A court ruling declining to hold Uniswap liable for alleged scams on its platform is a shield for decentralized crypto exchanges, and offers a preview for Coinbase Global Inc.’s closely watched fight with securities regulators.
Uniswap was sued by crypto users seeking to hold the exchange responsible after they lost money buying what they called “scam tokens” on the platform. It was one of the first efforts to apply US securities laws to a decentralized exchange, attorneys said.
Dismissing the suit last week, Judge Katherine Polk Failla in the US District Court for the Southern District of New York said the exchange wasn’t liable under existing law for users’ alleged losses.
Industry lawyers said the ruling of first impression is a significant win for exchanges like Uniswap that allow users to buy and sell crypto without an intermediary.
“It would’ve been a huge blow potentially had it come out a different way,” said Daniel McAvoy, co-chair of the fintech and blockchain practice at Polsinelli PC.
More broadly, the ruling provides a sense of Failla’s thinking about the interaction between crypto and securities laws. Her views are important: the judge is overseeing the Securities and Exchange Commission’s suit against Coinbase, a case that could reshape the industry.
“While the facts in the Coinbase case differ, it may be significant that Judge Failla refused to expand the scope of federal securities laws from the bench and instead placed the burden on Congress to enact new laws in order to fill the gaps in the current regulatory landscape,” Ropes & Gray LLP litigation and enforcement partner Helen Gugel said.
Coinbase Preview?
Uniswap was sued in April 2022 by a North Carolina resident who alleged there was rampant fraud on the popular exchange. The proposed class action sought to represent anyone who bought tokens on Uniswap since April 2021.
Failla said they were looking for a scapegoat because the alleged scammers were anonymous and couldn’t be found. The plaintiffs hoped “that this Court might overlook the fact that the current state of cryptocurrency regulation leaves them without recourse,” the judge said.
“The Court declines to stretch the federal securities laws to cover the conduct alleged, and concludes that Plaintiffs’ concerns are better addressed to Congress than to this Court,” Failla wrote.
Coinbase doesn’t operate the same as Uniswap—its retail trading site is centralized. And the SEC’s case, which accuses Coinbase of operating an unregistered securities exchange, raises different issues.
But Coinbase’s position has effectively been that existing securities laws don’t fit crypto products and services. That means Failla’s approach in ruling for Uniswap could bode well for Coinbase, attorneys said.
“The broader significance is that this case reflects judicial hesitance to stretch existing securities laws to fit crypto products and services, and recognition that where the laws do not fit as written, it is up to Congress to fix it,” Kayvan Sadeghi, lead of the blockchain practice at Jenner & Block LLP, said.
Coinbase has asked that Failla dismiss the SEC’s case. The agency’s response is due next month.
A key issue for Coinbase is whether the crypto tokens traded by the exchange’s users are securities, a question that could give the SEC broad authority over the crypto industry. The industry has seized on a reference from Failla in her Uniswap ruling to Ethereum being a commodity.
That description may “hint at Judge Failla’s thinking on the categorization of certain crypto assets as commodities or securities, which will be critical to the outcome of the Coinbase suit,” Gugel said.
Escaping Liability
The Uniswap decision adds to the crypto industry’s recent legal momentum.
The US Court of Appeals for the DC Circuit last week overturned the SEC’s decision to block Grayscale Investments LLC’s proposed spot Bitcoin exchange-traded fund. The court said the agency’s decision was arbitrary and capricious.
Weeks earlier, another New York federal judge found that offerings of Ripple Labs’ XRP token were not securities when sold to the general public. The SEC is fighting the decision.
The crypto users suing Uniswap claimed the exchange had contracts with each buyer because it required them to purchase tokens through smart contracts. The suit argued the contracts were void under securities laws and users should recover damages.
For that argument to succeed, the contracts would have to be illegal. But Failla said the protocol’s smart contracts could be carried out lawfully, such as when exchanging “commodities ETH and Bitcoin.” ETH is short for Ethereum.
Uniswap also beat arguments that it sold unregistered securities. Title to the tokens never transferred from the issuer to Uniswap, so the exchange wasn’t a “seller,” Failla said.
It’s an open legal question whether a protocol can take title to tokens, McAvoy said. Under this ruling, “you’re not going to be held liable for putting the guts in place to allow people to do that peer-to-peer trading,” McAvoy said.
‘Huge Victory’
If the suit against Uniswap was successful, the implications could’ve been sweeping, attorneys said.
Failla compared the users’ arguments against the exchange to claims that Venmo should be liable if the payment platform was used in a drug deal. Within the crypto industry, such a result would’ve had a chilling effect, Baker & Hostetler LLP’s Teresa Goody Guillén said.
“It would probably further stifle efforts in the US in this industry for fear of being held liable for things that you cannot control and third-party bad actors,” said Guillén, who co-leads the firm’s blockchain team.
The ruling was a “huge victory for the crypto world & software” developers, Uniswap’s chief legal officer Marvin Ammori said on X, formerly known as Twitter.
On the other side are crypto users who the judge recognized had an “identifiable injury.” The decision underscores the need to research before buying crypto assets, attorneys said.
There are analogies between the exchange’s protections and those for social media websites, like Meta Platform Inc.‘s Facebook, which can be shielded from liability when users post copyrighted pictures or defamatory statements, attorneys said.
“The bad actor is the person posting the content in the case of copyright,” said Jim Gatto, co-leader of the blockchain and fintech team at Sheppard, Mullin, Richter & Hampton LLP. “Same thing here. If there’s an issuer of coins doing something illegal and they post it on a decentralized exchange, it’s not clear why the decentralized exchange should be liable.”
The Uniswap case is Risley v. Univ. Navig. Inc., S.D.N.Y., No. 22-cv-2780.
