First Case! SEC Sues DeFi Lending Fraud, Governance Token Deemed Unregistered Security

The U.S. Securities and Exchange Commission (SEC) announced on the 6th the first enforcement action involving decentralized finance (DeFi) securities, targeting the DeFi protocol called DeFi Money Market. The SEC has filed a lawsuit against DeFi Money Market for selling unregistered securities and misleading investors about the operation and profit mechanism of DeFi Money Market.

Lawsuit against Cayman Islands Company and Two U.S. Executives

In December 2020, the company responsible for the DeFi Money Market (DMM) received investigation notices. By February of this year, DMM had already ceased operations and provided users with the option to redeem their tokens. The company associated with the protocol is registered in the Cayman Islands, with two executives from Florida being sued for offering and selling over $30 million in unregistered securities from February 2020 to February of this year.

Lending Protocol Tokens and Governance Tokens Deemed Securities

DMM issued mTokens and governance token DMG. Users could use the DeFi protocol to synthesize currencies like DAI, BTC, USDT into corresponding tokens such as mDAI, mBTC, mUSDT, and earn 6.25% interest accordingly. The governance token DMG provides governance rights, profit-sharing, and can also be traded for profit on the secondary market.

The SEC considers mTokens to be securities notes and are offered and sold as investment contracts. Similarly, the governance token DMG is also offered and sold as an investment contract.

Furthermore, the company claimed that profits came from investments in real assets such as car loans. Despite the executives having ownership in a car loan company, an SEC investigation revealed that DMM never had ownership of the loans, and the profits provided by DMM actually came from funds of the executives and another related company.