When on-chain governance encounters illegal fundraising crimes, where are the legal boundaries of DeFi protocols?

Article by: Liu Zhengyao

Introduction

Suppose you hold a governance token of a DeFi protocol, and every month you vote on-chain to decide the protocol’s interest rate parameters, the direction of the treasury’s use, or even whether to open new staking products to users. You might think you’re just “participating in community governance,” similar to shareholders raising their hands in a meeting—nothing serious.

But one day, a Web3 lawyer tells you: the protocol you’re involved in might be suspected of illegal fundraising. Even more surprisingly, your voting behavior could potentially lead to you being classified as an “participant” or even an “organizer.”

This is not alarmist talk. As DeFi protocols penetrate deeper into Chinese users, the label of illegal fundraising has quietly begun to cast a shadow over on-chain governance.

What is DeFi governance? Why does it relate to illegal fundraising?

Let’s clarify some basic concepts first.

DeFi (Decentralized Finance) protocols, simply put, are a set of “automatic financial programs” running on the blockchain. Users can deposit assets into the protocol to earn yields or lend funds from it. The entire process involves no banks, no manual approval—everything is executed automatically by code.

So what is governance? Many DeFi protocols issue “governance tokens,” which holders can use to vote on major protocol matters—such as setting deposit interest rates, how protocol revenues are distributed, or whether to launch new features. This mechanism is called “on-chain governance” or “DAO governance.”

At first glance, this seems just a community decision-making process—what does it have to do with fundraising?

The key point is here: when a DeFi protocol raises funds from the general public and promises returns, its behavior pattern closely overlaps with the legal definition of illegal fundraising. If a protocol says “deposit USDT, with an annualized yield of 20%”—this is similar to some illegal financial products advertising “invest principal, guarantee principal and interest”—from a legal perspective, the difference isn’t as big as you might think.

If the protocol’s own fundraising activities are already borderline, could the participants in governance voting also be implicated?

Can the “illegal fundraising” label be applied to DeFi?

Chinese law’s criteria for illegal fundraising mainly include four points: raising funds from the public (an unspecified majority); without approval from regulatory authorities; promising to return principal and interest or providing other benefits; and promoting or advertising publicly. In summary: social involvement, illegality, inducement, and publicity. The specific regulation is in Article 1 of the Supreme People’s Court’s 2022 “Interpretation on Several Issues Concerning the Application of Law in the Trial of Criminal Cases of Illegal Fundraising.”

Looking at it comparatively, many DeFi protocols’ operations almost fully meet these criteria:

• Open to anyone for deposits (public access);
• No approval from any regulatory body (no compliance qualification);
• Promising annualized returns (return promises);
• Possibly engaging in public promotion and advertising (which is why Lawyer Liu says “almost fully”).

Of course, DeFi also has aspects that confuse judicial authorities: it is “decentralized,” with no corporate entity, no legal representative, and no physical office. Who should be held responsible? Currently, judicial authorities are beginning to adopt a “piercing the veil” approach—meaning, regardless of the technical guise, if the core features match illegal fundraising, liability can be established. The development team behind the protocol, promoters, and even key governance participants could become targets of investigation.

Does voting participation in governance count as “helping” or “abetting” a crime?

This is the area where DeFi users feel most insecure and where legal disputes are most intense.

Let’s consider an extreme scenario: if you only occasionally participate in voting, such as deciding whether to change the protocol’s interface color—such minimal involvement is almost impossible to be deemed as jointly participating in illegal fundraising. The law wouldn’t prosecute you just for “clicking a vote.”

But what if the situation is like this?—you are a major holder of a certain protocol, holding a large amount of governance tokens; you support key votes such as “raising the fundraising cap,” “expanding user deposits,” or “increasing annualized returns”; and you thus receive substantial governance incentives.

In this case, your actions are no longer just “participating in community discussion,” but are substantively promoting a protocol that may be involved in illegal fundraising, expanding its scale. From a criminal law perspective, this is quite close to “helping to implement illegal fundraising.”

Judicial authorities usually assess whether you are “participating” based on three dimensions: whether you are aware of what the protocol is doing (subjective awareness); whether your actions substantively contributed to illegal outcomes (objective contribution); and how much benefit you gained (profit). Therefore, ordinary users holding a small amount of tokens and voting occasionally face relatively low risk; but those deeply involved over the long term and profiting heavily from governance are in a real legal gray area.

Where should the law expand, and where should it hold back?

Lawyer Liu believes that applying the crime of illegal fundraising to DeFi governance participants requires considerable restraint, for the following reasons:

1. Governance actions do not equal fundraising. Voting on protocol parameters is not the same as “raising deposits from the public.” If all governance participants are regarded as co-conspirators in fundraising, it would deny the legitimacy of community participation in decentralized protocols, which is legally untenable.

2. “Decentralization” should not be used as an excuse to evade regulation, but it also shouldn’t automatically make all participants collectively responsible. Those who should be held accountable (assuming a crime is established) are the core developers and major governance actors who knowingly lead illegal activities, not every small retail holder with dozens of tokens.

3. Criminal law should be a last resort, not the first. For emerging fields like DeFi, if illegal fundraising is truly involved, regulators should prioritize administrative measures (warnings, rectification, delisting). Overly quick criminal prosecution could cause a chilling effect, killing the entire industry along with innocent users.

Of course, Lawyer Liu also sees areas where law should expand: if a DeFi protocol’s governance is essentially a “decentralized shell under centralized control”—with a clear team leading, dedicated efforts to recruit users, and pre-designed profit transfer mechanisms—then legal responsibility should be pursued. Simply dressing it up as “on-chain governance” does not exempt it from accountability.

If you are involved in DeFi governance, Lawyer Liu has some recommendations:

1. Clarify whether the protocol is raising funds from Chinese users. If the protocol explicitly targets Chinese mainland users, with Chinese-language promotional materials and domestic community operations, the risk of crossing legal lines is high, and your participation carries legal risks.

2. Distinguish between “participants” and “promoters.” Ordinary users holding small amounts of tokens and voting occasionally are in a different legal risk category from core contributors holding large amounts and leading key decisions. The deeper your involvement and the greater your profits, the more carefully you should evaluate your legal position.

3. Don’t assume “decentralization” means “law cannot reach.” Chinese judicial authorities have accumulated extensive experience in penetrating technical shells and directly establishing legal responsibility in crypto cases. The protocol itself having no legal entity does not mean no one is responsible.

4. Once a protocol is under investigation, consult a professional lawyer immediately. Do not rush to make public statements, do not casually discuss the case in community channels, and do not answer inquiries without legal counsel present. Every word you say could become evidence of “subjective knowledge” later.

Conclusion

The blockchain world develops rapidly, and laws struggle to keep pace. But slow doesn’t mean impossible. DeFi governance fundamentally challenges traditional financial regulation logic with new technology. The law’s response should not be to blindly smash with old tools and turn all participants into criminals; nor should it be to completely abdicate responsibility because of technological novelty.

The true boundary should be drawn between “substantive illegal fundraising behavior” and “ordinary community participation”—not simply by “holding governance tokens.” How to draw this line is still undecided in China’s judicial practice. But one thing is certain: the more you understand this issue, the better you can protect yourself in this gray area.