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The situation: Decentralized Finance (“DeFi”) is a fast-growing sector that, by definition, completely avoids centralized financial institutions. The misconduct that has accompanied that growth has drawn the attention of the Commodity Futures Trading Commission (“CFTC”), which has filed three DeFi cases in the last 12 months.
The result: The latest subject of this scrutiny allegedly artificially affected prices through “oracle manipulation” on three digital asset exchanges to benefit their “perpetual futures” contract positions in a DeFi market. In response, the CFTC recently filed a civil enforcement action, the first for a fraudulent or manipulative DeFi scheme, charging an individual with trade laundering and illegally obtaining more than $110 million in digital assets through this manipulative scheme.
Looking to the future: The CFTC, the US Securities and Exchange Commission (“SEC”), the US Department of Justice (“DOJ”), and other federal agencies will continue to bring cases involving first impression issues for enforcement its jurisdiction in new markets, including DeFi markets. , in response to new methods of perception of violations of the statutes they administer.
On January 9, 2023, the CFTC initiated a civil enforcement action against the defendant, who was investigated in October 2022 when he allegedly employed a manipulation strategy on three digital asset exchanges and Mango Markets, a DeFi protocol, which generated more of $110 million. in digital assets. The DOJ and SEC also filed parallel charges. In its complaint, the CFTC alleges that on October 11, 2022, the defendant misappropriated more than $110 million in digital assets from Mango Markets through oracle manipulation. An oracle is a data source that moves data in and out of a blockchain. Oracle’s manipulation may consist of artificially influencing the data feed to the oracle and/or to the blockchain, in this case, the Mango Markets blockchain. This is the type of oracle tampering that the CFTC alleged in its complaint.
The defendant allegedly executed his improper plan by creating two anonymous accounts at Mango Markets, which he used to set long and short perpetual futures contracts on the different accounts based on the relative prices of MNGO, Mango Markets’ native token; and USDC, a stablecoin. According to the lawsuit, the defendant then began buying substantial amounts of MNGO on three digital asset exchanges that were the gateways to the Mango Markets oracle. The lawsuit alleges that these large-scale and large-quantity transactions severely inflated the price of MNGO on those exchanges, which in turn significantly increased the value of defendant’s long perpetual futures position on Mango Markets. He then allegedly cashed out his position by taking out a loan he did not intend to repay, which was collateralized by the value of the long position, effectively depleting Mango Markets’ liquidity completely and forcing it to suspend trading. Although the value of defendant’s short position dropped dramatically, defendant needed to establish the short position in order to have a counterparty for his long position in his other account, according to the lawsuit. The CFTC charged the defendant with laundering trading for executing this countertrade.
The lawsuit states that the defendant then contacted the Mango Decentralized Autonomous Organization (“DAO”), the operator of the Mango Markets blockchain, to negotiate the return of some of the digital assets it had “borrowed.” “, on the condition that Mango Markets accept, among others. things, so as not to carry out any criminal investigation or freeze the defendant’s funds. The defendant agreed to return approximately $67 million in digital assets, but retained about $47 million, according to the complaint.
This case represents the first CFTC enforcement action involving DeFi fraud and manipulation and the third CFTC DeFi action overall in a relatively short period of time, since January 2022. The first two were actions against Polymarket in January 2022. 2022 and Ooki DAO in September 2022. This trend suggests that the CFTC is in tune with DeFi developments and focused on this space. Two CFTC commissioners issued statements at the same time as the announcement of the complaint suggesting that the CFTC is just getting started. For example, Commissioner Kristen Johnson noted that she supports the CFTC by using its “existing authority to vigorously pursue misconduct…in novel venues such as a decentralized digital asset exchange.” Commissioner Caroline Pham noted that this enforcement action makes it clear that perpetual futures can constitute a trade, bringing such a scheme within the jurisdiction of the CFTC.
As for perpetual futures, it is interesting that although the product is called perpetual “futures,” a product over which the CFTC also has jurisdiction, the CFTC characterized it as a swap. This may be because the CFTC has lost several cases (eg,
CFTC v. Zelener373 F.3d 861 (7th Cir. 2004); CFTC v. Erskine, 512 F.3d 309 (6th Cir. 2008)) in which he purported to characterize the products as futures; and the definition of “swap” in the Commodities Exchange Act (“CEA”), the statute administered by the CFTC, is quite broad and arguably easier to apply to new products in particular. The CFTC has also stated in the past that the name given to a product does not dictate its legal treatment.
The case is also a notable example of cooperation and coordination between the CFTC, the DOJ, and the SEC in the DeFi application space. In that sense, the CFTC’s Enforcement Division has an Office of Cooperative Enforcement, which “provides expert help and technical assistance with the development of cases and trials to the Offices of the United States Attorneys, other federal and state agencies, and international authorities.” . The CFTC’s Mango Markets enforcement press release makes it clear that it is working closely with the Department of Justice and the SEC (which accused the defendant of tampering with MNGO, “a so-called government token that was offered and sold as value”), to crack down on various fraudulent schemes involving digital assets. Related to this, the Department of Justice criminal complaint against the defendant was opened on December 27, 2022.
Two key takeaways
- The CFTC and other federal agencies focus on DeFi misconduct.
- Although DeFi is new, the statutes cited in enforcement actions administered by the CFTC, DOJ, and SEC (including CEA, securities laws, or wire fraud) are not new. Therefore, DeFi innovators who wish to avoid federal compliance action are advised to familiarize themselves with the applicable federal regulatory framework.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought according to your specific circumstances.
