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Ooki vs CFTC: Emerging Questions on Legal and Tax Status of DAOs

Freeman Law | Andrew Mirisis | Oct 13, 2022

CFTC Chair Rostin Behman - Ooki vs CFTC:  Emerging Questions on Legal and Tax Status of DAOsThere are emerging and novel legal questions about how a DAO may be subject to regulatory or legal action. DAOs lack legal status in most of the United States, and, as a result, may be considered, by default, as a general partnership, with each member potentially having unlimited liability for its actions.

  • DAOs legal status in the U.S.: The lack of legal status in most of the United States is a significant liability risk to the DAO’s participants.  DAOs unlike their traditional legal entity counterparts are only recognized as legal entities in three states: Vermont, Wyoming, and Tennessee. Each of these states allows the DAO to register as a type of LLC.
    • It is unclear if a DAO may enter into a contract or conduct traditional business activities.
    • It is also unclear on what basis and how a DAO should be taxed. Should the IRS treat this emerging legal entity, by default, as a partnership? If so, how would Schedule K-1’s be issued since one of inherent features of a DAO is token holders anonymity? Absent a centralized structure, how would each participant receive aggregate information regarding the DAO’s activities (and their share thereof to be reported on a tax return)?
    • Finally, there are basic litigation issues under Federal Rules of Civil Procedure such as how can a party serve the DAO with a summons, discovery, notices, or motions?

See:  CFTC Enforcement Action Against Ooki DAO Outrages One of Its Own Commissioners (and Crypto)

  • CFTC v. Ooki DAO: On October 3, 2022, the United States District Court for the Northern District of California entered an order (the “Order”) granting the United States Commodities Futures Trading Commission’s (“CFTC”) motion to serve members of the “Ooki” DAO (formerly d/b/a/ bZx DAO) with a summons through online communications.
    • Specifically, the court granted the CFTC’s motion for alternative service on Ooki DAO and ruled that the CFTC effectively served Ooki on September 22, 2022, when the CFTC provided a copy of the summons and complaint through Ooki’s DAO help chat box as well as contemporaneous notice by posting the summons on Ooki’s online forum.
    • CFTC sued Ooki on September 22, 2022, alleging that the DAO, through its decentralized blockchain-based software protocol, illegally offered leveraged and margined retail commodity transactions in digital assets, engaged in activities that only registered futures commission merchants can perform, and violated the Bank Secrecy Act.
  • Who was caught in the summons?  The CTFC’s complaint seeks to impose legal liability on each Ooki DAO token holder that voted as part of the Ooki DAO’s governance process. The CFTC also did not make a distinction between token holders that specifically voted to engage in alleged illegal activities and those who did not.
    • The legal theory is likely that the exercise of the right to vote is an indication that the token holder participated in the governance of the DAO and if that governance resulted in illegal activity, that token holder should be held individually liable for their role in the collective DAO governance decision.

See:  BoE Speech by Carolyn Wilkins on DeFi Governance Limits and Opportunities: Get Up, Stand Up!

  • What's next?  Ooki DAO has until October 13, 2022, to respond to the complaint otherwise the CFTC may win a default judgment against the token holders that voted as part of the Ooki DAO governance process. If this happens, another novel legal issue that will emerge will be how will the government enforce the judgment on the DAO?
  • Implications: While decentralization may provide many technological benefits it comes with significant risk as it may introduce unlimited legal liability for any token holders that participate in the DAO governance process. This may be a headwind to the proliferation of Web3, DAOs, and other technologies that rely on decentralization. Additionally, the outcome of the Ooki case may spur additional state legislation to recognize DAOs as a subset of an LLC to limit the potential liability of token holders that participate in a DAO’s governance.

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