Uniswap wins collective lawsuit from investors, potentially becoming a case study under the regulatory challenges of DeFi

Written by: Joy, PANews

Cryptocurrency institutions have been winning victories in court. After Grayscale won its lawsuit against the SEC, Uniswap also won a collective lawsuit from investors.

The judge ruled that current cryptocurrency regulations do not provide a basis for the plaintiffs' claims. Under existing U.S. securities law, Uniswap is not liable for any damages caused by third parties misusing the protocol, and their claims were dismissed.

Investors Sue Uniswap for Losses from Trades

Previously, a group of investors from North Carolina, Idaho, New York, and Australia collectively sued Uniswap Labs, its founder Hayden Adams, its venture capital firms Paradigm, Andreessen Horowitz, and USV, claiming under federal securities law.

The investors alleged that the tokens they purchased through the protocol from December 2020 to March 2022 were fraudulent, resulting in their financial losses. Investor Nessa Risley stated that he lost about $10,000 after buying scam tokens like BoomBaby, Rocket Bunny, and Matrix Samurai.

The investors also argued that the decentralized exchange was selling unregistered securities and that Uniswap was an exchange or broker-dealer not registered with regulators. However, Uniswap disagreed with being labeled as an "exchange" or "broker or dealer."

In the lawsuit, presiding Judge Katherine Polk Failla acknowledged that the tokens in question could be considered "real" securities. However, this acknowledgment did not help them win the case. The judge also stated that Uniswap's ability to charge transaction fees and other aspects, such as governance tokens, were insufficient to convincingly establish that the platform's developers should be held liable.

Court documents stated: "The court completely dismisses the complaint," explaining that just because investors purchased scam tokens on Uniswap does not mean the decentralized protocol itself bears responsibility. "Due to the decentralized nature of the protocol, the identity of the scam token issuers is essentially unknown and unknowable, causing identifiable harm to the plaintiffs but with no identifiable defendants."

Judge States Current Policies Are Insufficient, Lacking Precedent

As a judge with extensive experience in cryptocurrency cases, Judge Failla previously presided over the SEC's lawsuit against Coinbase. She has also overseen other cryptocurrency cases, including those involving Tether and Bitfinex. Her ruling highlights a deep understanding of cryptocurrency projects.

She noted that Uniswap's decentralized nature means the protocol cannot control which tokens are listed on the platform or who can interact with it. She further stated, "These underlying smart contracts are distinct from the token contracts created by issuers unique to each pool." "The contracts related to the plaintiffs' claims are not the overall code provided by the defendants, but rather the token trading pairs or token trading contracts created by the issuers themselves."

To better illustrate, Judge Failla made several analogies, such as comparing it to payment applications Venmo and Zelle, stating that the plaintiffs' lawsuit is akin to trying to hold companies that facilitate fund transfers on their platforms responsible for drug trafficking rather than the drug dealers themselves. She also likened it to "holding the developers of self-driving cars liable for traffic violations or bank robberies committed by third parties using those cars."

Meanwhile, Failla acknowledged the current lack of case law surrounding DeFi protocols, stating, "No court has yet ruled on this issue in the context of smart contracts of decentralized protocols."

The application of securities law to DeFi lacks clarity. The court found no legal avenue to hold Uniswap Labs or the venture capital firms liable under federal securities law, stating, "Laws are currently being formulated around these exchanges, and regulators may one day address this gray area." Additionally, regarding the plaintiffs' concerns about federal securities law, she believed it would be better addressed to Congress rather than this court.

In her ruling, the judge also referenced SEC Chairman Gary Gensler's statement from September 2021, in which he hinted that DeFi projects would be subject to stricter scrutiny. At that time, the SEC began investigating Uniswap Labs but apparently took no further action.

Nevertheless, she went on to state that Uniswap's core smart contracts are essentially not illegal and that for other tokens, "they can be legally executed, just like transactions of cryptocurrency commodities such as ETH and Bitcoin." In this statement, the judge specifically mentioned the commodity nature of ETH.

While Judge Failla's comments do not constitute a definitive ruling on the legal classification of Ethereum in the U.S., they do indicate a position and serve as a rebuttal to Gensler, who previously only acknowledged Bitcoin's commodity nature, asserting that all other cryptocurrencies are securities and thus fall under SEC jurisdiction.

DeFi Applications Face Challenges, Uniswap Provides Regulatory Sample

Marvin Ammori, Chief Legal Officer (CLO) of Uniswap Labs, acknowledged this legal victory. He believes this is another significant win for the crypto world and software developers. The SDNY court dismissed the collective lawsuit against them, ruling that the "self-driving" Uniswap protocol is primarily used "legally," and that the protocol developers are not liable when others misuse it. The trend in the courts is evident.

In fact, Uniswap's "victory" occurred after the Tornado Cash incident, where the U.S. Department of Justice charged Tornado Cash founders Roman Storm and Roman Semenov with conspiracy to launder money, violate sanctions, and operate an unlicensed money transfer business. Roman Storm has been released on bail after his arrest. However, the situation for Tornado Cash, which provides mixing services as a DeFi application, does not seem ideal.

Craig Timm, a senior anti-money laundering officer at the Association of Certified Anti-Money Laundering Specialists (ACAMS), stated that the Department of Justice seems to specifically point out issues with its user interface rather than the smart contracts themselves in the Tornado Cash case. Without a user interface, it seems unlikely that charges could be brought.

Tornado Cash's native token TORN is another factor that complicates matters. Former financial crimes prosecutor Anand Sithian noted that the indictment stated the defendants profited from the operation of the Tornado Cash service using that token. The document cited messages they allegedly exchanged discussing the necessity of raising the price of TORN.

So, even though the U.S. government views only 7% of all activities conducted through the service as illegal, the profits associated with the Tornado Cash token TORN may add a layer of liability for the founders. Perhaps the illegal activities occurring on the Tornado Cash platform are not as extensive as imagined, and the courts will now begin to focus on profits, as the Tornado Cash founders have a clear profit motive.

Currently, it seems that Uniswap is still in a "favorable" position regarding U.S. regulation, as it previously cooperated with regulators to block certain privacy tokens' user interfaces, and the tokens have always had governance functions, which may provide a regulatory sample for other DeFi projects.