who just publish the commit code.
But in conjunction with the DOJ's criminal charges against the founder of Tornado Cash, the CFTC v. The Ooki DAO case, as well as the CFTC's regulatory enforcement, shows that the regulators don't think so. The CFTC will still place the responsibility of the abusive third party on the developer, even if the developer has no control over the mischievous third party's behavior. For example, in the regulatory enforcement of ZeroEx, the regulation did not consider whether the protocol developer is related to the listed derivative token, or whether the protocol developer has the ability to control the listing of the derivative token.
Previously, the CFTC used the precedent of Ooki DAO to identify violations of DeFi business and assume responsibility for on-chain DAOs and voting members within the DAO. After the DAO can be sued, the chain is no longer an extralegal place, and regulatory and law enforcement agencies can use this as a breakthrough to supervise DAO, DeFi, and DEX projects on the chain. This case is a further expansion of the CFTC in the field of DeFi regulatory enforcement.