The US Commodity Futures Trading Commission (CFTC) has fined Uniswap Labs (Uniswap) $175,000 settling allegations that it illegally offered leverage or margined retail commodity transactions in digital assets, via a decentralized digital asset trading protocol. As part of the settlement, the CFTC also requires Uniswap to cease and desist from violating the Commodity Exchange Act (CEA).
The Uniswap website user interface is operated by Universal Navigation Inc. (t/a Uniswap Labs), a Delaware company based in New York. It is one of the most popular Decentralised Finance (DeFi) protocols, facilitating token swaps on more than a dozen blockchain networks. It has more than $4.4 billion in total value locked, according to DefiLlama.
CFTC highlighted the settlement as part of its continuing enforcement efforts in the DeFi space:
Today’s action demonstrates once again the Division of Enforcement will vigorously enforce the CEA as digital asset platforms and DeFi ecosystems evolve.
Case background
According to the CFTC, Uniswap contributed to the development and deployment of a blockchain-based digital asset protocol that allowed users to trade digital assets through use of the Ethereum blockchain. The protocol allows users to create and trade with liquidity pools, which consist of a matched pair of digital assets that are valued against each other.
In order to facilitate access to the protocol, Uniswap Labs also developed and maintained a web interface that it made available to users. Through the interface, users could trade in hundreds of liquidity pools on the protocol.
Specifically, CFTC's enforcement action focused on leveraged tokens being traded in these liquidity pools:
Among the digital assets traded on the protocol and through the interface were a limited number of leveraged tokens, which provided users leveraged exposure to digital assets such as Ether and Bitcoin.
CFTC alleged that these leveraged tokens are leveraged or margined commodity transactions that can only be offered by a CFTC designated or registered contract market, which Uniswap Labs was not. This is important as CFTC generally only has jurisdiction to regulate derivatives products, not spot commodity markets or securities.
Uniswap’s smart contract based swapping protocol is permissionless and allows users to establish liquidity pools and create ways to trade, including leveraged tokens without permission from Uniswap Labs as the developer of the protocol and provider of the interface. In this case, Uniswap Labs subsequently took steps to blacklist and remove access to these tokens from its interface but not the underlying permissionless protocol, and very limited trading in the leveraged tokens occurred.
Uniswap’s chief legal officer, Katherine Minarik, said in a statement that the CFTC investigation involved:
a small fraction of a percent of trading through our interface related to a handful of tokens
and highlighting that the settlement did not involve any admission or denial of the regulator’s findings. Uniswap appeared to have been cooperative with the CFTC, which resulted in a reduced civil monetary penalty in this case.
Uniswap was previously successful in defeating a civil class action which had sought damages for breaches of securities laws over user losses suffered from dealings in scam tokens via the platform. The judge in that case emphasised the decentralised nature of the Uniswap protocol and the responsibility of the token issuers for their misuse of the software.
Dissent within CFTC
CFTC Commissioners Summer Mersinger and Caroline Pham both issuing blistering dissenting opinions. Mersinger pointed out that Uniswap had already blocked trading of the tokens at issue, and the settlement was a wasteful example of "regulation through enforcement":
Rather than applauding Uniswap for being attentive to our enforcement efforts and initiating steps to respond to our approach in policing the DeFi space, we brought charges against Uniswap covering the time period before those particular tokens were blocked from its platform
She continued,
It was my hope that one day soon the commission would consider rulemaking, or at the very least guidance, making clear how DeFi protocols could comply with them...Unfortunately, today is not that day.
Commissioner Pham also said in her dissents:
I believe the CFTC can and should vigorously pursue fraud and manipulation in our markets and bring bad actors to justice...But that is not what this case is about. It is regretful that the Commission’s action today is instead a misguided and rushed attempt to beat the SEC to the punch and claim jurisdiction over DeFi.
While the CFTC's order does not identify the tokens’ issuer, they appear to be created by Index Coop, a DeFi protocol specialising in leveraged yield strategies. It is not clear whether the CFTC plans to take any action against the issuers.
The cofounder of paradigm compared this the approach of the CFTC as seeking to criminalise a tool and ignoring the actual law breakers:
Enforcement actions against Uniswap and DeFi
In April this year, Uniswap also received a Wells notice from the US Securities and Exchange Commission (SEC), an indication that the regulator was planning to take action against the company. Uniswap has publicly responded to the Wells Notice, advocating for the recognition and support of open source technologies that aim to enhance traditional financial systems.
In recent years, both the SEC and the CFTC have taken action not only against centralized exchanges like Binance but also against decentralized crypto projects that employ automated software in place of traditional intermediaries. Some of these cases have been settled, while others continue through the courts.
Takeaways
The Uniswap settlement order demonstrates how US regulators such as CFTC have sought to continue regulation by enforcement, focusing on technology as a choke point and not seeking to hold the individual users engaging in the objectionable conduct (issuing leveraged tokens) responsible.
US authorities continue this hardline approach to trying to regulate decentralised technologies is likely to chill innovation, enforcing centralisation and leave US users more exposed to the risk of unregulated scams and tricks. US authorities have adopted an approach of trying to find a person responsible they can enforce against in actions, while the EU has left open some scope for fully decentralised platforms to operate outside the MiCA regime.
In light of this decision, software developers and platform operators now must consider what steps they should take to mitigate the risks of inadvertently facilitating regulated securities or derivative transactions given the potentially very serious penalties for breaching financial services laws.
While the CFTC settlement could be seen as casting a shadow on DeFi systems which enable anyone to access swaps, sensible dissent like Commissioners Mersinger and Pham continue to powerfully debate the current administration's approach, and it remains to be seen how Congress will approach these issues in legislation in the years ahead.
By J Huang, S Pettigrove and M Bacina
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