Federal court dismisses putative class action lawsuit against DEX developer Uniswap Labs: key takeaways

On August 30, the US District Court for the Southern District of New York dismissed a putative class action lawsuit against Uniswap Labs, Inc., the developer behind one of the most popular decentralized exchanges (DEX) on the Ethereum blockchain, as well as the company’s CEO and Founder of the Uniswap Foundation as well as several high-profile VCs and shareholders of Uniswap. The lawsuit also targeted some large “liquidity providers,” i.e. companies that had deposited significant amounts of virtual currencies into the DEX so that traders could buy and sell in their liquidity pools.

The named plaintiffs were a group of investors who purchased various ERC-20 “fraud tokens” on the Uniswap DEX and lost money when the tokens declined in value. The plaintiffs alleged that these tokens were securities and that Uniswap violated the SEC’s registration requirements by operating an unregistered exchange. They asserted claims under Section 29(b) of the Exchange Act and Section 5 of the Securities Act.

In a 51-page decision, the court granted the defendant’s motion to dismiss the case due to insufficient presentation of a legal claim.

Claim under Exchange Act Section 29(b).

The court initially dismissed plaintiffs’ Exchange Act claim after expressing skepticism that plaintiffs were simply pursuing defendants as the only available deep pockets. Under Section 29(b), contracts entered into in violation of the Exchange Act are void. In other cases, most notably Underwood v. Coinbase, plaintiffs have argued (unsuccessfully) that agreements with cryptocurrency trading platforms violate Section 29(b) and can be reversed. In the present case, the plaintiffs attempted much the same argument. They alleged that contracts with the defendants existed because (i) the protocol requires users to trade tokens using “contracts” created by the defendants; (ii) Plaintiffs actually traded Tokens in accordance with the Protocol; and (iii) the plaintiffs paid fees for each transaction.

The court rejected these arguments. Although its analysis was unclear, the court assumed that Uniswap’s “smart contracts” constituted contracts in the legal sense and likened them to user agreements, which, according to the court in Underwood, were not prima facie unlawful and therefore not undoable can be. The court reasoned that “the smart contracts themselves could be lawfully executed here, as in the exchange of the crypto goods ETH and.” [wrapped] Bitcoin.” Accordingly, the court stated: “It defies logic that an author of the computer code underlying a particular software platform could be held liable under Section 29(b) for a third party’s misuse of that platform.” The court further rejected the Plaintiffs declined to compare the protocol to self-driving car defects for which the automaker could be held liable, instead comparing the protocol to an application like Venmo, whose developers are generally not liable for users’ illegal activity.

The court also noted that the SEC itself has acknowledged the lack of clarity regarding the legal regulation of DeFi and that “the law is currently evolving around these exchanges, so defendants are not currently subject to a traditional Section 29(b). ) can be held liable.” Theory.”

Claim under Section 5 of the Securities Act

The Court’s analysis in Section 5 also relied on the Underwood case. Section 5 places liability on the “seller” of securities, specifically the one who either transfers ownership of the securities or solicits to purchase them. The court rejected the premise that the defendants had transferred ownership of one of the tokens on the grounds that it was not even clear that a liquidity pool had “ownership” of the tokens contained therein and that this proposal was in relation to the Uniswap defendants are even less secure. The court also rejected the plaintiffs’ solicitation theory because it was supported only by minor, general marketing efforts by Uniswap defendants to use the protocol.

The court’s decision is a setback for potential plaintiffs who want to hold exchanges responsible for their losses. The decision could also provide resistance to regulators’ enforcement of decentralized protocols.

The central theses

• The court did not address the question of whether the tokens in question were securities, nor the circumstances under which cryptocurrencies may constitute securities. The court also did not comment on whether and when decentralized exchanges can constitute “exchanges” within the meaning of the Stock Exchange Act.
• This case may provide clues as to the extent to which centralized, peripheral actors can be held liable for the actions of a decentralized (partial or complete) software.
• The Court expanded on Underwood, holding that smart contracts could be comparable to user agreements, useful for both lawful and unlawful purposes, and therefore not subject to repeal under Section 29(b). This conclusion relates to the extent to which product developers can be held liable for the unlawful use of a device by third parties.
• At a high level, this case represents a qualified victory for the industry, which, along with other cases, could give courts pause before assuming a defeat for the industry in other contexts.

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