What I make of the Maker class-action lawsuit

Look, I am going up front this – I've never really thought very much of MakerDAO. It always struck me as hand-wavy decentralization theater that was built on a turtles-all-the-way down principle.  

You borrow volatile assets secured by collateral that has questionable equal volatility and thin order books.  There's supposedly a decentralized ecosystem but there are selected liquidators, market makers, and corporate entities with websites that have terms of service.  And governance conference calls.  It also uses a lot of jargon – baskets, CDPs, oracles.  I am suspicious, naturally, of jargon.

In short, turtles all the way down, but no ground.  That was and is my take. I'll allow that that I could be wrong. And if you like the cut of this purportedly decentralized jib, I am not judging; you do you.  

With that skepticism, however, when I heard that "Maker" had been sued, I, of course, thought “well, of course they have – I am surprised it took that long.” 

Then I read the lawsuit and, well friends, it was not what I expected. 

The lawsuit itself has been summarized in these pages previously, so I'm just going to provide a quick summary. 

Plaintiff has sued three defendants – Maker Ecosystem Growth Holdings, Inc, Maker Ecosystem Growth Foundation and DAI Foundation – which are collectively referred to as The Maker Foundation.

Plaintiff says that:

"[d]espite representing that it manages a decentralized, open, digital currency platform that boasts overcollateralized (and therefore secure) currency and has certain measures in place to prevent significant investor loss, The Maker Foundation in fact has promoted a system that it maintains primary control and ownership over while actively misrepresenting to investors in its platform (or collateralized position holders, CDP Holders) the risks associated with it."

In particular, Plaintiff finds fault with the way his collateral was liquidated when, on March 12, 2020, the value of ether (ETH) held as collateral dropped dramatically, from $190 to $90 in several hours. This triggered mass liquidations for investors whose positions in CDPs (collateralized debt positions) dropped below a collateral-to-debt ration of 150%.   

Plaintiffs says that instead of triggering actual collateral auctions that would have mitigated their losses, the Maker Foundation's protocol allowed two bots to operate and purchase collateral without competitive bidding for zero-dollar bids. In short, instead of being protected by a competitive auction process that might have returned a portion of the collateral, Plaintiff says that he (and a putative class of people who were liquidated) ended up receiving nothing. 

He claims that this led to an $8.325 million loss.

Plaintiff also says that in addition to misrepresenting risk, "[t]he Maker Foundation neglected its responsibilities to its investors by either fostering or, at the very least, allowing the conditions that led to Black Thursday, all after actively soliciting millions of dollars of investment into its ecosystem."

There are a couple of things that don't necessarily add up to me. 

First of all, it's not clear to me at all that the system (regardless of the commercial wisdom behind its design) may have actually functioned other than exactly as designed. 

That is to say, there was no guarantee that in difficult market circumstances such as these multiple bidders would necessarily be available. This difficulty was compounded here by factors out of the control of the Maker Foundation, including network congestion that might have also impeded a competitive auction process.

Second, and relatedly, the zero-dollar purchase is described as an "exploit" but it's not clear that these bots were doing anything that the system wasn't explicitly designed to do or against which there were prohibitions. Stated differently: I don't think – and correct me if I am wrong, world – that there was intent or agency behind the functioning of these bots, deployed as smart contract code. The fact that there was not competitive bidding seems to have resulted from known and foreseeable market forces.

I would expect the defendants to argue – assuming that they don't get dismissed on a motion to dismiss – that this may have a bad result for the plaintiff (and class members, if certified as such) that this was an entirely predictable result, and one which the plaintiff (who the Complaint alleges was involved in Maker from early days) should have been particularly aware of.  

Note the following passage:

In other words, even if the system was not perfect to an average consumer, you'd expect the Defendants to argue that this particular plaintiff knew or should have known that this was a possibility. 

In fact, the Complaint alleges that uncertainty and risk associated with the platform was identified as early as a 2017 published white paper:

Then there are the legal claims, which sound in tort and include negligence, negligent misrepresentation and intentional misrepresentation. 

For the negligence claims, the plaintiff will have to show that the the defendants owed a duty of care to the plaintiff, that the duty was breached, that this was the actual and legal/proximate cause of reasonably foreseeable harm to the plaintiff.  The challenge to this may be an argument that if the CDPs were created on a Maker-controlled platform – Oasis is an example – that the claims, if any, arise out of a contractual relationship that is circumscribed by contractual terms if service.  

This is complicated for plaintiffs by something called the economic loss doctrines, which typically restrict or limit economic losses in tort claims where the damages arise out of a contractual relationship. Generally speaking, you can't sue someone for negligence for claims that arise out of a breach of contract claim. There are some exceptions that apply to professionals like doctors, lawyers and engineers, but they wouldn't apply here I don't think. So if this arose of a contractual relationship or terms of service of some kind, the tort claims have problems. 

Why would someone sue for negligence instead of breach of contract? The terms of service on the Oasis website include a class waiver and arbitration clause, so there's that. It also includes a variety of limitations-of-liability and disclaimer language, as well as what I like to call an Angela Walch clause, which waives claims for breach of fiduciary duty.

I am also initially skeptical that the punitive damages claim has legs. It definitely doesn't work if this is really a breach of contract claim – you don't get punitive damages for breach of contract. That is generally not a thing in the United States. In order to get these in the tort context, you have to show some sort of knowing, malicious and intentionally bad conduct. I just don't see it – at least, I read the Complaint and literature, the system functioned pretty much as it was intended to function, and this was not a flaw in the platform. I suppose that discovery can end up proving me wrong.

Regardless, there is real risk here. And it's not really financial – it's the fact that the Court could make factual findings in this case that could be used in another one, with greater stakes. There's a principle in U.S. law called non-mutual offensive collateral estoppel. Say this out loud in a bar if you want to scare people away. What it means – again, I am gonna oversimplify slightly – is that a plaintiff in another suit could use factual finding in this case for litigation in another case. 

So if the Court were to agree with that factual proposition that Maker's not really decentralized and the Defendants are really in charge of everything – that could be used affirmatively in other cases. It would be similar to a court finding that a product was defective but that the defect didn't harm a particular plaintiff in a particular lawsuit. That finding could be used in a subsequent action by a different, new plaintiff – without having to prove it again.