SEC Lawsuit Against Uniswap as DeFi Moves Towards Compliance Era

On April 10th, Uniswap Labs disclosed receiving a Wells notice from the U.S. Securities and Exchange Commission (SEC), signaling potential legal action by the regulator against the company.

In response to the SEC investigation, Uniswap openly criticized the SEC, suggesting its actions were politically motivated and that regulatory bodies failed to provide clear guidance for companies operating in the United States, nor did they offer legitimate channels for registration. Uniswap argued that most cryptocurrencies, including stablecoins, governance tokens, and major commodities like Ethereum and Bitcoin, should not be considered securities and thus should not fall under SEC regulation.

Since its inception, the Uniswap protocol has become a critical part of the Ethereum ecosystem, serving as a primary use case of block space and processing over $2 trillion in trading volume.

Uniswap expressed concerns that actions by the SEC and similar institutions could hinder innovation and progress in the United States. It referenced the SEC’s lawsuit against Ripple and anticipated clear cryptocurrency regulatory legislation from Congress.

Notably, Uniswap firmly believes that the SEC, as a regulatory body, should only have jurisdiction over securities and agrees with the court ruling in the SEC vs. Ripple case, which affirmed that secondary market transactions of digital assets should not be considered investment contracts. Furthermore, Uniswap claimed legal victories in cases such as Risley v. Uniswap Labs and recent rulings like SEC vs. Coinbase, further demonstrating that Uniswap’s operations and UNI issuance do not constitute securities issuance.

In discussing the nature of UNI, Uniswap stated that UNI is not a security because it does not meet the legal definition of security and is not tied to any investment contract linking token holders with the company. Uniswap also pointed out that the Uniswap ecosystem is sufficiently decentralized, similar to Bitcoin and Ethereum, and therefore should not be considered a security.

Struggles of the Predecessors

The United States, as a typical common law country, has long relied on past precedents as the main basis for future rulings. Therefore, it is necessary to carefully examine previous legal battles between the SEC and the cryptocurrency industry.

As mentioned earlier, the SEC sent a Wells notice to Uniswap, a formal notice sent to the party under investigation before enforcement action by the SEC. When the SEC identifies potentially unlawful behavior during an investigation and decides to take enforcement action, it issues Wells notices to individuals or companies involved. These notices typically include actions the SEC staff may take, such as filing a lawsuit or imposing administrative penalties.

Individuals or companies receiving Wells notices will have the opportunity to review the SEC’s evidence, allegations, and proposed remedies before formal enforcement action begins. They can also submit a “Wells response,” in which they can refute, explain, or provide additional information regarding the SEC’s allegations.

A Wells notice itself does not indicate that the SEC has made a final decision or necessarily mean that the notified party will face formal enforcement action. It is simply a procedural step by the SEC before taking formal action, aimed at ensuring fairness and providing the investigated party an opportunity to respond to the allegations.

In a broader sense, Wells notices are an important part of the SEC’s enforcement process, providing accused parties with an opportunity for self-defense before formal litigation or penalties.

It is now Uniswap’s turn to respond, marking the beginning of the legal and investigative process. Given the recent cases between the SEC and various parties in the cryptocurrency sector, Uniswap has a good chance to win. The worst-case scenario may involve a situation similar to that of Binance, where parties admit guilt, but Uniswap can still operate normally with minimal consequences, as it has been operating normally and has not gone against users’ interests or misappropriated their assets.

Furthermore, in the past, the SEC primarily targets centralized exchanges, rather than decentralized exchanges. Therefore we can refer to the litigation processes of those centralized exchanges, including Coinbase and Binance.

On June 5, 2023, the SEC filed a lawsuit against Coinbase, one of the largest cryptocurrency exchange platforms in the United States, alleging violations of U.S. securities laws. The SEC accused Coinbase of operating its trading platform as an unregistered securities exchange, broker, and clearing agency, and unregistered offer and sale of securities in connection with its staking-as-a-service program.

The latest development came on March 28, 2024, when a U.S. court ruled that the SEC could proceed with its lawsuit against Coinbase.

Coinciding with Coinbase, the SEC also sued Binance, the world’s largest crypto exchange, in June 2023. The current status of the case is that the world’s largest exchange pays a fine, and Binance can continue to operate.

It can be observed that the SEC primarily targets the non-compliant operations of crypto exchanges, while rulings on decentralized products have long been absent. The outcome of Ripple’s lawsuit may be a reference to the Uniswap case.

The lawsuit between Ripple and the SEC has been ongoing for many years, spreading from 2020 to the present. The main argument for the SEC’s allegations is that Ripple executives’ sale of XRP tokens constitutes an unregistered securities offering, involving a staggering $1.38 billion. Therefore, the core of the case is whether XRP should be considered a security.

On July 13, 2023, the court ruled that the sale of $757 million worth of XRP to retail investors out of the $1.38 billion involved did not constitute improper securities issuance, but sales to institutional investors should be considered securities. In fact, the SEC and Ripple each achieved half of the victory.

In March of this year, the SEC sought a $2 billion fine against Ripple, second only to the amounts for Binance and CZ. It may indicate a starting point for general regulations on DeFi in the entire cryptocurrency industry, where decentralization may no longer be a disclaimer.

Uniswap’s Confession

In fact, as early as June 13, 2023, Uniswap had written to the SEC, expressing its opinion on SEC’s proposal to redefine the concept of “exchange” by taking decentralized finance (DeFi) protocols into account.

Specifically, the SEC proposed to include DeFi protocols in the definition of “exchange”. However, in Uniswap’s view, according to the text of the Exchange Act, the definition of “exchange” requires an organized “group of persons” providing a market or facility for trading “securities,” which Uniswap does not meet for several reasons:

• The Uniswap protocol is a series of open-source smart contract code running on the Ethereum network.
• Uniswap, as an Automated Market Maker (AMM) mechanism DEX, only facilitates the injection of liquidity from LPs into liquidity pools for trading pairs.
• Uniswap Labs does not control the protocol itself, neither Uniswap Labs nor its developers can prevent trading activities on the protocol or unilaterally change the protocol code.

Uniswap also argued that the SEC’s proposed amendments may be overly broad, potentially encompassing any technology or product related to communication, including email or WhatsApp. Moreover, Uniswap invoked constitutional interpretation:

• Uniswap Labs believes that the SEC’s proposal is illegal, including violating obligations under the Administrative Procedure Act (APA), and failing to provide a reasonable explanation for its actions, which are not only arbitrary but also capricious.
• Secondly, Uniswap believes that the SEC’s proposal violates the separation of powers principle in the Constitution and hopes to prevent the SEC from giving itself too much power.

Overall, Uniswap opposes the SEC’s argument by using its open-source and permissionless characteristics. Looking back at Uniswap’s history, it does not oppose regulatory structure and may even actively embrace it.

In August 2022, the privacy protocol Tornado Cash was banned by the U.S. government, and subsequently, several well-known DeFi protocols including Aave and Uniswap voluntarily banned addresses associated with Tornado Cash. Uniswap even blocked its trading pairs on the front end, although users could still use them at the smart contract level. However, frontend blocking would prevent the vast majority of ordinary users from participating in trading.

Moreover, Uniswap has actively collaborated with security company TRM Labs to review entities and individual addresses included in U.S. sanctions, fully meeting compliance requirements.

However, in the end, Uniswap still finds itself in court.

Overseeing Freedom: An Endless Struggle

Looking at the SEC’s actions against the cryptocurrency industry, from stablecoins and exchanges to DeFi protocols, it covers almost everything and mainly targets the significant fund flow of CEX and DEX.

Uniswap will undoubtedly also become the protagonist of the next landmark event, as DeFi establishes its own compliance space through litigation, truly paving the way for entering mass adoption.