The lawsuit was filed in December 2022 against 9 big VC investors, including famous Silicon Valley firms like Andreessen Horowitz and Bain Capital Ventures. Together, these firms own over 50% of the Compound tokens that give voting power over the Compound Decentralized Autonomous Organization (or Compound DAO).
The specific VC firms named as defendants in the case are:
Together these 9 firms hold a majority stake in Compound, controlling the DAO’s critical decisions. The lawsuit argues this level of influence makes them potentially liable. COMP, the token associated with the DAO, crashed significantly in 2021 and has not recovered.
Compound DAO, like others, functions on blockchain technology and smart contracts rather than centralized control. However, with major venture capital firms owning a significant share of voting tokens, the “decentralized” nature of the DAO is up for debate.
The plaintiffs argue these VCs were not just passive investors, but actively pushed and promoted Compound to pump up demand and make their stakes more valuable. They claim the VCs had influence over Compound’s decisions and worked to get the tokens trading on popular crypto exchanges like Coinbase.
The key allegation is that the VCs should be treated like general partners in a partnership. In partnerships, individual partners can be personally liable for debts and misconduct of the overall partnership entity. Here, the plaintiffs say liability for losses should extend from Compound to the major VCs behind it.
The VCs tried to get the case thrown out early on. They said they were just regular investors, not actively involved in illegal activity. But on September 21 , the judge, William H. Orrick, said there was enough evidence of the VCs’ control and promotion of Compound to let the case move ahead for now.
In one of the cases cited by the defendants, Underwood v. Coinbase Global Inc ., a New York judge permanently dismissed it in February. The reason for the dismissal was that the judge found Coinbase to be a secondary marketplace, thus absolving it from any liability in soliciting investments.
However, Judge Orrick, presiding over the Compound suit, took a different stance. He argued that the plaintiffs in the Compound case have convincingly asserted that the partner defendants actively engaged in soliciting the sale of cryptocurrency assets. They are not merely peripheral participants, as was the case with Coinbase in Underwood.
“The allegations support the partner defendants’ control over the solicitations or others making solicitations on their behalf and at their direction,” Judge Orrick said.
A major dispute is whether securities laws, which normally apply to stocks and bonds, can extend partnership-based liability to cryptocurrencies like Compound tokens (COMP). The VCs say the law does not allow this, but the judge decided it was too early to dismiss the case on those grounds.
The lawsuit faces lots of legal hurdles before major investors would actually have to pay damages. But it represents a new legal threat for large crypto investors, who can no longer assume decentralization always limits their responsibility.
To date, DAOs have had a limited interaction with the law, so how the case pans out is largely theoretical. But it puts pressure on VCs to carefully consider how much control and influence they exert over crypto projects.