In the inaugural Grayscale Legal Spotlight, we summarize how various classifications affect digital assets through a two-part series. In Part One, we discuss the various classifications and their implications for digital assets. Here, in Part Two, we unpack a recent example of the MNGO token that demonstrates the nuances of regulating and classifying digital assets.
Given crypto’s unique technological underpinnings, it is unsurprising that digital assets may blur the lines between traditional securities and other asset classifications. In this piece, we examine recent complaints by the United States Department of Justice (DoJ), the Commodities Futures Trading Commission (CFTC), and the Securities Enforcement Commission (SEC) that appear to demonstrate the complexities brought by a digital asset that is simultaneously classified as both a commodity and a security.
The Eisenberg Case and the DoJ Complaint
On December 23, 2022, the United States Department of Justice filed charges against Avraham Eisenberg alleging, among other charges, that the defendant engaged in commodities manipulation related to his activities on the decentralized exchange, Mango Markets.
The CFTC Complaint
On January 9, 2023, the CFTC filed a complaint against Eisenberg alleging (among other claims) he engaged in fraud and manipulation related to the price of MNGO and the associated perpetuals. The complaint includes a list of “digital asset commodities” that the defendant withdrew from Mango Markets, which it identified as “including bitcoin, ether and Tether.” MNGO is absent from this list, despite Eisenberg’s having executed spot transactions for MNGO. In fact, the complaint focuses on the manipulation of perpetuals, stopping short of identifying MNGO as a commodity.
The CFTC’s reluctance to identify MNGO itself as a commodity might seem strange given its position that digital assets are commodities and the fact that MNGO is a digital asset. The complaint even notes “Certain digital assets are ‘commodities’ in interstate commerce, including BTC, ETH, USDC, and others, as defined under” the CEA. It is unclear why the CFTC stops short of recognizing MNGO as a commodity like it does these other assets.
The SEC Complaint
On January 20, 2023, the SEC filed its own complaint against Eisenberg alleging (among other claims) he engaged in fraud or deceit upon other persons in connection with the purchase or sale of securities. The complaint alleged that at the time of Eisenberg’s conduct, MNGO was a security. Following the Howey Test, the SEC pointed to the fact that purchasers had used USDC to purchase MNGO in the token’s initial sale to satisfy the first prong.
In the complaint, the SEC specifically countered the claims that MNGO is useful as a governance token or sufficiently decentralized as to avoid investment contract status, claiming that the governance rights afforded to MNGO holders as members of the Mango DAO treasury were “illusory.” The SEC noted that approximately five to ten wallet addresses voted on any given proposal despite thousands of addresses holding the token. According to the SEC, some of these voting addresses were the protocol’s creators (who received an equal 5% of the MNGO total allocation—equal to the amount allocated to the general public immediately after the token sale), causing the creators to “dominate the votes.” The SEC also pointed to the approved governance proposal establishing Mango Markets’ seven-member “Upgrade Council” that had unilateral authority to control upgrades of Mango Markets and included several of the protocol’s creators. According to the complaint, The Upgrade Council proposal was allegedly approved with only 2.29% of the MNGO supply voting in favor, with at least 70% of those votes cast by two of the protocol’s creators. Thus, according to the SEC’s complaint, MNGO satisfied all four Howey prongs, causing it to be an investment contract which Eisenberg manipulated in his scheme.
The Curious Case of the MNGO Commodity-Security
This case of a token that appears to be simultaneously a commodity and a security also muddles the analysis for responsible actors in the space trying to conform with applicable requirements. If a team is building a token, should they be engaged with the SEC or should they assume the commodities spot rules will apply to the token? Would Eisenberg’s conduct have been prosecuted differently merely because the token he allegedly chose to manipulate was closer to “illusory governance,” and not “sufficiently decentralized,” at that point in time? Should securities rules apply differently, or even apply at all, to secondary transactions of a digital asset that may have started as a digital asset security?
These are some of the challenging issues that may not be able to be resolved without congressional action. Fortunately, we have seen some legislative willingness to help resolve issues like this in a manner that attempts to protect token purchasers and consumers while alleviating this overlap between the agencies. For example, Title III of the Responsible Financial Innovation Act would provide a path for tokens to be issued as pure commodities while the issuing team is still subject to certain information disclosure requirements, thereby possibly mitigating the potential for exploiting insider information while decreasing the regulatory burden placed on crypto-asset secondary transactions. The Digital Commodities Consumer Protection Act and the Digital Commodity Exchange Act each also attempt to provide some guidance on the issue.
More broadly, the SEC and other regulatory bodies’ activities have demonstrated the need for clarity around regulatory issues in the crypto space. Outside of the case of the MNGO commodity-security we discuss here, regulatory actions just over the last month have included shutting down Kraken’s staking service platform, a Wells notice from the SEC to Paxos regarding their minting of BUSD, as well as an agreement between Paxos and the New York Department of Financial Services to stop the minting.
In future Grayscale Legal Spotlights, we look forward to keeping readers apprised with insights on timely topics in the industry.
