Current regulatory interpretations of law can cause digital assets to simultaneously fall under multiple legal classifications by different federal agencies (e.g., as both a commodity and a security). This can potentially make it difficult to develop compliance and operational requirements for individual crypto assets – and may complicate which federal regulators have oversight of the asset.

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.

Mango Markets is a decentralized exchange that intended to allow users to lend, borrow, swap, and leverage-trade crypto assets without a centralized intermediary. Like other decentralized exchanges, Mango Markets is allegedly managed by a Decentralized Autonomous Organization (DAO), or an organization constructed by rules encoded as a computer program that is often transparent, controlled by the organization’s members and not influenced by a central government. The Mango DAO is controlled by holders of the MNGO token, who use MNGO to vote on decisions affecting the protocol.

The complaint revolves around Eisenberg’s alleged scheme to steal approximately $110 million by artificially manipulating the price of “perpetuals” (a type of derivative known as a swap) for the MNGO token that were available via Mango Markets. According to the complaint, the scheme worked as follows:

EISENBERG used an account that he controlled on Mango Markets to sell a large amount of Perpetuals for MNGO and used a separate account on Mango Markets to purchase those same Perpetuals. In other words, EISENBERG sold himself MNGO Perpetuals. EISENBERG then engaged in a series of large purchases of MNGO, with the objective of artificially increasing the price of MNGO relative to USDC, which had the effect of increasing the price of MNGO Perpetuals on Mango Markets. That purchasing . . . causing the price of MNGO Perpetuals on Mango Markets to increase precipitously over the course of approximately 20 minutes. Over that time span of approximately 20 minutes, the price of MNGO Perpetuals rose from approximately 0.0382 USDC/MNGO to approximately 0.54 USDC/MANGO, an increase of approximately 1,300 percent.

Eisenberg then allegedly used his inflated-price MNGO perpetuals as collateral to borrow a large amount of various crypto-assets from Mango Markets which he allegedly never intended to repay, “bankrupting” the market and resulting in a large personal windfall for Eisenberg.

The DOJ’s jurisdiction over the Eisenberg matter is not surprising since perpetuals are typically considered transactions under the purview of the Commodities Exchange Act (CEA), and Eisenberg allegedly manipulated the price of perpetuals in violation of the CEA. However, while the DOJ complaint largely focuses on the manipulation of these perpetual transactions, Count Two of the complaint alleges Eisenberg “knowingly and intentionally manipulate[d] and attempt[ed] to manipulate the price of a commodity in interstate commerce.” The complaint does not explicitly state which commodity Eisenberg allegedly manipulated the price of, nor that MNGO is a commodity. But the wording of this allegation raises the question “which commodity is the DOJ referring to here?” While the complaint does explicitly state that USDC (a stablecoin) is a commodity, Eisenberg’s scheme did not involve manipulating the price of USDC. Can we draw from this that MNGO should be viewed as a commodity?

Aside from the complaint, there appear to be coherent arguments for why MNGO should not be regarded as an investment contract, and therefore not a security under the securities laws. While the first two prongs of the Howey Test are arguably present, it’s relevant that the token may be used to contribute to governance decisions of the Mango DAO, indicating that a person who purchases MNGO is doing so for this utility rather than out of an expectation of profits (thus failing the Howey Test).

Moreover, Mango Markets is supposedly decentralized and coordinated by a DAO, indicating there might not be a specific party whose efforts drive the success of the venture. As Former Director of the SEC’s Division of Finance William Hinman said, “If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract.” If Mango Markets is determined to be sufficiently decentralized, MNGO might not be considered a security.

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.

Indeed, Count I of the complaint, titled “Use of a Manipulative or Deceptive Device,” cites the statutory prohibition on fraud and manipulation of both swaps and contracts for the sale of commodities, but only identifies the MNGO-USDC perpetuals —and not MNGO itself—as within the CEA’s definition of “commodities.” Similarly, Count II of the complaint, titled “Manipulation and Attempted Manipulation of a Swap,” ignores that the statutes and rules under which Eisenberg is being charged may also apply to manipulation “of any commodity in interstate commerce,” again focusing on the manipulation of the swap as the prohibited conduct.

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.

The SEC then pointed to the fact that the “price of MNGO tokens moved up and down together” and that each of the Mango DAO treasury and the protocol’s creators received 5% of the MNGO supply, allegedly satisfying the second Howey prong. In alleging the third Howey prong was satisfied, the SEC pointed to facts like how MNGO holders could use the tokens to earn more MNGO by providing liquidity or simply earn interest by depositing their tokens into their Mango Markets accounts to show an expectation of profits. According to the SEC, Mango Markets creators demonstrated entrepreneurial or managerial efforts to satisfy the fourth Howey prong through activities such as deploying code for different versions of the platform, creating content for the Mango Markets’ website and Twitter account, submitting and voting on governance proposals, and responding to users on the Mango Markets Twitter and Discord channels.

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

The above interpretation of MNGO as a commodity in the DOJ complaint and the allegations of the SEC complaint paint MNGO as simultaneously being a commodity and a security. The CFTC leaves the issue as to whether MNGO is a commodity as ambiguous even though, as mentioned above, the CFTC has posited that digital assets may be both a commodity and a security. Under these circumstances, a person who manipulates the price of a crypto-asset the SEC deems a security may be subject to an enforcement action by both the SEC and the CFTC (and, as we see in Eisenberg’s case, the DoJ) even though they only committed one spot trade.

Such an outcome would represent overlapping administration by two or more government agencies and open questions of justice in whether it is fair for a person to be enforced against multiple times by different agencies for the same conduct. In Eisenberg’s case, he was allegedly manipulating the price of MNGO-USDC perpetuals which would fall within the CFTC’s jurisdiction. But if he was embarking in a simple “pump-and-dump scheme” in which he artificially increased manipulated the price of a token to sell to unwitting buyers without involving perpetuals, would it be efficient to bog down the administrative and judicial systems with redundant actions filed by both the CFTC and the SEC? Is it fair to bring simple commodity transactions under the more onerous securities regime? Does bringing all crypto-asset transactions under the SEC’s purview hamper the ability for a token to be a token? If we take the CFTC’s view that all digital assets are commodities that may also be securities, should we have two separate agencies regulating policing the same assets? And is this evidence of a “turf war” brewing between the agencies?

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.

We have yet to see whether these bills will be adopted as law, but at least legislators are considering the issue. Until sensible legislation is adopted to resolve this issue, we may see more cases of simultaneous commodity-securities in the crypto space.

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.

Read more: https://grayscale.com/legal-spotlight-curious-case-mngo-commodity-security/

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