Two Important Legal Updates at the CFTC
Uniswap Labs and Kalshi's legal fates diverge, for now
I started Brogan Law to provide top quality legal services to individuals and entities with legal questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their startup mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz.
Usually this newsletter focuses on a single weekly topic, but this week has seen such substantial development in crypto law that we’re covering two. On September 4th, the CFTC announced that it was issuing an ordering settling certain charges against Uniswap Labs (“Uniswap” herein[1]) for “Offering Illegal Digital Asset Derivatives Trading.” Then, on September 7th, Judge Jia Cobb on the United States District Court of the District of Columbia issues an order throwing out the CFTC’s 2023 decision prohibiting Kalshi from listing certain political event contracts. Both of these decisions could portend crucial advances in cryptocurrency law.[2]
Uniswap Labs Pays A Fine
The CFTC decision and settlement against Uniswap comes amid increasing regulatory pressure on the platform. In April, the SEC served Uniswap with a Wells Notice, alleging, inter alia, that it was operating an “unregistered exchange in violation of Section 5 of the Exchange Act” and an “unregistered broker in violation of Section 15(a) of the Exchange Act.” This type of notice, as we discussed last week, suggests that enforcement might be imminent. Uniswap Labs subsequently submitted a formal response arguing, inter alia, that the Uniswap Protocol[3] is not a statutory securities exchange or and that Uniswap is not legally responsible for trading occurring on the Uniswap protocol. Uniswap also cites the Major Questions Doctrine that we discussed with Iowa Solicitor General Eric Wessan a couple weeks ago.
As of now, the SEC has not publicly filed charges against Uniswap and so the matter remains in regulatory limbo. Commentators have suggested that Uniswap may be hunkering down for a serious fight, and this view may be bolstered by their hiring of attorney Donald Verilli Jr., who is thought to charge among the highest billable rates in the country.
Apparently, at the same time, Uniswap has been the subject of CFTC investigation, as a new order came out this week. The CFTC order:
“finds Uniswap Labs illegally offered leveraged or margined retail commodity transactions in digital assets via a decentralized digital asset trading protocol. The order requires Uniswap Labs to pay a $175,000 civil monetary penalty and to cease and desist from violating the Commodity Exchange Act (CEA), as charged.”
The subject of the order is quite narrow, reflecting only transactions of certain “leveraged tokens” created by third parties allegedly to act as derivatives, including:
“BTC 2x Flexible Leverage Index token (BTC2XFLI); ETH 2x Flexible Leverage Index token (ETH2XFLI); ETH 2x Flexible Leverage Index token-Polygon (ETH2XFLI-P); and BTC 2x Flexible Leverage Index token-Polygon (BTC2xFLI-P); as well as an ERC-20 token whose value was based on an index that tracked the price of ETH squared (oSQTH).”
The CFTC found that trade in these tokens using the Uniswap web interface was a violation of Section 4(a) of the Commodities Exchange Act, 7 U.S.C. § 6(a). Importantly, while any unregistered and undesignated commerce in these tokens would constitute a violation, the CFTC ascribes a nexus between these transactions, which putatively occur on on-chain at the decentralized Uniswap Protocol (and thut out of Uniswap Labs’ control), and the Uniswap web interface. Uniswap generally argues these two “Uniswap” branded platforms are, in fact, legally distinct. The CFTC Order does not discuss this complication and instead simply finds that Uniswap:
“through the use of the Interface and the Protocol, offered to enter into, entered into, executed, confirmed the execution of, or conducted an office or business anywhere in the United States, its territories or possessions, for the purpose of soliciting or accepting orders for, or otherwise dealt in, these Leveraged Token transactions”
This lack of clarity is vexing, as it suggests that the CFTC does not consider “decentralization” meaningfully protective against enforcement without specifically discussing the extent of that view. Uniswap neither admits nor denies the findings and conclusions of the order, but “consents to the use of the findings of fact and conclusions of law in this Order in this proceeding and in any other proceeding brought by the Commission or to which the Commission is a party or claimant, and agrees that they shall be taken as true and correct and be given preclusive effect therein, without further proof.” This, together, is unlikely to directly affect the merits of any SEC arguments against Uniswap.
There are a few other interesting takeaways from the Uniswap order. For one, the amount of fine is effectively nominal, $175,000 may be a lot of money to you or me, but it is not for entities of this size. The CFTC suggests that this is because it “recognizes Uniswap Labs’ substantial cooperation with the Division of Enforcement’s investigation of this matter in the form of a reduced civil monetary penalty.”
The order also includes a cease and desist of offending conduct, but since the scope of conduct specifically found to be offending in the order is quite narrow[4], this seems to have little preclusive power. Indeed, the language of the order provides no clarity to what conduct is prohibited and simply enjoins Uniswap from violating the law, something that astute observers will note is, in fact, already illegal.
Read liberally, this could be interpreted as tacit forbearance of Uniswaps other conduct, which could arguably fall within the CFTC’s purview but is not alleged in this order. The extent of this quiescent approval is completely speculative, but it raises the question of whether other professedly decentralized exchanges like dYdX and Hyperliquid that arguably offer similar products to Uniswap are now operating within the CFTC implicit approval so long as they don’t offer “leveraged tokens.”
It is also interesting to note that both Republican commissioners wrote dissents to the order. Commissioner Summer K. Mersinger argues that the order constitutes “regulation through enforcement” without first going through notice-and-comment rulemaking, and is likely to chill “responsible innovation.” Commissioner Caroline Pham argues that the tokens being called “leveraged” is not necessarily sufficient for them to qualify within the meaning of the CEA, as well as invoking the need for notice-and-comment rulemaking. Taken together, these dissents are a powerful indication that this case may have turned out differently if the Republican side had been in control. With the election just months away, and a closely divided electorate, DeFi operators may take this as good news.
That said, while this may be bullish for the affirmative legality of DEX offerings, sources within the industry are pessimistic, telling the newsletter that “175k is just the most recent pay-to-play price tag collected by self-proclaimed arbiters in the DeFi arena.” For its part, Uniswap remained defiant, with chief legal officer Katherine Minarik vowing to continue to “fight.”
Kalshi Grabs a “W”
Kalshi was the first prediction market to gain CFTC registration as a DCM, much to the surprise of many given the CFTC’s known distaste for this kind of market. Commentators speculated that that registration could be isolated, as it came at the tail end of the outgoing Trump administration in November 2020. However, it turned out to be a bellwether, as this year the CFTC approved another prediction market, ForecastEx, LLC, in June.
In a difficult maze of mixed signals for the industry, this was a strong sign that the form may be affirmatively legal moving forward. However, there is still a crucial limitation that the CFTC has remained firm on, elections markets. In 2023, the Comission prohibited Kalshi from listing a market related to control of congress. In a concurrent press release, Chair Rostin Benham noted the Commission found “that such political event contracts involve both gaming and activity that is unlawful under State law, and are contrary to the public interest.”
As we covered a couple weeks ago, the CFTC subsequently doubled down and issued a Notice of Proposed Rulemaking seeking to formally classify these contracts, including those concerning election outcomes and e.g. award show results, as “contrary to the public interest.”
Well Kalshi went to court, and a year later has a major victory. Judge Cobb’s ruling overturns the 2023 order and would allow Kalshi to list the contracts at issue (so-called “congressional control contracts”) immediately. According to reporting from the Wall Street Journal, Kalshi co-founder Luana Lopes Lara has said that Kalshi “will move quickly to list other kinds of political-event contracts.”
In response, the CFTC has filed an emergency motion seeking a temporary stay of the order to give it time to appeal. At time of writing, that motion is pending.
While Kalshi has rightfully hailed this order as a major win, the exact implications are unclear. Judge Cobb has so far issued no reasoning for the order, saying that it will come in a future memorandum decision. This reasoning is very important, as, if Judge Cobb believes that a ban on certain political event contracts requires notice-and-comment rulemaking, well, the CFTC is already in that process. If that turns out to be the case, then these contracts may become legal for only a limited period of time before disappearing again. Moreover, this issue will likely be decided on the appellate level, and it is unclear how the D.C. Circuit Court of Appeals, and potentially the Supreme Court[5] would rule, meaning that any win could be retrenched or reversed.
So, while the industry should not jump to count unhatched chickens, this order is certainly a victory. If Judge Cobb’s memorandum comes out this week, we will have more coverage here. In the meantime, don’t hestitate to contact Brogan Law at aaron@broganlaw.xyz with any questions about how this or other crypto rulings may apply to you or your business.
[1] As a decentralized platform, the name “Uniswap” could have multiple legal connotations. In this case, Uniswap refers only to the U.S. entity “Uniswap Labs” that is the target of certain regulatory enforcement.
[2] Strictly, this newsletter covers cryptocurrency exclusively, and Kalshi, a predictions market platform, is not “cryptocurrency.” However, for obscure reasons, these industries have a close affinity. Many predictions platforms are built on crypto rails, and since this decision will redound there, it is covered here.
[3] The Uniswap Protocol is a collection of interrelated smart contracts existing on a number of blockchains.
[4] And the dissents make clear that Uniswap has already ceased that conduct.
[5] To my eye, it seems unlikely that the Supreme Court would take this question since there is currently no circuit split, but anything is possible.
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