By Andrew M. Hinkes, Clifford C. Histed, Cheryl L. Isaac, and Maxwell J. Black

The Commodity Futures Trading Commission (“CFTC”) filed a civil enforcement action this week against Avraham Eisenberg, charging him with a scheme to defraud others and engage in price manipulation (as announced by the CFTC here). While there have been other enforcement actions related to decentralized finance (“DeFi”) protocols, this is the first case in which the CFTC has charged a person for fraud in connection with “oracle manipulation” on a decentralized exchange.  In addition to this CFTC action, the U.S. Department of Justice previously charged Eisenberg with criminal fraud and commodity price manipulation in connection with this same alleged scheme.

As background, an “oracle” is a source of data used by a smart contract to execute or to establish the conditions under which that smart contract’s code may execute. An oracle may be any stream of data, including pricing information from another protocol which may be used by a Defi Protocol to establish, for example, the price for exchange of a pair of given assets. In the Eisenberg enforcement action, the oracle in question provided pricing data for certain digital assets, operating akin to a price reporter like Platts or OPIS in traditional commodity markets.  Oracle manipulation is somewhat similar to a “pump-and-dump” scheme, but is usually accomplished by a person or group of persons who take large positions in relatively illiquid crypto assets, particularly on exchanges whose trading data provides information for pricing to other exchanges. This trading activity in an asset with low trading volume can artificially inflate its price, allowing those holding large positions to make substantial profits.

In this case, Eisenberg allegedly used two accounts on Mango Markets to establish a large swaps position between his accounts, with the exchange-native cryptocurrency token MNGO and the stablecoin USDC as the underlying assets. Once he had established this position, he rapidly purchased large quantities of MNGO on exchanges that were inputs for the oracle providing pricing data to Mango Markets. After this pricing information made its way to Mango Markets, the market price of MNGO rapidly inflated, artificially increasing the price of Eisenberg’s swaps position. Eisenberg then allegedly used his inflated swaps position as collateral to take out a loan on the exchange large enough to render Mango Markets insolvent. In all, the CFTC alleges that Eisenberg made off with around $110 million, though he returned around $67 million to Mango Markets, as part of an attempted negotiation to obtain a release from Mango Markets.

Though Eisenberg has tweeted publicly that, “all of [his] actions were legal open market actions,” the CFTC sees it differently. According to Commissioner Kristin Johnson, Eisenberg’s actions qualify as fraud and manipulation. In her statement, Johnson advocated for the CFTC to use its authority to pursue misconduct on decentralized digital exchanges and to increase federal scrutiny of the code operating those exchanges. Commissioner Caroline Pham likewise issued a statement reminding DeFi market participants that “many products that are offered on digital asset exchanges… may be some type of derivative within the CFTC’s jurisdiction,” regardless of what they are called or how they are marketed.

 The important takeaway is that federal regulators and prosecutors are paying attention to and trying to get smart about decentralized exchanges despite the fact that many market participants, like Eisenberg, contend that these exchanges fall outside the purview of federal regulations.