U.S. Court Dismisses Uniswap Lawsuit, Calls ETH & Bitcoin Commodities

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The perplexing debate as to whether or not a digital asset is considered to be a “security” or a “commodity” continues to frustrate U.S. regulators and industry participants, as we aren’t getting much closer to understanding what criteria truly distinguish them. 

But now, things just got interesting with respect to the role developers and smart contracts play in a securities class-action lawsuit.

In a “case of first impression,” New York District Judge Katherine P. Failla addressed whether the developers and investors in the Uniswap Protocol crypto exchange platform were subject to various provisions of our current federal securities laws. 

The class-action securities lawsuit, filed on September 27, 2022, centered around Uniswap’s alleged involvement in the creation and dissemination of fraudulent tokens, which allegedly inflicted financial harm on investors. 

The Complaint specifically named Universal Navigation Inc., d/b/a Uniswap Labs, its CEO Hayden Adams, and the Uniswap Foundation, alleging two primary federal securities claims against Uniswap:

  1. The rescission of Plaintiff’s purportedly “unlawful contracts” with Uniswap pursuant to Section 29(b) of the Securities Exchange Act of 1934; and 
  1. Uniswap’s alleged violation of Section 12(a)(1) of the Securities Act of 1933.

Both of the Plaintiffs’ claims stem from reported losses that arose out of scams and other misconduct that was committed by unknown issuers of the tokens.

On December 21, 2022, Uniswap et al. filed its respective motions to dismiss, which the Court ultimately granted.

Lawful Smart Contracts vs. Unlawful Transactions

The Plaintiffs allege that Uniswap contracted with them so as to require its users to buy and sell tokens using smart contracts that were drafted by the DeFi protocol, to which Plaintiffs assented to. 

However, the Court wasn’t convinced by these arguments. Its Order, which underlines the distinction between a security and a commodity, not only absolved Uniswap of liability but provided a deeper analysis of today’s utilization of smart contracts.

Under Section 29(b) of the Exchange Act:

“Every contract made in violation of any provision of this chapter or of any rule or regulation thereunder, and every contract … the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of this chapter or any rule, or regulation thereunder, shall be void … as regards the rights of any person who, in violation of any such provision, rule, or regulation, shall have made or engaged in the performance of any such contract.”

To establish a violation of this provision, the Plaintiffs were required to show that the (smart) contract involved:

(1) A prohibited transaction

(2) Contractual privity with Uniswap, and

(3) They are in a class of persons that the Exchange Act was designed to protect.

Turning to the first element of “prohibited transactions,” the Court stated that rescinding such a contract isn’t allowed when “the violation complained of is collateral or tangential to the contract between the parties.” 

Applying common law principles, the Court added that a contract can only be voided or rescinded when performance under the contract is completely prevented without a party violating the Exchange Act. 

Citing the 1968 case of Eastside Church of Christ v. Nat’l Plan, Inc., the Court stated that “only unlawful contracts may be rescinded, not unlawful transactions made pursuant to lawful contracts.” 

In other words, there is no logic in holding the drafter or programmer of computer code that underlies a particular software platform liable for a third party’s misuse of that platform. 

The Court compared this to a “manufacturing defect” and something that more closely resembles a group of users attempting to hold a platform like Venmo or Zelle liable for a drug deal that used those platforms to facilitate a fund transfer. It also used the example of an attempt to hold a developer of self-driving cars liable for a third party’s use of the car to commit a traffic violation or to rob a bank.

“In those circumstances, one would not sue the car company for facilitating the wrongdoing; they would sue the individual who committed the wrong,” Judge Failla wrote.

“There, as here, collateral, third-party human intervention causes the harm, not the underlying platform,” her ruling continued.

The filing further drew parallels between the exchange of Bitcoin and Ether and the functioning of the smart contracts in question, recognizing the nature of smart contracts to be “self-executing, self-enforcing code” that contains the terms and conditions as agreed to between a buyer and seller. 

“While no court has yet decided this issue in the context of a decentralized protocol’s smart contracts, the court finds the smart contracts here were themselves able to be carried out lawfully,” Judge Failla stated. 

Bitcoin and ETH Labeled As Commodities

At the end of the day, Judge Failla refused to “stretch the federal securities laws to cover the conduct alleged” in the complaint, referring to Bitcoin (BTC) and Ether (ETH) as “commodities,” dismissing the plaintiff’s Motion to Dismiss. 

While the U.S. Securities and Exchange Commission (SEC) is determined to extend this debate as far out as possible, its chair, Gary Gensler, continues to remain a sight for sore eyes when it comes to taking a clear position on how the agency applies its “subjective” criteria to determine whether or not a digital asset is classified as a “security.” 

On the same day of Judge Failla’s ruling, leading crypto asset manager, Grayscale Bitcoin Trust (GBTC) finally had its long-awaited legal victory against the SEC in attempting to transform its over-the-counter GBTC application into a listed Bitcoin ETF.

The differentiation set forth in the August 29 ruling certainly introduces an additional layer of complexity to the SEC’s stance on digital assets, underscoring the evolving nature of cryptocurrency regulation. As the legal landscape continues to take shape, this decision could reverberate throughout the industry, prompting further discussions and potential recalibrations of regulatory perspectives. 

But for now, Judge Failla’s ruling is a starting precedent for how smart contracts are analyzed and BTC and ETH’s treatment as commodities.

Gensler has consistently maintained that Bitcoin holds the sole distinction of being a crypto commodity. However, the recent court ruling presents a contrasting perspective.

Editor’s note: This article was written by an nft now staff member in collaboration with OpenAI’s GPT-4.

The post U.S. Court Dismisses Uniswap Lawsuit, Calls ETH & Bitcoin Commodities appeared first on nft now.

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