Facilitator of Smart Contracts Protocol Fined $1.4 Million by CFTC for Purportedly Enabling Unregistered Events-Based Binary Options Trading Platform

Blockratize, Inc., d/b/a Polymarket, the owner of a website through which customers access smart contracts on the Polygon blockchain to place "winner-take-all" bets on enumerated future events, settled charges brought by the Commodity Futures Trading Commission for purportedly offering binary options -- a form of swaps -- without being registered as one of two forms of a trading facility as required by law -- either as a designated contract market or a swap execution facility. As reflected in a CFTC order announced on January 3, 2022, Polymarket agreed to pay a fine of $1.4 million to resolve the CFTC's allegations, as well as to cease offering products that do not comply with applicable law by January 14, 2022.

According to the CFTC, from at least June 2020 through the present, Polymarket deployed smart contracts that permitted its customers and liquidity providers to transact in event-based binary option markets. Customers buy and sell options by committing USDC stablecoins and trade against a liquidity pool funded by liquidity providers. An automated market maker prices the premiums for each option based on the relative demand for each position, automatically re-balancing the prices after each transaction.

According to the CFTC, because binary options are a form of swaps under applicable law (i.e., the Commodity Exchange Act), Polymarket could only provide a facility for transacting in such products if it was registered as a DCM or SEF. Since it was not so licensed, it engaged in activities related to commodity options without appropriate registration.

Although Polymarket relied on smart contracts for its markets, it was not run as a pure decentralized application. Notwithstanding, in announcing the CFTC's charges against and settlement with Polymarket, Vincent McGonagle, Acting Director of the Commission's Division of Enforcement noted that "[a]ll derivatives markets must operate within the bounds of the law regardless of the technology used, and particularly including those in the so-called decentralized finance or 'DeFi' space."

In June 2021, former CFTC Commissioner Daniel Berkovitz (and now current General Counsel of the Securities and Exchange Commission) presaged potential CFTC enforcement action involving DeFi when he stated "[n]ot only do I think that unlicensed DeFi markets for derivative instruments are a bad idea, I also do not see how they are legal under the CEA... The CEA requires any facility that provides for the trading or processing of swaps to be registered as a DCM or a [SEF]. DeFi markets, platforms, or websites are not registered as DCMs or SEFs.  The CEA does not contain any exception from registration for digital currencies, blockchains, or “smart contracts. (Click here to access Mr. Berkovitz's full statement.)

In settling with Polymarket, the CFTC noted the company's "substantial cooperation" that it said "materially assisted [its] investigation." Under it terms of settlement, Polymarket is not precluded from applying for registration as a DCM or SEF and hosting its smart contracts functionality on a sponsored basis.

Access settlement order here.

Access background on Polymarket here.