How much longer can the "decentralized facade" of on-chain lending last?

Introduction

“As long as the code is sufficiently decentralized, there is no legal entity, and regulators have nowhere to start.” — This was once considered a safe haven by many on-chain lending entrepreneurs. They tried to build an “algorithmic bank” with no CEO and no headquarters.

However, with the enforcement of the Ooki DAO case in the United States, this “de-subjectification” cloak is being pierced layer by layer by regulators. Under the stricter logic of “look-through regulation,” how far can on-chain lending really go?

On-Chain Lending: Web3’s Autonomous Bank

On-chain lending can be understood as an automated lending machine with no human operators, with key functions including:

• Automated liquidity pools: Lenders deposit funds into a public pool managed by code and immediately start earning interest.
• Overcollateralization: Borrowers must pledge assets worth more than their loan amount to control risk.
• Algorithmic interest rates: Interest rates are automatically adjusted by algorithms based on supply and demand, making the process fully market-driven.

This model eliminates the intermediary role of traditional banks, enabling a 24/7 global automated lending market. There’s no need for manual review—everything is executed automatically by code, greatly improving capital efficiency, unlocking asset liquidity, and providing native leverage for the crypto market.

Lofty Ideals: Why Do Entrepreneurs Pursue “De-Subjectification”?

In traditional finance, banks and lending platforms have clear corporate entities—when something goes wrong, you know who to look for. But on-chain lending is designed to erase the question of “who”—not just through anonymity, but via a system architecture, mainly in two ways:

1. Your counterparty is code, not a person

You no longer sign contracts with any company or individual, but interact directly with a public, self-executing smart contract. All lending rules, such as interest rates and collateral ratios, are hard-coded. Your counterparty is simply the program.

2. Decisions are made by the community, not management

Protocols have no board of directors or CEO. Major upgrades or parameter adjustments are decided by governance token holders worldwide through voting. Power is decentralized, making responsibility attribution ambiguous.

For entrepreneurs, choosing “de-subjectification” is not just an idealistic choice but a pragmatic survival strategy, with a core purpose of defense:

• Regulatory defense: Traditional lending requires expensive financial licenses and strict compliance. By positioning themselves as “technology developers” rather than “financial institutions,” teams aim to bypass these barriers.
• Liability defense: When user losses occur due to hacks or other incidents, teams can claim “the code is open-source, the protocol is non-custodial,” attempting to avoid compensation responsibilities like traditional platforms.
• Jurisdiction defense: With no legal entity and servers distributed globally, it becomes difficult for any single country to shut it down. This “uncensorable” feature is the ultimate defense against geopolitical risks.

Harsh Reality: Why “Code is Innocent” Doesn’t Work

1. Regulatory Risk:

Regulators are wary of on-chain lending due to its three core risks:

1. Shadow Banking:

On-chain lending essentially creates credit outside the central bank and financial regulatory systems—classic shadow banking. Large-scale price drops could trigger cascading liquidations, resulting in systemic risk that shocks the entire financial system.

2. Illegal Securities:

Users deposit assets into liquidity pools to earn interest—a behavior regulators like the US SEC see as akin to issuing an unregistered “security” to the public. As long as yields are promised and delivered, regardless of how decentralized the technology is, it may violate securities laws.

3. Money Laundering Risk:

• The liquidity pool model is easily exploited by hackers: They deposit stolen “dirty money” as collateral, borrow clean stablecoins, sever the traceability chain, and complete money laundering with ease—posing a direct threat to financial security.
• Regulatory Principle: Substance over Form

Functional regulation: Regulators don’t care if you’re a company or code; they care whether you’re essentially conducting banking activities—taking deposits and making loans. If you’re in finance, you’re subject to financial regulation.

Look-through enforcement: If there’s no clear legal entity to hold accountable, regulators will go after the developers and core governance token holders behind the scenes. The Ooki DAO case set a precedent—members who participated in governance voting were also held liable.

In short, “de-subjectification” only makes the system appear “driverless,” but as long as it can threaten financial stability or harm investors, regulators—the “traffic police”—will issue fines and find ways to identify the hidden “car owner” behind the scenes.

2. Cognitive Misconceptions:

Many entrepreneurs attempt to evade regulation in the following ways, but these defenses are fragile. Here are four common misconceptions:

Misconception 1: DAO governance provides immunity—decisions are made by community vote, so the law can’t hold everyone accountable.

In the Ooki DAO case, governance token holders who voted were also deemed managers and penalized. If a DAO is unregistered, it may be considered a “general partnership,” making each member jointly and severally liable.

Misconception 2: I only write code, not operate—I just developed open-source smart contracts, others deployed the frontend.

Even though EtherDelta was a decentralized exchange protocol, the SEC still found founder Zachary Coburn responsible for writing and deploying the smart contract and profiting from it, holding him liable for operating an unregistered exchange.

Misconception 3: Anonymous deployment is untraceable—the team hides their identities and server IPs, making tracking impossible.

Absolute anonymity is almost a myth! Cashing out at centralized exchanges, code commit histories, and social media clues can all expose identities.

Misconception 4: Offshore setup is untouchable—the company is in Seychelles, servers are in the cloud, the US SEC has no jurisdiction.

The US’s “long-arm jurisdiction” is very aggressive. If even one US user accesses the service, or if transactions involve US dollar stablecoins, US regulators may assert jurisdiction. BitMEX was heavily fined and its founders jailed for this reason.

Entrepreneurial Dilemma: The Real-World Challenges of Full “De-Subjectification”

When entrepreneurs choose full “de-subjectification” to avoid regulation, they face numerous obstacles:

1. No Contract Signing, Difficult Collaboration

Code cannot sign contracts as a legal entity. When you need to rent servers, hire audit firms, or work with market makers, no one can sign on behalf of the protocol. If a developer signs personally, they assume liability; if no one signs, you can’t form partnerships with major institutions.

2. No Rights Protection, Code Easily Copied

Web3 values open source, but this means competitors can legally copy your code, interface, and even brand with minor tweaks (a “fork”). Without a legal entity, it’s difficult to protect your intellectual property through lawsuits or other means.

3. No Bank Account, Fundraising and Payroll Issues

DAOs have no bank accounts, making it impossible to receive fiat investments directly or pay salaries and benefits to employees. This severely limits talent recruitment and blocks entry for traditional major investment institutions.

4. Slow Decision-Making, Missed Crisis Response Opportunities

Delegating all decisions to the DAO community means every major decision requires lengthy proposals, discussions, and votes. In the face of a hack or market volatility, this “democratic process” may cause the project to miss optimal response windows, making it hard to compete with centralized rivals in terms of efficiency.

Compliance Path: How Entrepreneurs “Rebuild the Entity”

Facing reality, top projects are no longer pursuing absolute de-subjectification, but are shifting to a pragmatic “Code + Law” model, with the core being to establish a compliant “shell” for the protocol.

The three mainstream compliance structures:

1. Dual-Layer Structure: Separation of Development and Governance

Operating company: Register a standard software company in Singapore or Hong Kong, responsible for frontend development, hiring, and marketing. It claims to be a “tech service provider” and avoids direct financial business.

Foundation: Set up a non-profit foundation in the Cayman Islands or Switzerland to manage the token treasury and community voting. The foundation serves as the protocol’s legal representative and assumes ultimate responsibility.

2. DAO Limited Liability Company

Directly use new legal structures in Wyoming, USA, or the Marshall Islands to register the DAO itself as a limited liability company. This limits members’ liability to their capital contributions, avoiding unlimited joint liability risks.

3. Compliant Frontend and Permissioned DeFi

While the underlying protocol can’t prevent anyone from using it, the official website operated by the project can screen users:

• Geo-blocking: Block IP addresses from sanctioned or high-risk regions.
• Address screening: Use professional tools to block known hacker and money laundering addresses.
• KYC pools: Partner with institutions to provide lending pools exclusively for users who have completed identity verification.

Conclusion: From “Code Utopia” to “Compliant Infrastructure”

The next breakout point for on-chain lending is undoubtedly RWA, bringing real-world assets (such as government bonds and real estate) on-chain. To handle trillions in traditional assets, a clear legal entity and compliance structure are essential entry tickets.

Compliance is not betraying the original vision, but the only path for Web3 projects to go mainstream. The future of on-chain lending is not a binary choice between “decentralization or compliance,” but a dual-track fusion of “code autonomy + legal entity.”