CFTC's First Enforcement on DeFi in 2022: Fines and Shut Down Illegal Markets

On Monday, the U.S. Commodity Futures Trading Commission (CFTC) took its first enforcement action against a decentralized finance (DeFi) company this year, with crypto prediction market platform Polymarket failing to obtain Commodity Exchange Act (CEA) approval for offering binary options contracts based on off-exchange events. CEA) for registration of Designated Contract Market (DCM) and Swap Execution Facility (SEF). Polymarket is required to pay a $1.4 million fine and shut down all marketplaces that do not comply.

Obviously, the CFTC classifies the event products on the Polymarket platform as a swap transaction (a form of transaction in which the two parties agree to exchange a certain asset with each other at a certain period in the future).

According to the survey, since its establishment, Polymarket has provided more than 900 independent event markets, deployed and hosted on the blockchain to operate smart contracts. Since its launch in June 2020, Polymarket has seen approximately 5 billion trades, while also ranking among the crypto unicorns with a $1 billion+ valuation.

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The crypto market is not first-come, first-served

In layman's terms, a prediction market is a derivatives market created based on clear and verifiable facts in the future. Unlike platforms with preset odds, prediction markets are based on factual information collected by participants, and prices are determined by the activities of all participants in the prediction market. Participants judge and bet on the outcome of future events. According to publicly provable rules, if the prediction is correct, they can make a profit.

Essentially, the price of a "stock" in a prediction market reflects what participants believe to be the outcome. These events range from the outcome of the presidential election to tomorrow's weather.

Since the information revolution, humans have been committed to making the prediction market online, so that all users can quickly and easily participate in the prediction market through the Internet. The traditional prediction market relies heavily on intermediaries to play a role. The correctness and fairness of the prediction results require intermediaries to match them, which also leads to fees being charged by the intermediary. Factors such as maintenance costs, fragmented markets, and black-box operations will prevent users from getting corresponding returns.

As encrypted assets continue to move towards the mainstream, the underlying blockchain technology provides solutions and promotes the development of a decentralized world. With the blessing of blockchain technology, the prediction market has acquired the characteristics of openness and credibility. For example, who will be elected in the next U.S. election, and which team will win in a football game? These problems occur at some point in the future, and the end result is clear and verifiable, not ambiguous.

A crypto prediction market is a decentralized DeFi protocol where anyone can trade the outcome of an event on a smart contract when certain conditions are met, without intermediaries. As the user experience of DeFi becomes better, the advantage of the decentralized prediction market is that it can access more hot events around the world, providing users with more competitive interest rates and better liquidity.

Polymarket is a decentralized prediction market project built on the second-layer solution Polygon of Ethereum, where users can bet on hot topics in the world, such as the US election, the epidemic situation, encrypted asset prices, etc., and use US dollars to support The stablecoin USDC to trade the outcome of the event. It is worth noting that V God, the co-founder of Ethereum, once praised Polymarket:

“Try Polymarket now. It’s unique in that it’s built on top of Polygon’s Ethereum sidechain and offers an optimized UI to attract outsiders. It also offers the option to buy USDC with a credit card .”

Take an unfinished forecasting event as an example—"Will the EU's annual inflation rate reach 5.4% or higher in December?" This event provides users with two investment options: YES or NO, and the prices of the two can be determined is the probability that the market may realize the event, and the sum of the two is fixed at $1. If users think that the market price deviates from the actual probability, they can choose to buy the corresponding option and benefit from it.

Compared with other prediction market projects, Polymarket has two main features:

First, the project is built on Polygon, and the user's transaction behavior does not need to be confirmed by the Ethereum main network, which avoids defects such as high handling fees and long time-consuming.

Second, users can directly use debit cards or credit cards to purchase USDC for transactions in this project, without having to own encrypted assets and perform corresponding private key storage, which can greatly reduce the entry barrier for users.

At the same time, Polymarket has adopted an automated market maker (AMM) mechanism, and all user transactions will deduct 2% of the handling fee to the liquidity provider.

However, Polymarket’s development team did not disclose any technical details about the operation of the project. At the same time, there is currently no entry for users to independently create forecast events. All forecast events seem to be created by the project party and independently determine the results based on public information. It is only mentioned that the market with disputes will be handled by the Market Integrity Committee (MIC).

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Can Crypto Prediction Markets Evade Regulation?

In 2021, the CFTC hopes to become the main crypto regulator. Rostin Behnam, acting chairman of the CFTC, said at the hearing that the CFTC is ready to become the "policeman" of encrypted assets. Considering that the total size of the encrypted market has reached 2.7 trillion US dollars, nearly 60% of the 2.7 trillion US dollars % is a commodity, so expanding the CFTC's powers is especially important.

The CFTC has been taking enforcement actions in the crypto market for the past several years. In October 2021, it fined Tether, the largest issuer of the largest stablecoin USDT, $41 million for misleading statements about its capital reserves. Currently, the CFTC regulates the crypto derivatives market and can take action against fraud in the underlying crypto spot market.

According to a press release on the Polymarket penalty, Acting Director of the Enforcement Division Vincent McGonagall said: “No matter what technology is used, all derivatives markets must operate within the law, especially technologies that include the ‘DeFi’ space, Developers should actively engage with the CFTC to ensure the market remains robust, transparent, and provides customers with protections under the CEA and our regulations."

In June 2021, CFTC Commissioner Dan Berkovitz stated that unlicensed DeFi markets may be illegal in the United States. Derivative instruments in DeFi markets, such as futures contracts, may not be legal under commodity exchange laws, and federal law "does not contain any exceptions for decentralized financial markets." At the same time, in his view, the DeFi market for derivatives will fall under the purview of the CFTC.

In addition, excessive regulation, legal restrictions, and regulatory costs that platforms need to bear also greatly limit the development of traditional prediction markets, while blockchain-based encrypted prediction markets are generally considered a way to avoid regulations.

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In pics: Political events in 2020 for compliant prediction market platform PredictIt

Blockchain-based prediction markets can avoid regulation by being distributed instead of making predictions through a centralized platform. In a blockchain-based prediction market, users can arrange their own transactions at will, and the blockchain platform provides governance and financial incentives for good behavior.

It is uncertain whether other crypto prediction markets, such as Augur and Omen, will meet the same fate as Polymarket.

It is worth noting that current crypto prediction market platforms are not fully decentralized. The blockchain research organization The Block believes in the 2021 annual report that the forecasting process should use an economically reasonable and anti-corruption decentralized event oracle machine. Prediction market platforms do not prioritize full decentralization.

According to the "Notice on Further Preventing and Dealing with the Risk of Hype in Virtual Currency Transactions" issued by the central bank and other departments, the content of this article is only for information sharing, and does not promote or endorse any operation and investment behavior. Participate in any illegal financial practice.

risk warning:

According to the "Notice on Further Preventing and Dealing with the Risk of Hype in Virtual Currency Transactions" issued by the central bank and other departments, the content of this article is only for information sharing, and does not promote or endorse any operation and investment behavior. Participate in any illegal financial practice.