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26 September 20235 minute read

Federal court dismisses putative class action 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 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, the Uniswap Foundation, and several high-profile VCs and shareholders of Uniswap. The lawsuit also targeted some large “liquidity providers,” ie, entities that had deposited substantial quantities of virtual currencies into the DEX so that traders could buy and sell into their liquidity pools.

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

In a 51-page order, the court granted the defendants’ motion to dismiss the case for failure to adequately state a legal claim.

Exchange Act Section 29(b) claim

The court dismissed the plaintiffs’ Exchange Act claim first after expressing skepticism that that the plaintiffs were merely pursuing the defendants as the only available deep pockets. Under Section 29(b), contracts made 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 are subject to rescission. In this case, the plaintiffs attempted roughly the same argument. They alleged contracts existed with the defendants because (i) the protocol requires users to trade tokens using “contracts” created by the defendants; (ii) the plaintiffs in fact traded tokens on the protocol; and (iii) the plaintiffs paid fees for each transaction.

The court rejected these arguments. Though its analysis was unclear, the court assumed that Uniswap’s “smart contracts” constitute contracts in the legal sense analogizing them to user agreements, which the court in Underwood found were not facially unlawful and thus not subject to rescission. The court reasoned that “the smart contracts here were themselves able to be carried out lawfully, as with the exchange of crypto commodities ETH and [wrapped] Bitcoin.” Accordingly, the court observed “it defies logic that a drafter of computer code underlying a particular software platform could be liable under Section 29(b) for a third-party’s misuse of that platform.” The court further rejected the plaintiffs’ attempt to analogize the protocol to self-driving car defects, for which the car manufacturer might be held liable, and instead analogized the protocol to an application like Venmo, the developers of which are generally not liable for users’ illegal activity.

The court also noted that the SEC itself has acknowledged the lack of clarity with respect to legal regulation of DeFi, and that “the law is currently developing around these exchanges, such that Defendants cannot currently be held liable under a traditional Section 29(b) theory.”

Securities Act Section 5 claim

The court’s Section 5 analysis also relied on the Underwood case. Section 5 imposes liability on the “seller” of securities, specifically one who either passes title to the securities or solicits the purchase. The court rejected the premise that the defendants passed title to any of the tokens, reasoning that it is not even clear that a liquidity pool holds “title” to tokens contained therein, and that this proposition is even less certain as applied to the Uniswap defendants. The court also rejected the plaintiffs’ solicitation theory as supported by only de minimis, general marketing by the Uniswap defendants to use the protocol.

The court’s decision is a setback for would-be plaintiffs seeking to blame exchanges for their losses. The decision may also offer resistance to regulatory enforcement against decentralized protocols.

Key takeaways

  • The court did not address whether any of the tokens at issue were securities or the circumstances under which cryptocurrencies can constitute securities. Nor did the court weigh in on whether or when decentralized exchanges can constitute “exchanges” within the definition of the Exchange Act.
  • This case may offer guidance on the degree to which centralized, peripheral actors can be held liable for acts of a decentralized (partially or fully) piece of software.
  • Extending Underwood, the court held that smart contracts could be analogous to user agreements useful for both lawful and unlawful purposes and thus were not subject to rescission under Section 29(b). This conclusion bears on the extent to which product developers can be held liable for a third party’s unlawful use of a device.
  • At a high level, this case represents a qualified victory for the industry that, presented alongside other cases, may give courts pause before assuming defeat for the industry in other contexts.

Learn more about this decision by contacting the author or your usual DLA Piper attorney.