What does the US court’s friendly judgment on Uniswap mean for DeFi regulation?

US court's friendly judgment on Uniswap Implications for DeFi regulation

Regulatory compliance is now an unavoidable topic in the field of cryptocurrency. On one hand, there are mainstream CEXs like Binance and Coinbase fighting against US regulatory agencies, and on the other hand, Ripple, Grayscale, and the SEC are battling it out in and out of the courtroom. If we focus on the DeFi field, Tornado Cash was defeated due to regulatory issues, and its founder faced imprisonment. Now, the leading DEX Uniswap has also joined this “popularity party,” putting DeFi regulation on the table.

DeFi’s “Huge Win” Moment

“The court believes that the defendant’s defense has its merits. This case is more like requiring the developer of an autonomous driving car to be held responsible for the actions of a third party who uses the car to commit traffic violations or rob a bank.” Hayden Adams, the founder of Uniswap, excerpted a court document from the Southern District of New York in a long thread today and exclaimed, “Huge Win, Long Live DeFi!”

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This “Huge Win” refers to the dismissal of a class-action lawsuit against Uniswap by a judge in the Southern District of New York.

On April 9, 2022, law firms Kim & Serritella and Barton announced the initiation of a securities class-action lawsuit, accusing Uniswap Labs, LianGuairadigm, a16z, and other defendants of violating securities laws by issuing and selling unregistered securities in the form of digital tokens on the Uniswap platform, including Uniswap’s own token, UNI.

The outcome of this lawsuit is scheduled for August 29, 2023. The court document from the Southern District of New York indicates that the Uniswap platform is capable of and, in many cases, operating legally; there were no transactions between the plaintiffs and the Uniswap platform and protocol; the current securities laws do not seem to cover the responsibility of DeFi protocols themselves for fraudulent behavior by users. The judge believed that the plaintiffs were harmed by fraudulent token issuers who took advantage of Uniswap’s core contracts and relays for front-running, and Uniswap created this platform where fraudulent token issuers engaged in fraud. At least according to US securities laws, this does not mean that Uniswap is responsible for fraud and the resulting damages.

Bill Hughes, a lawyer from Consensys, stated that the judge’s ruling in the class-action lawsuit against Uniswap clearly determines that Ethereum is a commodity, not a security. Although it is currently unclear whether the plaintiffs will appeal, this case and its ruling may be cited by many lawyers in the cryptocurrency field in the future. The “Huge Win” moment for Uniswap also reminds us of the Tornado Cash case.

Tornado Cash Impacted by Strong US Sanctions

On August 8, one year ago, the official website of OFAC (the Office of Foreign Assets Control of the US Treasury Department) showed that certain Ethereum addresses that interacted with the Tornado Cash protocol or were related to it were included in the SDN List (Specially Designated Nationals List) for sanctions.

Tornado Cash has always emphasized the privacy of its platform since its inception, allowing users to transact without revealing their identities. However, this privacy feature also provides convenience for illegal transactions to some extent.

Hayden Adams, the founder of Uniswap, expressed his views on the Tornado Cash incident in a tweet: “Privacy is crucial for a normal and secure society. It is absurd and dangerous to focus only on privacy providing convenience for illegal activities. Imposing reasonable laws or policies is often more effective than sanctioning companies to make them comply with the law.”

This year, Tornado Cash has been hit by a new round of sanctions from the U.S. government, which claims that Tornado Cash is involved in facilitating a series of illegal transactions. On August 24th, Tornado Cash co-founder Roman Storm was arrested by the FBI and the IRS on charges of “conspiracy to launder money, conspiracy to operate an unlicensed money transmitting business, and conspiracy to violate sanctions regulations.” Roman Storm has been released on bail, but they are disappointed with the prosecutor’s accusations against Roman Storm for developing software, as their novel legal theories have a dangerous impact on all software developers. Tornado Cash’s other co-founder, Roman Semenov, is still at large.

Now, the founder of Tornado Cash is also included in the list of numerous other political offenders in the United States, just like Ross Ulbricht (founder of the dark web Silk Road) and Julian Assange (founder of WikiLeaks) before.

The incident involving Tornado Cash made all the protocols in the crypto community sweat, as this round of sanctions bypassed the user privacy layer and directly targeted the protocol layer. This is a direct attack by regulators on the protocol layer, stating that “creating privacy protocols for criminals to use is a criminal act.”

The Protocol Layer and DeFi: A New Direction for Global Regulation

After Tornado Cash, other cryptocurrency service providers have also been alerted, reminding them to ensure compliance while pursuing technological innovation. The ongoing Uniswap lawsuit has also sparked discussions about DeFi regulation.

Today, DeFi is not only a booming trend but also seen as a disruptor of the future of finance by many industry insiders. However, as the financial system undergoes transformation, the regulatory challenges for this new economic model have also emerged. With the continuous expansion of the DeFi space, regulatory authorities have started to take action and formulate corresponding policies to ensure the healthy development of this field. It can be said that DeFi is gradually attracting the attention of regulatory agencies worldwide, from the United States to France, and to Hong Kong. The compass of global regulatory trends has clearly shifted.

In April 2023, the U.S. Treasury presented a thought-provoking gift to the world by releasing an assessment report on illicit financial activities in DeFi. This carefully crafted document not only reveals the potential risks in DeFi services but also provides in-depth analysis of criminal activities carried out by illegal actors using these services. In addition, in July, four U.S. senators introduced the “Cryptocurrency Act of 2023” aimed at strengthening regulation in the areas of KYC, AML, and DeFi.

Some of the provisions have sparked widespread discussion on social media: the bill provides a new regulatory framework for DeFi, which requires DeFi to be regulated in the same way as other cryptocurrency institutions, requiring any “person” who can control the project to be responsible for the project. The bill may also mention that if there is no specific person who can control the DeFi service, any investor who invests more than $250,000 in the project should be responsible for the project.

Just one day later, the International Organization of Securities Commissions (IOSCO) once again drew widespread attention from the market. The news revealed that the organization intends to gradually release regulatory consultations on crypto assets and DeFi within this year. It is worth noting that IOSCO is not an isolated entity, it represents an international cooperation network aimed at promoting globally recognized securities regulatory standards.

In Europe, the attitude of the French Financial Markets Authority (AMF) towards DeFi is relatively positive. Its recent discussion report believes that DeFi not only has the potential to promote financial innovation, but also carries hidden risks. Therefore, the AMF expressed its intention to work closely with all parties in the coming years to create a balanced regulatory system.

Gary Gensler, Chairman of the SEC, a prominent figure in the crypto community, has a more sharp viewpoint. He believes that most DeFi trading platforms are actually no different from traditional exchanges in their definition. Four heavyweight U.S. senators have also proposed a new bill targeting crypto assets, KYC, anti-money laundering, and DeFi, aiming to further clarify the regulatory framework and responsible parties.

Most countries are still in the exploration stage of specific management strategies for DeFi. The Dubai Financial Services Authority (DFSA), as one of the few regions that has clearly issued DeFi-related policies, has set clear licensing thresholds for DeFi participants. The Financial Conduct Authority (FCA) in the UK has also opened a regulatory sandbox for DeFi applications, providing a testing ground for emerging enterprises.

In Hong Kong, as one of the global financial centers, the attitude towards DeFi seems to be more pragmatic. In the opinion of the Chairman of the Fintech Advisory Group of the Securities and Futures Commission of Hong Kong, Tsai Chung-hui, DeFi is not a completely novel existence, and its substantive activities should be subject to regulatory requirements similar to traditional financial entities.

Different Judgments on Regulation for Uniswap and Tornado Cash

The Tornado Cash incident signifies the escalating struggle between “crypto protocols” and “regulation”, but today in the collective lawsuit ruling against Uniswap, the judge made a favorable judgment for Uniswap, seemingly wanting to suppress the flames of this war.

Last year, a16z wrote a comment letter for the “International Regulation of Crypto Asset Activities” theme event of the Financial Stability Board (FSB), which mentioned discussing the difference between DeFi and CeFi from the beginning, and how the appropriate DeFi regulatory framework should regulate Web3 applications, not Web3 protocols (regulating companies, not software). The debate about which aspects of DeFi protocols and applications are suitable for a regulatory environment has been ongoing, but even so, most legal experts agree that any DeFi front-end with any connection to the United States (broadly defined) must comply with U.S. sanctions laws.

The different outcomes of Tornado Cash and Uniswap provide excellent case studies for this viewpoint. Regulatory agencies are trying to find a balance between not suppressing financial technological innovation and ensuring fairness, justice, and stability in the market. Behind this, the real challenge for regulation lies in how to ensure that technology and law progress synchronously and how to find a common standard in a global financial market.

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