Why Regulators Will Target Governance Tokens as Unlicensed Insurance Products

Regulators will argue that governance tokens like Maker's MKR or Aave's AAVE constitute an investment contract. The 'common enterprise' is the protocol, and the 'expectation of profit' is derived from the token's role as a capital buffer that appreciates with protocol success and is first to be liquidated in a shortfall event. This is functionally identical to an insurance underwriting pool.

Protocols explicitly market their governance tokens as a final layer of defense. In a MakerDAO black swan, MKR is minted and sold to recapitalize the system. This is not a passive governance utility; it's a capital call on token holders to cover losses, mirroring the core function of a licensed insurance or reinsurance entity. The ~$1B in MKR market cap is a de facto unregulated insurance fund.

The SEC and state insurance commissioners will target the revenue stream. Protocols like Compound and Aave distribute fees to token holders/stakers. Regulators will classify this as premium income paid to capital providers (token holders) for assuming insolvency risk. This creates liability for the foundation, core developers, and potentially large token holders as unlicensed insurers.

Survival requires a clean separation. Governance tokens must shed their role as loss-absorbing capital. The solution is dedicated, licensed insurance wrappers (e.g., Nexus Mutual, Uno Re) or over-collateralized, non-governance-backed stability pools. This turns the governance token into a pure utility for parameter voting, severing the direct profit-from-risk link that triggers securities law.

Maker's Surplus Buffer and Direct Deposit Module (D3M) create a clear promise: the protocol's $1B+ treasury backstops bad debt. MKR holders vote to deploy capital for yield and risk coverage, mirroring an insurer's capital pool and claims-paying function.

• Legal Trigger: Profits from stability fees fund the Surplus Buffer, a direct analog to insurance premiums.
• Precedent Risk: The SEC's case against BarnBridge DAO established that profit-sharing from a pooled asset is a security.

Protocols like Aave and Compound direct fee revenue to their governance token treasuries or stakers. Regulators see this as policyholder premiums flowing to capital providers (token holders) who bear the protocol's underwriting risk (e.g., smart contract failure, mass liquidations).

• Howey Test Hook: The expectation of profit is derived from the managerial efforts of the DAO to manage risk and allocate capital.
• Systemic Scale: DeFi insurance sector TVL ~$500M, dwarfed by the implicit insurance in $50B+ lending TVL.

To decouple from insurance frameworks, protocols must pivot tokenomics to pure utility. This means fees fund non-financial, consumable services like gas subsidies, computation credits, or data storage, or are permanently burned.

• Example: ENS uses fees to fund ecosystem development, not a capital reserve.
• Avoidance Tactic: A pure burn (e.g., EIP-1559) severs the link between treasury management and token value, framing it as a deflationary utility token.
• Trade-off: This reduces the "sticky" capital incentive for governance participation.

Uniswap Labs carefully avoids directing protocol fees to UNI holders, keeping UNI as a pure governance token. Contrast this with UniswapX, which uses a Dutch auction for fee capture—a structure that could be interpreted as a profit-sharing mechanism if governed by UNI.

• Strategic Divergence: Core protocol remains "clean"; auxiliary services absorb regulatory risk.
• Industry Signal: Major protocols (Lido, Rocket Pool) face the same scrutiny for staking derivative revenue models, which are explicit promises of yield backed by protocol operations.

A DAO is the quintessential common enterprise. Regulators will argue token holders' fortunes are tied to the success of the DAO's "insurance" business—managing collateral, setting risk parameters, and allocating the treasury. Ooki DAO set the precedent for holding a DAO liable.

• Key Evidence: Governance proposals that explicitly discuss treasury diversification, risk modules, and capital allocation are exhibits A-Z.
• Vulnerable Cohort: Lending protocols, cross-chain bridges (LayerZero, Across), and restaking protocols (EigenLayer) where pooled capital guarantees system solvency.

The nuclear option: migrate treasury and risk management to a licensed, off-chain entity (e.g., a Cayman Islands foundation) that issues a traditional security to represent claims on profits. The on-chain governance token becomes a pure voting instrument, severing the financial link.

• Real-World Example: This mirrors how traditional fintechs separate equity (SEC jurisdiction) from app tokens (utility).
• Cost: Sacrifices decentralization dogma and incurs ~$500k+ in annual legal/compliance overhead.
• Outcome: Creates a regulatory moat but fractures the DeFi composability narrative.

Protocols like Uniswap and Compound distribute fees to token holders. Regulators see this as a profit-sharing enterprise, not a utility tool. The legal precedent from the SEC vs. LBRY case shows any expectation of profit from a common enterprise is a security.

• Key Risk: Retroactive enforcement and penalties.
• Key Insight: Airdrops to users are safer than public sales.

Decouple financial rights from governance. Follow the MakerDAO model where MKR holders bear downside risk but don't get direct fee dividends. Focus governance power on non-financial parameters.

• Key Action: Create separate, non-transferable voting NFTs for governance.
• Key Action: Route all fees to a treasury, with disbursals requiring a separate vote.

Services like Lido (stETH) and Rocket Pool (rETH) offer yield-bearing derivatives. The SEC's case against Kraken established that staking services can be unregistered securities offerings. Native delegation is less risky than pooled, liquid staking tokens.

• Key Risk: Centralized exchanges will delist tokens with obvious yield.
• Key Insight: Cosmos-style native delegation is the compliant path.

The strongest defense is a fully decentralized, on-chain autonomous organization. If no single entity controls the protocol or treasury, the SEC vs. DAO report's 'sufficient decentralization' defense applies. Curve's veToken model and Aave's decentralized governance are benchmarks.

• Key Action: Sunset admin keys and multi-sigs.
• Key Action: Use Snapshot for signaling, but require on-chain execution.