Key Takeaways
- A DeFi user has filed a lawsuit against Pool Together Inc. after depositing $10 in a pool of funds governed by a smart contract.
- PoolTogether is a “no loss” lottery that lets users stake their tokens into savings pools for a chance to win a weekly prize.
- The outcome of this case could set a precedent toward establishing a regulatory framework in the DeFi space.
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The plaintiff has argued that PoolTogether occupies a regulatory “grey zone.”
PoolTogether Faces Lawsuit
A new DeFi user with connections to Senator Elizabeth Warren is suing one of Ethereum’s earliest yield farming protocols.
PoolTogether Inc., a Delaware corporation linked to the blockchain based app PoolTogether, is facing a class-action lawsuit filed in New York federal court. The lawsuit was filed by a software engineer named Joseph Kent, a former technology lead for Warren’s 2020 presidential campaign. PoolTogether is a DeFi protocol that sells itself as a “crypto-powered savings protocol based on Premium Bonds.” It’s a smart contract on Ethereum that gives users the opportunity to win token prizes from the interest generated by the assets it pools. The protocol earns yield from farming the deposited tokens on other DeFi protocols. One of DeFi’s most widely used lending protocols, Compound Labs Inc., is also named in Mr. Kent’s suit.
The lawsuit comes after Mr. Kent deposited $10 worth of cryptocurrency in PoolTogether in October 2021. Kent has claimed that PoolTogether isn’t legally permitted to run prize-linked savings accounts His suit has been filed under a New York state law that lets a person who purchases an illegal lottery ticket bring a class-action lawsuit on behalf of themselves and other ticket-holders.
Under the law, defendants in these lawsuits are liable for as much as twice the amount that the entire class paid for their tickets. PoolTogether users have made deposits of at least $122 million, according to Mr. Kent’s lawsuit.
In the traditional finance system, users are trusted to follow the law, and face punishment if they break the rules. DeFi operates differently as the rules are encoded in smart contracts that anyone can see.
A Regulatory “Grey Zone”
However, while crypto proponents profess that “code is law,” the DeFi space is largely unregulated. That’s part of what’s made the space a fertile ground for criminal activity through hacks, rug pulls, and smart contract exploits. Regulators have paid closer attention to the space as it’s grown over the past year; stablecoins, a key component of DeFi, have been the subject of intense scrutiny, not least in the U.S. (the SEC Chair Gary Gensler, Treasury Secretary Janet Yellen, and the Federal Reserve Chair Jerome Powell have all issued warnings about the technology in recent months, while Warren has taken shots at DeFi and the environmental impact of Bitcoin mining on multiple occasions).
Kent’s lawsuit points to the alleged regulatory “grey zone” that PoolTogether occupies. Whether PoolTogether Inc. will come under fire depends on if the PoolTogether smart contract is classified as a managed investment scheme. Additionally, the case will also consider whether PoolTogether Inc. needed any territory-based permits to deploy a smart contract on the blockchain. As PoolTogether claims to be a “no loss” savings protocol, there is also an argument that the product can not be considered a lottery.
Defending PoolTogether Inc. is Kevin Broughel, who has argued that the company doesn’t own or control the protocol; instead, he says its operations are governed by its original coding, which can only be changed by a majority vote of holders of its governance token, POOL. Broughel has also said that deposits don’t qualify as lottery entries.
While the case is still in its early stages, it could set an important precedent for the DeFi and cryptocurrency industry. The focus will be on who gets to decide what the rules of code are, and how much control smart contract coders have over their projects. In other words, it will try to determine whether DeFi is truly decentralized.
Disclosure: At the time of writing, the author of this feature owned ETH and several other cryptocurrencies.
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