How long can the "decentralized cloak" of on-chain lending last?

Introduction

"As long as the code is sufficiently decentralized, there is no legal entity, and regulation has nowhere to start." — This was once the sanctuary many on-chain lending entrepreneurs believed in. They attempted to build an "algorithmic bank" without a CEO or headquarters.

However, with the penalties imposed in the US Ooki DAO case, this cloak of "decentralization" is being pierced layer by layer by regulatory agencies. Under the stricter logic of "penetrating regulation," how far can on-chain lending really go?

On-chain Lending: Autonomous Banks for Web3

On-chain lending can be understood as an automated lending machine operated without human intervention. Its main functions include:

• Automatic Funding Pool: Lenders deposit money into a public pool managed by code and immediately begin earning interest.

• Overcollateralization: Borrowers must collateralize assets exceeding the loan amount to control risk.

• Overcollateralization: Borrowers must collateralize assets exceeding the loan amount to control risk.

Algorithm-based interest rate setting: Interest rates are automatically adjusted by an algorithm based on the supply and demand of funds, making it completely market-driven. This model eliminates the intermediary role of traditional banks, realizing a 24/7 global automated lending market. No manual review is required; everything is executed automatically by code, greatly improving the efficiency of fund utilization, releasing asset liquidity, and providing a native source of leverage for the crypto market. The ideal is grand: Why do entrepreneurs pursue "de-subjectification"? In traditional finance, banks and lending platforms have clearly defined corporate entities, so it's clear who to contact if problems arise. However, on-chain lending, by its very design, attempts to eliminate "who." It doesn't pursue simple anonymity, but rather a system architecture, primarily manifested in two aspects: 1. The counterparty is code, not a person. You no longer sign contracts with any company or individual, but interact directly with a public, automatically executing smart contract. All lending rules, such as interest rates and collateral ratios, are hardcoded into the code. Your counterparty is this program. 2. Decisions are made by the community, not by management. The protocol has no board of directors or CEO. Major upgrades or parameter adjustments are decided by a vote of governance token holders distributed globally. Power is decentralized, thus blurring the lines of responsibility. For entrepreneurs, choosing "de-subjectification" is not only an ideal but also a realistic survival strategy, with the core purpose of defense: Defending against regulation: Traditional lending requires expensive financial licenses and adheres to strict rules. Positioning oneself as a "technology developer" rather than a "financial institution" aims to bypass these barriers. Defending against liability: When user losses occur due to events such as hacking, the team can claim that "the code is open source and the protocol is unmanaged," attempting to avoid liability for compensation like traditional platforms. Defending against jurisdiction: With no physical entity and servers spread globally, it is difficult for any single country to easily shut it down. This "unshutdownable" characteristic is its ultimate defense against geopolitical risks.

Reality is harsh: Why the "code is innocent" approach doesn't work?

I. Regulatory Risks:

Regulatory agencies' vigilance towards on-chain lending stems from three core risks that cannot be ignored:

1. Shadow Banking:

On-chain lending essentially creates credit, but it operates entirely outside the central bank and financial regulatory system, making it a typical shadow banking activity. A large-scale price drop could trigger a chain reaction of liquidations, causing systemic risk and impacting the entire financial system.

2. Illegal Securities:

Users depositing assets into a liquidity pool to earn interest is seen by regulators such as the US SEC as very much like issuing unregistered "securities" to the public.

3. Money Laundering Risk: The pooled fund model is easily exploited by hackers: they deposit stolen funds as collateral, then lend out clean stablecoins, cutting off the traceability of the fund chain and easily completing money laundering, posing a direct threat to financial security. Regulatory Principle: Substance over Form Functional Regulation: They don't care if you're a company or just code; they only care if you're actually doing the work of a bank, accepting deposits and making loans. If you're conducting financial business, you're subject to financial regulation. Penetrating Enforcement: If there's no clear legal entity to hold accountable, they will directly trace back to the developers and core governance token holders. The Ooki DAO case serves as a precedent, where members participating in governance voting were also held accountable. Simply put, "decentralization" only makes the system appear to be "self-driving," but if it potentially endangers financial security or harms investors, the regulators, like traffic police, will issue tickets and try to find the "owner" hiding behind the scenes. II. Common Misconceptions: Many entrepreneurs attempt to circumvent regulation using the following methods, but these defenses have proven to be very fragile. The following four points are common misconceptions: Misconception 1: DAO governance is exempt from liability: decisions are made by community voting, and the law does not punish the masses. In the Ooki DAO case, token holders who participated in the voting were also identified as administrators and punished. If a DAO is not registered, it may be considered a "general partnership," with each member bearing unlimited joint and several liability. Myth 2: Only writing code, not operating: I only developed the open-source smart contract; the front-end was deployed by someone else. Although EtherDelta is a decentralized trading protocol, the SEC still determined that founder Zachary Coburn wrote and deployed the smart contract and profited from it, and is therefore liable for not registering an exchange. Myth 3: Anonymous deployment is untraceable: Team identities are hidden, server IPs are concealed, and it's impossible to trace. Absolute anonymity is almost a false proposition! Funds can be converted to cash on centralized exchanges, code commit records, and social media information can all expose identities. Myth 4: Offshore architecture is beyond jurisdiction: The company is in Seychelles, the server is in the cloud, and the US SEC has no jurisdiction. The United States' "long-arm jurisdiction" is very strong. If even one US user accesses or trades involving US dollar stablecoins, US regulators can assert jurisdiction. BitMEX was heavily fined as a result, and its founder was sentenced. The Entrepreneur's Dilemma: The Real Challenges of Complete "De-Subjectification" When entrepreneurs choose complete "de-subjectification" to circumvent regulation, they face numerous obstacles: 1. Inability to Sign Contracts, Difficulty in Cooperation Code cannot act as a legal entity to sign contracts. When it comes to renting servers, hiring auditing firms, or cooperating with market makers, no one can sign the agreement on their behalf. If the developer signs, they will bear the responsibility; if they don't sign, it's impossible to establish cooperation with large, reputable institutions. 2. Inability to Protect Rights, Code Can Be Copied at Will. Web3 champions open source, but this means competitors can legally copy your code, interface, and even brand entirely, making only minor modifications (i.e., "forking"). Without a legal entity, it's difficult to protect your intellectual property through lawsuits or other means. 3. No Bank Account, Funding and Salary Payments Hindered. DAOs lack bank accounts, making it impossible to directly receive fiat currency investments or pay employee salaries and social security contributions. This severely limits recruitment and hinders the entry of funds from traditional large investment institutions. 4. Slow Decision-Making, Missed Crisis Management Opportunities. Giving complete decision-making power to the DAO community means any important decision requires a lengthy process of proposals, discussions, and voting. When faced with hacker attacks or severe market volatility, this "democratic process" may cause projects to miss the best opportunity to respond, making them unable to compete with centralized counterparts in terms of efficiency. Compliance Path: How Entrepreneurs "Rebuild the Subjectivity" Facing reality, top projects no longer pursue absolute decentralization, but instead turn to a pragmatic "Code + Law" model, the core of which is to establish a compliant "shell" for the protocol. Currently, there are three mainstream compliance architectures: 1. A two-tier architecture with development and governance layers: Operating Company: Register a regular software company in Singapore or Hong Kong, responsible for front-end 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, responsible for managing the token treasury and community voting. It acts as the legal embodiment of the protocol, assuming ultimate responsibility. 2. DAO Limited Liability Company: Directly utilizing the laws of Wyoming or the Marshall Islands, the DAO itself can be registered as a new type of limited liability company. This limits members' liability to the amount they have invested, avoiding the risk of unlimited liability. 3. Compliant Front-End and Permissioned DeFi: While the underlying protocol cannot prevent anyone from using it, the official website operated by the project can filter users: Geoblocking: Prohibiting access from IPs in sanctioned or high-risk areas. Address Screening: Using professional tools to block known hacker and money laundering addresses. Establishing a KYC-compliant funding pool: A lending pool established in partnership with institutions, specifically for professional users who have completed identity verification. Conclusion: From "Code Utopia" to "Compliant New Infrastructure" The next explosive growth point for on-chain lending is undoubtedly RWA, bringing real-world assets (such as government bonds and real estate) onto the blockchain. To handle trillions of dollars in traditional funds, a clear legal entity and compliance structure are essential. Compliance is not a betrayal of the original intention, but an inevitable path for Web3 projects to become mainstream. The future of on-chain lending is not a binary choice between "decentralization or compliance," but a dual-track integration of "code autonomy + legal entity."