Philip Liu is the Co-Founder and Chief Legal Officer of Arca, a blockchain- and crypto-focused investment advisor in Los Angeles.
Uniswap is the largest decentralized exchange (DEX) by trading volume and is the first DEX to really compete on a daily volume basis against some of the larger digital asset exchanges. This is seen when Uniswap passed Coinbase Pro daily trading volumes.
Are UNI tokens securities and/or subject to Securities Enforcement Action by the SEC?
Immediately after the airdropping of UNI tokens to the Uniswap protocol’s users, some vocal US law commentators (lawyers and others) thought that Uni tokens were beyond a doubt a security, that the airdropping was an illegal distribution, and that the Uniswap team laid down the gauntlet and dared the US Securities and Exchange Commission (SEC) to hold them to account.
A flippant review of the facts (as well as past precedent, and official and unofficial regulatory statements) may lead one down that path. However, if one were to also consider that the Uniswap team is well funded, backed by seasoned venture capitalists who have most likely lent their legal, regulatory, technical and other expertise, one might also take a more careful consideration of the facts and circumstances of this particular offering and why UNI tokens may very well be outside the enforcement framework of US securities laws.
Brief survey of official and unofficial SEC guidance
The first important regulatory statement by the SEC on whether tokens are securities was the DAO Report, issued in July 2017. The report discusses the underlying factors on what would be considered a “securities offering” subject to SEC registration and/or oversight. The report goes into detail about the factors underlying the old Howey test and its progeny—simplistically, a token offering would be a securities offering if:
- there was an investment of money
- in a common enterprise
- with a reasonable expectation of profits derived from the efforts of others.
The SEC followed up the DAO Report with a “Framework for ‘Investment Contract’ Analysis of Digital Assets” in April 2019 intended to provide even greater clarity to ICOs by attempting to define whether an investment contract was a security in an ICO offering. The Framework provides a comprehensive, but not exhaustive, listing of factors the SEC considers in determining whether a token offering is a securities offering. These include whether:
- a purchaser of a token is reasonably relying on the efforts of an “active participant,”
- whether the network is still in development or is fully functional
- the purchaser has a reasonable expectation of continued involvement and development in the network, whether there are essential tasks or responsibilities that are expected to be performed by an active participant, etc.
- purchasers reasonably can expect the active participant’s efforts to result in capital appreciation of the token
- the offering is to users or broadly to both users and non-users
- holders are able to use to the token for its intended functionality, etc.
In between those official reports, William Hinman, Director in the SEC Division of Corporation Finance, made remarks in June 2018 at the Yahoo Finance All Markets Summit: Crypto unofficially suggesting that certain token offerings that may have started out as a securities offering could become sufficiently decentralized so that no entity, person, or group provides essential managerial or entrepreneurial efforts (e.g., controls the network’s existence, development or, essentially, its profit potential).
Most interestingly, Director Hinman also remarked that a disclosure regime, like universe of the US securities law, serves to provide a purchaser of securities with information (background, financing, plans, financial stake and so forth) so that the purchaser can make an informed decision prior to purchasing a security. Furthermore, Director Hinman opines that as a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful. In other words, there’s little value in having a decentralized network and associated token be subject to a securities law disclosure regime.
Also, in February 2018, the Chairman of the SEC Jay Clayton testified before the US Senate Committee on Banking, Housing, and Urban Affairs on the roles of the SEC and the Commodity Futures Trading Commission (CFTC) on virtual currencies. Chairman Clayton testified that the mission of the SEC is to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.
In that role, Chairman Clayton stated that, “determining what falls within the ambit of a securities offer and sale is a facts-and-circumstances analysis, utilizing a principles-based framework that has served American companies and American investors well through periods of innovation and change for over 80 years.”
Chairman Clayton also stated that he had yet to see an ICO that wasn’t a securities offering and emphasized the protection of “Main Street investors.”
Enforcement actions and non-actions
Several ICO enforcement actions occurred in parallel with the SEC guidance cited above. Most of these were obvious securities offerings due to the amount of control exerted by the sponsors both before and after the related token offerings, or the fact that the networks supposedly supporting the tokens were non-functioning or required essential managerial and entrepreneurial effort by the sponsor.
Arguments that UNI tokens fall outside the US Securities Enforcement Framework
The Uniswap team has built a vast network of users distributed globally using their exchange protocol. The team never raised money through a token offering to create a network, it was only after the network was fully functioning that the team distributed the Uni governance token to all users of their protocol. Only users, team members, investors and advisors were entitled to receive the initial distribution of Uni tokens from Uniswap.
The functioning of the network is open source and fork-able (in fact, it was forked in the infamous Sushiswap saga currently playing out on Crypto Twitter). The initial governance rules place the power directly into the holders of the UNI token to direct the future development of the exchange protocol. The team has committed to refrain from governance proposals and will not vote for any proposals or work on any v2 protocol development. Essentially, the Uniswap team has placed the power to morph, change, add, delete, delegate, etc., directly to the community.
The UNI token has an essential function – the power to vote on proposals and to influence future direction of the network. But the network is not controlled by a central entity; it is controlled by its users (and by extension, the UNI tokenholders) who are vastly distributed. No one became a user intending to become a UNI tokenholder; so, there was no quid pro quo of consideration for being allocated UNI tokens. Even users who tried to complete a transaction but failed for some reason were allocated UNI tokens.
Based on the available details reviewed, the network is no longer controlled by the Uniswap team. The team doesn’t influence policy, can’t make unilateral changes, and doesn’t control essential network governance, audits, treasury, fees, etc.
By having UNI tokens subject to registration regimes like US securities laws, UNI would have to deliver periodic reports on financial performance, business developments, etc. Not only are these unlikely to be usefully definable or measurable, there is still the question as to who will actually be responsible for meeting such obligations.
Based on my review of existing guidance, precedent and enforcement actions, I believe the UNI tokens do not meet the SEC’s tests for concluding they are securities and/or are subject to enforcement action under existing US securities framework. This isn’t a legal opinion and, as the SEC has stated, these determinations are based on facts and circumstances.