Original Author: Lawyer Zhang Qianwen
Introduction
"As long as the code is sufficiently decentralized, there is no legal entity, and regulation has no way to intervene." — This was once seen as a refuge by many on-chain lending entrepreneurs. They attempted to establish an "algorithmic bank" without a CEO and without a headquarters.
However, with the penalties imposed in the U.S. Ooki DAO case, this layer of "de-subjectification" is being pierced by regulators. In the context of stricter "penetrating regulation" logic, how far can on-chain lending still go?
On-Chain Lending: The Autonomous Bank of Web3
On-chain lending can be understood as an automated lending machine that operates without human intervention, primarily featuring:
Automated Fund Pool: Lenders deposit money into a public pool managed by code, immediately starting to earn interest.
Over-Collateralization: Borrowers must pledge assets exceeding the loan amount to control risk.
Algorithmic Fixed Interest Rate: The interest rate is automatically adjusted by algorithms based on the supply and demand of funds, fully market-oriented.
This model eliminates the intermediary role of traditional banks, achieving a 24/7 uninterrupted global automated lending market without manual review, fully executed by code, greatly improving the efficiency of capital use, releasing asset liquidity, and providing a native source of leverage for the crypto market.
Idealism is abundant: Why do entrepreneurs pursue 'decentralization'?
In traditional finance, banks and lending platforms have clear corporate entities, and when problems arise, it is clear who to approach. However, on-chain lending is designed to erase 'who'; it does not pursue simple anonymity but a system architecture, mainly reflected in two aspects:
1. The counterpart is code, not a person
You no longer sign contracts with any company or individual, but interact directly with a public, autonomously executing smart contract. All lending rules, such as interest rates and collateral ratios, are hard-coded. Your counterparty is this piece of software.
2. Decisions rely on the community, not on management
The protocol has no board of directors or CEO. Major upgrades or parameter adjustments are determined by governance token holders distributed globally through voting. Power is decentralized, and therefore responsibility becomes blurred.
For entrepreneurs, choosing 'decentralization' is not only idealistic but also a realistic survival strategy, with the core purpose being defense:
Defensive Regulation: Traditional lending requires expensive financial licenses and compliance with strict rules. Positioning oneself as a 'technology developer' rather than a 'financial institution' aims to bypass these thresholds.
Defensive Responsibility: When incidents such as hacker attacks cause user losses, the team can claim 'the code is open source, and the protocol is non-custodial,' trying to avoid bearing compensation responsibilities like traditional platforms.
Defensive Jurisdiction: Without a physical entity and with servers distributed globally, it is difficult for any single country to easily shut it down. This 'cannot be shut down' characteristic is its ultimate defense against geopolitical risks.
Reality is harsh: Why does 'code is innocent' not work?
I. Regulatory Risks
Regulators' vigilance over on-chain lending stems from three core risks that cannot be ignored:
1. Shadow Banking:
On-chain lending essentially creates credit but is completely detached from central banks and financial regulatory systems, representing typical shadow banking activities. Once a large-scale price drop occurs, triggering a chain liquidation, systemic risks arise, impacting the entire financial system.
2. Illegal Securities:
Users deposit assets into the fund pool to earn interest, and this behavior, in the eyes of regulators like the SEC, very much resembles issuing an unregistered 'security' to the public. As long as commitments and returns are provided, no matter how decentralized the technology is, it may violate securities laws.
3. Money Laundering Risks:
The fund pool model can easily be exploited by hackers: they deposit the stolen 'dirty money' as collateral and then lend out clean stablecoins, cutting off the tracking of the funds, easily completing money laundering, which poses a direct threat to financial security.
Regulatory Principles: Substance over form
Functional Regulation: They do not care whether you are a company or code; they only care whether you are essentially engaged in banking activities of accepting deposits and lending. As long as you are doing financial business, you must accept financial regulation.
Penetrating Law Enforcement: If there is no clear legal entity to hold accountable, they will directly trace back to the developers and core governance token holders behind it. The Ooki DAO case is a precedent, and members participating in governance voting are also held accountable.
In simple terms, 'decentralization' just makes the system appear to be 'autonomous,' but whenever it might threaten financial security or harm investors, the regulatory 'traffic police' will definitely issue fines and find the 'owner' hiding behind the scenes.
II. Cognitive Misconceptions
Many entrepreneurs attempt to evade regulation in the following ways, but it has been proven that these defenses are very weak; the following four points are common misconceptions:
Myth 1: DAO governance is exempt from liability: Decisions are made by community votes, and the law does not penalize the group.
In the Ooki DAO case, participating token holders in voting were also recognized as managers and penalized. If the DAO is not registered, it may be considered a 'general partnership,' and each member must bear unlimited joint liability.
Myth 2: Just writing code without operation: I only developed the open-source smart contract; the frontend is deployed by others.
Although EtherDelta is a decentralized trading protocol, the SEC still determined that founder Zachary Coburn wrote and deployed the smart contracts and profited from them, and must bear the responsibility of an unregistered exchange.
Myth 3: Anonymous deployment cannot be caught: Team identity is hidden, server IP is concealed, and tracking is impossible.
Absolute anonymity is almost a false proposition! Funds turning into cash on centralized exchanges, commit logs of code repositories, and social media information can all expose identities.
Myth 4: Offshore structures are not regulated: Companies in Seychelles, servers in the cloud, the U.S. SEC has no jurisdiction.
The 'long-arm jurisdiction' in the U.S. is very strong. As long as there is one U.S. user accessing or a transaction involving a USD stablecoin, U.S. regulators may claim jurisdiction. BitMEX was thus heavily fined, and its founder was sentenced.
Entrepreneurial Dilemma: The Real Challenges of Complete 'Decentralization'
When entrepreneurs choose complete 'decentralization' to evade regulation, they face numerous obstacles:
1. Unable to contract, difficulty in cooperation
Code cannot sign contracts as a legal entity. When it comes to leasing servers, hiring auditing firms, or collaborating with market makers, no one can sign on behalf of the protocol. If signed by individual developers, the individual will bear responsibility; if not signed, it is impossible to establish cooperation with legitimate large institutions.
2. Inability to defend rights, code is copied at will
Web3 advocates open source, but this means competitors can legally copy your code, interface, and even brand entirely, with only slight modifications (i.e., 'forking'). Due to the lack of a legal entity, it is very difficult to protect your intellectual property through lawsuits or other means.
3. No bank accounts, financing and payroll hindered
DAOs do not have bank accounts, making it impossible to directly receive fiat currency investments or pay salaries and social security for employees. This not only greatly limits talent recruitment but also hinders access to funds from traditional large investment institutions.
4. Slow decision-making, missing crisis response opportunities
Completely handing decision-making power to the DAO community means that any important decision must go through a long process of proposals, discussions, and voting. When facing hacker attacks or severe market fluctuations, this 'democratic process' may cause the project to miss the best response opportunities, making it inefficient compared to centralized counterparts.
Compliance Path: How Entrepreneurs 'Rebuild the Subject'
Facing reality, top projects no longer pursue absolute decentralization but turn to a pragmatic 'Code + Law' model, with the core being to establish a compliant 'shell' for the protocol.
Currently mainstream compliance structures are of three types:
1. A two-tier structure of development and governance:
Operating Company: Register a regular software company in Singapore or Hong Kong, responsible for frontend development, recruitment, and marketing. It calls itself a 'technology service provider' and does not directly engage in financial business.
Foundation: Establish a non-profit foundation in the Cayman Islands or Switzerland to manage the token treasury and community voting. It serves as the legal embodiment of the protocol and bears ultimate responsibility.
2. DAO Limited Liability Company:
Directly utilize the laws of Wyoming or the Marshall Islands in the U.S. to register the DAO itself as a new type of limited liability company. In this way, members' liabilities are limited to their contributions, avoiding the risk of unlimited accountability.
3. Compliance Frontend and Permissioned DeFi:
Although the underlying protocol cannot prevent anyone from using it, the official website operated by the project team can filter users:
Geographic Blocking: Prohibiting IP access from sanctioned or high-risk areas.
Address Screening: Using professional tools to block known hacker and money laundering addresses.
Establishing KYC Fund Pools: Partnering with institutions to provide services to professional users who have completed identity verification.
Conclusion: From 'Code Utopia' to 'Compliance New Infrastructure'
The next explosion point for on-chain lending is undoubtedly RWA, bringing real-world assets (like government bonds and real estate) on-chain. To accommodate trillions of traditional funds, a clear legal entity and compliance structure are the tickets to entry.
Compliance is not a betrayal of the original intention, but a necessary path for Web3 projects to go mainstream. Future on-chain lending will not be a choice between 'decentralization or compliance,' but a dual-track integration of 'code autonomy + legal entity.'