Written by Aaron Krowne
Uniswap, a prominent decentralized exchange (DEX) in the cryptocurrency space, recently responded to a Wells Notice from the U.S. Securities and Exchange Commission (SEC), which accused the DEX of operating an unregistered securities exchange and claimed that its interface and wallet were functioning as unregistered securities brokers.
This notice is a formal indication that the SEC’s staff intends to recommend enforcement action. Uniswap’s detailed response challenges the SEC’s assertions and sheds light on the broader regulatory implications for decentralized finance (DeFi) platforms.
This article summarizes Uniswap’s response and provides insights by comparing it to previous regulatory cases.
Key Takeaways
- No Congressional Authority. Uniswap claims that the SEC only oversees securities, like assets classified as “investment contracts” and lacks the authority to regulate bitcoin, ether or stablecoins, which are the primary assets traded on the Uniswap protocol (Protocol). Uniswap further contends that regulation of the crypto industry requires Congressional action, as the SEC cannot achieve its objectives through litigation alone.
- Decentralization and Governance: Uniswap emphasizes that its Protocol operates autonomously without central control, governed by a decentralized community, which distinguishes it from traditional, centrally-controlled exchanges. This implies that Uniswap does not align with the statutory definition of a securities exchange and therefore operates outside the purview of SEC regulations.
- Functional Differences from Traditional Exchanges: Uniswap utilizes an automated market-making (AMM) system, where liquidity is provided by users rather than a central entity, highlighting the unique operational model of DeFi platforms, supporting the argument that it does not fit into the statutory definition of an exchange.
- No Securities Offering. While it is unclear if the the SEC’s Wells Notice contained a claim that Uniswap’s UNI tokens are securities, Uniswap addressed this point in its response, asserting that its UNI tokens do not qualify as securities under U.S. laws, including the Howey Test.
- Proactive Compliance Measures: Uniswap details its efforts to comply with regulations and prevent illicit activities, demonstrating a cooperative stance towards regulatory bodies and commitment to lawful operations.
- Legal Frameworks and Precedents: The response argues that traditional securities laws are inappropriate for decentralized protocols, calling for new regulatory approaches that recognize the distinct characteristics of DeFi platforms.
- Comparison to Previous Cases: Uniswap’s response is contrasted with cases like SEC v. Ripple Labs and SEC v. Telegram, highlighting the need for regulatory clarity and updated frameworks to address the complexities of digital assets and decentralized finance.
Summary of Uniswap’s Response
Definition of an Exchange vs DEX
Uniswap said that it believed that it did not meet the SEC’s current definition of an exchange. Under the Exchange Act, an “exchange” is defined as “any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a marketplace or facilities for bringing together purchasers and sellers of securities.” First, the Protocol is not a marketplace for bringing together purchasers and sellers of securities. Second, the Protocol is not an organization, association, or group of persons. Unlike centralized exchanges, the Protocol is an autonomous smart contract created from software code, not controlled by any person or entity. Third, since the Protocol is autonomous, there is no intermediary bringing together purchasers and sellers. Furthermore, even if the Protocol could qualify as an exchange, it is not an organization, association, or group of persons under the control of Uniswap, so Uniswap cannot be penalized for its use. Furthermore, in March 2022, the SEC proposed amending Rule 3b-16 to expand the definition of “exchange” to include “communication protocols” like the Protocol. This proposal highlights that the Protocol is not currently considered an “exchange” under existing rules.
Definition of a Broker vs DEX
The SEC claims Uniswap is operating as an unregistered broker, violating Section 15(a) of the Exchange Act, which defines a “broker” as “any person engaged in the business of effecting transactions in securities for the account of others.” The SEC alleges Uniswap is an unregistered broker by participating in securities transactions, soliciting customers, routing orders, evaluating investments, and providing advice. Uniswap, however, argues that these claims are unfounded because transactions on the Protocol are not securities transactions. They further contend that even if they were, the allegations do not hold up, as evidenced by the Coinbase case summary judgment decision on the pleadings. In Coinbase, the SEC alleged that Coinbase Wallet, similar to the Uniswap and legally indistinguishable in terms of how their DEX trades work, allowed users to connect with external liquidity sources to send, receive, or swap crypto assets. The SEC also claimed Coinbase solicited investors through ads, provided pricing information, routed orders, and charged fees on asset swaps. The court ruled these allegations were insufficient to establish “brokerage activities” under the broker definition and relevant case law. On similar rationale, Uniswap maintains that it does not operate as an unregistered broker.
Decentralization and Control
Uniswap’s response underscores the decentralized nature of its Protocol, highlighting that it operates autonomously without central control. The governance of the Protocol is managed by a decentralized community of token holders, which significantly limits the influence of any single entity. This decentralization is a core argument in asserting that Uniswap should not be treated under the same regulatory framework as centralized exchanges.
Functional Differences from Traditional Exchanges
Uniswap emphasizes the fundamental differences between its platform and traditional financial exchanges. Without limitation, nlike traditional exchanges that use order books, Uniswap utilizes an automated market-making (AMM) system. Moreover, iquidity is provided by users who earn fees for their participation, distinguishing it from the centralized control seen in traditional markets.
Compliance and Cooperation
In its response, Uniswap details its proactive measures to comply with existing regulations and prevent illicit activities. The platform has engaged in dialogue with regulatory bodies and implemented measures to enhance transparency and security. This cooperative stance is highlighted to demonstrate Uniswap’s commitment to lawful operations and responsible innovation.
Legal Frameworks and Precedents
Uniswap’s argument also draws on existing legal precedents and frameworks, asserting that applying traditional securities laws to its decentralized protocol is inappropriate. The response suggests that new regulatory approaches are needed to address the unique characteristics of DeFi platforms without stifling innovation.
Comparisons to Previous Cases
SEC v. Ripple Labs
The ongoing case of SEC v. Ripple Labs is a pertinent comparison. The SEC accused Ripple of conducting an unregistered securities offering through the sale of XRP tokens.
On December 22, 2020, the SEC filed an action against Ripple Labs Inc. and two of its executives, accusing them of raising over $1.3 billion through an unregistered digital asset securities offering. The SEC claimed that Ripple failed to register its digital asset, XRP, as “investment contracts” under the Securities Act, which requires securities to have a registered statement before being sold. Ripple countered, arguing that the term “investment contract” was too vague under the law to apply to XRP transactions, invoking the “fair notice” defense based on the Fifth Amendment’s Due Process Clause. This defense challenges laws that are not clear enough to provide objective notice of prohibition. Ripple claimed it was not clearly notified that their actions were against the law. The SEC sought to dismiss this defense, but on March 11, 2022, the court denied the SEC’s motion, allowing Ripple’s fair notice defense to proceed.
Uniswap’s defense similarly hinges on Ripple’s fundamental argument that laws regulating persons or entities must clearly define what behavior is forbidden or required. This principle states that the relevant statute should give anyone of ordinary intelligence clear understanding of what is prohibited. Uniswap, similar to Ripple, argues that a regulated entity should not be held liable for actions based on interpretations that are first revealed during enforcement proceedings.
While there are differences between the two cases, with Ripple primarily accused of conducting unregistered securities offerings and Uniswap accused of operating an unregistered securities exchange and acting as unregistered securities brokers, there are notable similarities. The most striking similarity is both companies’ reliance on the “fair notice” defense. Overall, these cases underscore the ongoing regulatory challenges and the need for clearer guidelines in the digital asset space.
SEC v. Telegram
In SEC v. Telegram, the SEC successfully argued that the sale of Gram tokens constituted an unregistered securities offering. Telegram acknowledged that its initial private sale agreements, involving the sale of its digital coins to early buyers, constituted a securities offering exempt under Rule 506(c) of Regulation D, which allows offerings to accredited investors without registration, provided the issuer verifies that the buyers are not statutory underwriters as per Rule 502(d). However, the court ruled that Telegram’s intent for these initial purchasers to resell the Grams in the public market meant they were acting as statutory underwriters. Since the Grams were deemed securities, this setup did not qualify for an exemption under Regulation D. The court highlighted the SEC’s focus on Telegram’s strategy, noting that Telegram had arrangements with initial buyers to provide capital upfront in return for later delivery of Grams at a discount, which were then intended to be sold publicly for a profit.
Uniswap argued that contrary to Gram tokens, the UNI token did not qualify as a security under U.S. law, as it did not meet the criteria of an “investment contract” as defined by the Howey test. According to the Howey test, an investment contract involves an investment of money in a common enterprise with the expectation of profits derived from the efforts of others. In the case of UNI, Uniswap asserts that there is no contractual agreement or promise between Uniswap and its over 300,000 token holders, and the fact that UNI tokens were distributed through a free airdrop to historical users did not involve an investment of money or property under the Howey Test as it did not involve the kind of “risk of loss” that is essential to Howey Test. Additionally, Uniswap claims there is no common enterprise, and the token’s value does not solely depend on the actions of Uniswap.
Uniswap confidently stated that the sale of UNI tokens did not involve an investment contract. To mitigate the risk of potential misclassification by the SEC, Uniswap structured each UNI sale to ensure it was exempt from registration requirements. Uniswap did not engage in public solicitation or advertisement for these private UNI sales. The tokens were sold exclusively to sophisticated, accredited investors. Furthermore, each investor purchased tokens for their own account and agreed not to transfer or sell their tokens for a defined period, thus removing them from the definition of underwriters. This approach contrasts with the Telegram case, where Gram tokens were sold to initial buyers with the intent of reselling them in the public market, thereby avoiding classification as statutory underwriters. Another key distinction between the two cases is that Gram tokens were intended to raise capital for the development of the Telegram Open Network (TON) platform, which was still under development at the time. In contrast, Uniswap was already fully operational when the UNI token was introduced to the public, at which time, it was “airdropped” to a large number of actual users of the Protocol. The UNI token was designed to be functional from the outset, allowing holders to participate in the Protocol’s governance system, which enabled limited decisions related to the Protocol.
SEC Framework for Digital Assets
In 2019, the SEC issued the Framework for “Investment Contract” Analysis of Digital Assets (“Framework for Digital Assets”), providing guidance on determining whether digital assets, such as cryptocurrencies or tokens, should be classified as securities under U.S. law. This framework (while non-binding) is intended to clarify the application of the Howey Test, a legal standard used to identify investment contracts, ensuring that issuers and market participants understand when compliance with federal securities laws is required. The Howey Test determines whether a transaction qualifies as an investment contract. According to the Howey Test, there are four criteria for determining whether a contract qualifies as a security:
1. There must be an investment of money;
2. The investment must be in a common enterprise;
3. There should be a reasonable expectation of profits;
4. The profits should be derived primarily from the efforts of others.
A token is classified as a security only if it meets all four criteria. If any of these elements is absent in a token transaction, then, according to the Howey Test, the token would not be considered a security.
Another major piece of guidance was delivered by William Hinman, the former director of the Division of Corporate Finance, in a speech on June 14, 2018. A critical point from his speech highlights the role of decentralization in token classification. He suggested that tokens or coins operating on a decentralized network—where it’s unreasonable to expect that specific individuals or groups are responsible for significant managerial or entrepreneurial efforts—might not constitute an investment contract.
Uniswap maintains that its UNI tokens do not meet the criteria set forth by the Howey Test to be considered securities. It also asserts that other digital assets transacted on its Protocol, like Bitcoin and Ether, which constitute the majority of transactions on the Protocol, do not fulfill the Howey Test’s requirements to be classified as securities. Consequently, Uniswap argues that SEC regulations should not apply to its operations.
Uniswap also stated that pursuant to the SEC’s Framework for Digital Assets, the Commission has noted that a token is less likely to be part of an investment contract if the network is fully developed and operational which happens to be the case for Uniswap. Another critical point (though not mentioned by Uniswap in their Wells response) is that the same framework provided that if the holders of a digital asset are immediately able to use it for its intended functionality on the network it is less likely to be a security. As noted above, the UNI token was designed to be functional from the start, allowing its holders to participate in specific governance decisions.
Comment: Routing in the SEC’s Crypto Exchange Cases
Critical to potential unlicensed broker liability for Uniswap under the Exchange Act is the question of whether violative “routing” is taking place. Yet, broker liability in the non-custodial crypto setting has now been rejected by multiple courts – e.g., in Coinbase, discussed above, as well as Risley, decided the previous year. But the precise boundaries of what counts as regulated “routing” in the blockchain and DeFi context haven’t been widely-established, as evidenced by the fact that this is explicitly a live issue in the Consensys case (recently-filed), and, presumably, will be in any yet-to-be-filed case against Uniswap (in accordance with the Wells notice). For example, on this question, the Coinbase court stated
… the SEC’s allegations do little to suggest that Wallet undertakes routing activities in a manner recognized by courts to have been traditionally carried out by brokers, such as by providing trading instructions to third parties or directing how trades should be executed. See, e.g., GEL Direct Tr., 2023 WL 3166421, at *3 (finding that complaint alleged defendant routed securities orders in part because broker “exercised discretion” and “provided trading instructions on behalf of its customers,” including directives on “price and volume”).
As alleged, Coinbase’s participation in the order-routing process is minimal. While Wallet “provide[s] access to or link[s] to third-party services, such as DEXs” (User Agreement App’x 4 § 8.1.2), the SEC does not allege that Coinbase performs any key trading functions on behalf of its users in connection with those activities. As the Complaint acknowledges, Coinbase has no control over a user’s crypto-assets or transactions via Wallet, which product simply provides the technical infrastructure for users to arrange transactions on other DEXs in the market. (Compl. ¶ 64). Only the user has control over her own assets, and the user is the sole decision-maker when it comes to transactions.
It is hard to find much factual distinction between self-hosted wallet software that connects to various DeFi venues to make trades, and a non-custodial DeFi protocol that allows various parties to connect to each other and make trades with no central party intermediating. On the other hand, in the Consensys case, the SEC goes to lengths to lay out routing-related facts that could be seen to distinguish from Coinbase and Uniswap, including that (i) Metamask’s routing process allegedly places user assets momentarily in an on-chain contract before commencing a trade, (ii) that Metamask’s router smart contract routes only to a limited number of liquidity providers, some of which may be in a “pay-to-play” arrangement, and (iii) Consensys provides Lido and Rocket Pool through its Metamask staking interface – although there are numerous other ETH staking services – highlights the option with the highest rewards, and disables staking if these two providers are “full”. Points #1 and #3 of the foregoing amount to conduct that is alleged to be arbitrary or biased for the purposes of constituting broker-like routing in the SEC’s view.
In the end, the facts and circumstances of a particular scenario are likely to be material to whether routing-based enforcement claims “stick.” This may come down to so granular a level of detail as (i) the degree to which “routing” smart contracts are immutable by their own publisher, (ii) whether the selection of routing targets is seen to be artificially-biased in some way, and/or (iii) whether routing targets get a share of transactions in a putative “pay-to-play” manner.
Conclusion
Uniswap’s response to the SEC Wells Notice is an important contribution to the ongoing discourse around DeFi regulation.
By emphasizing its decentralized nature, functional differences from traditional exchanges, proactive compliance measures, and relevant legal precedents, Uniswap makes a compelling case against the application of traditional securities laws to its Protocol. Firstly, the current regulatory landscape has significant limitations when applied to DeFi platforms, highlighting the need for regulatory actions to provide clarity. Secondly, comparisons with other major SEC enforcement actions demonstrate that each case is unique. Regulatory bodies must consider the distinct and evolving characteristics of DeFi platforms to balance law enforcement without unduly stifling innovation. Additionally, the “fair notice” defense could profoundly impact future cases involving innovative solutions if successfully argued by Uniswap and others.
As the regulatory environment continues to evolve, Uniswap’s case will undoubtedly influence the evolution of how securities law is applied to blockchain token issuers in the U.S. For policymakers, balancing innovation with investor protection remains a critical challenge. The outcome of this case may set significant precedents for the treatment of decentralized platforms in the broader financial ecosystem.
footnotes
[1] Uniswap Wells Notice Response (May 21, 2024), available at https://blog.uniswap.org/wells-notice-response.pdf
[2]Securities and Exchange Commission v. Ripple Labs, Inc., et al., No. 1:20-cv-10832 (S.D.N.Y. 2023)
[3] Securities and Exchange Commission v. Telegram Group Inc., et al., No. 1:19-cv-09439 (S.D.N.Y. 2020)
[4] Securities and Exchange Commission, “Amendments Regarding the Definition of ‘Exchange’ and Alternative Trading Systems (ATSs)” (March, 2022), available at https://www.sec.gov/files/rules/proposed/2022/34-94062.pdf
[5] SEC v. Coinbase, Inc. and Coinbase Global, Inc., No. 1:23-cv-4738 (S.D.N.Y. 2024)
[6] SEC, Framework for “Investment Contract” Analysis of Digital Assets (Apr. 3, 2019), available at https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets
[7] William Hinman, SEC, Digital Asset Transactions: When Howey Met Gary (Plastic), Remarks at the Yahoo Finance All Markets Summit (June 14, 2018), available at https://www.sec.gov/newsroom/speeches-statements/speech-hinman-061418.
[8] Risley v. Universal Navigation Inc., 2023 WL 5609200* (S.D.N.Y. 2023) (slip op.).
[9] SEC v. Consensys Software Inc. (case 1:24-cv-04578 (E.D. NY)) (June 28, 2024).
[10] SEC v. Coinbase, 2024 WL 1304037 (Mar. 27, 2024) (case 1:23-cv-04738 (S.D.N.Y.)) at 82-83.
[11]E.g., “Consensys’s software routes the investor’s order by transferring their asset and trading instructions through Consensys’s own smart contracts on the blockchain, which interface with third-party liquidity providers on the investor’s behalf. As is typically the case in traditional securities markets, the investor here never interacts directly with the third party; all investor interactions are directly with Consensys’s platform. And Consensys collects a fee on most transactions;” Consensys at 2, ¶ 4.
[12]E.g, “Consensys’s software does not query all third-party liquidity providers; it only pulls pricing information from the approximately 14 providers that Consensys configured it to interface with, at least some of whom have contracted with Consensys and with whom Consensys may share a portion of the fees it charges investors;” Consensys at 20,¶ 101.
