The U.S. Securities and Exchange Commission (SEC) has settled charges against Rari Capital, Inc. and its co-founders, Jai Bhavnani, Jack Lipstone and David Lucid.
In the SEC’s words, Rari Capital is a “purported” decentralized finance (DeFi) protocol, and the regulator “will not be deterred by someone characterizing a product as decentralized and autonomous.”
Looking beyond the labels and looking at economic realities, the US financial watchdog found that the DEX platform and its founders were facing deceitful investors and engaged in unregistered brokerage activities while managing over $1 billion worth of crypto assets through blockchain-based investment platforms.
The SEC also accused Rari Capital of conducting unregistered securities offerings related to its investment platforms, including the Earn and Fuse pools — products that allowed investors to deposit crypto assets into lending pools in exchange for profits, representing unregistered offers and sales of securities, according to the SEC complaint.
Rari Capital was not so “autonomous” and overestimated its returns
The agency says Rari Capital falsely touted Earn pools’ ability to maximize returns autonomously while failing to disclose manual intervention requirements. The misleading promotions also overstated returns, with many investors suffering losses after fees. Rari Capital’s unregistered broker-dealer business extended to the Fuse platform, where users could create lending pools.
Additionally, Rari Capital Infrastructure LLC, which resumed operations in 2022, settled charges that it continued to offer unregistered securities and brokerage activities. The SEC’s investigation was led by its San Francisco-based Crypto Assets and Cyber unit.
Monique C. Winkler, Director of the SEC’s San Francisco Regional Office, said, “We allege that Rari Capital and its co-founders misled investors about the characteristics and profitability of some of the cryptoasset investments offered by Rari Capital, and acted as unregistered broker-dealers. We will not be deterred by someone who labels a product as ‘decentralized’ and ‘autonomous,’ but will look beyond the labels to the economic realities, as we did here, and hold the people behind crypto products and platforms accountable when they harm investors and violate federal securities laws.”
SEC Considers Suing DeFi Giant Uniswap
The SEC is only just beginning its crackdown on DeFi, as the regulator is likely to charge Uniswap in the near future, having already sent a Wells Notice to the decentralized exchange in April. Weeks later, Uniswap implored the SEC in legal documents to reconsider its proposed lawsuit, arguing that it was not warranted.
Uniswap is the leading decentralized exchange (DEX) by daily trading volumes, holding a 22.5% market share. This increase in regulatory scrutiny comes shortly after a similar subpoena was sent to Uniswap competitor SushiSwap, indicating a continuing trend of increased regulatory scrutiny on decentralized trading platforms.
In its response to Wells’ notice, Uniswap Labs claimed that its protocol does not meet the criteria of an exchange under current definitions and is not subject to SEC regulation. The company said that while it created the protocol, it is now a “passive” technology used for cryptocurrency trading.
Martin Ammori, Uniswap Labs’ chief legal officer, said the SEC should redefine the term “exchange” to assert jurisdiction over Uniswap. Ammori argued that Uniswap was not specifically designed for securities trading and that the majority of its trading volume was in non-exchange products like Ethereum, Bitcoin, and stablecoins, which make up 65% of the protocol’s volume.
Ammori noted that the SEC is attempting to redefine several terms in its regulations to capture Uniswap, a move he said exceeds the authority granted to the agency by Congress. He also pointed to a recent federal court decision dismissing the SEC’s allegations that Coinbase Wallet was an unregistered broker-dealer, suggesting a similar outcome for Uniswap’s interface and wallet.
Uniswap Labs’ lawyers have argued that the SEC should not risk litigation by expanding its authority to regulate the protocol. They have warned that such actions would incentivize U.S. cryptocurrency investors to use foreign trading platforms and discourage innovation in financial and trading markets.
The filing provided additional details about the SEC’s potential enforcement actions against Uniswap Labs. The SEC is targeting Uniswap’s native UNI token and liquidity provider (LP) tokens. LP tokens are an integral part of how automated market makers like Uniswap operate. Users who deposit assets into the protocol’s trading pools receive LP tokens as a receipt for their contribution. These tokens can be redeemed for the value of the deposits, while the protocol uses the assets to facilitate trading.
According to Uniswap Labs’ response to Wells’ notice, the SEC alleges that LP tokens are investment contracts whose distribution violates securities laws. Uniswap Labs disputes this claim, saying that LP tokens are “bookkeeping devices” and do not fit within the SEC’s regulatory frameworks.
The CFTC fined Uniswap earlier this month
Earlier this month, the CFTC already fined Uniswap $175 million for illegally offering leveraged or margined retail commodities trading in digital assets through a decentralized digital asset exchange protocol.
The financial watchdog recognized Uniswap Labs’ substantial cooperation with the Enforcement Division’s investigation into this matter in the form of a reduced civil monetary penalty.
According to the CFTC, Uniswap Labs helped develop and deploy a blockchain-based digital asset protocol that allows non-eligible contract participants and institutional users in the United States and abroad to trade digital assets using the Ethereum blockchain. The protocol allows users to create and trade using liquidity pools, which are pairs of digital assets valued against each other.
To facilitate access, Uniswap Labs created and maintained a web interface that allowed users to trade in hundreds of liquidity pools on the protocol. Some of these pools included leveraged tokens, giving users leveraged exposure to assets like Ether and Bitcoin.
The order concluded that these leveraged tokens qualify as margined commodity transactions that did not result in actual delivery within 28 days. As such, they can only be offered to ineligible contract participants through a CFTC-registered trading venue, which was not the case with Uniswap Labs.
CFTC Commissioners Summer K. Mersinger and Caroline D. Pham issued dissenting statements regarding the CFTC’s settlement with Uniswap Labs.
Mersinger criticized the CFTC’s “regulate by enforcement” approach, saying the Commodity Exchange Act (CEA) was written for traditional, centralized markets, not decentralized protocols like Uniswap. She argued that instead of providing clear guidance or rules for DeFi, the Commission is relying on enforcement actions, which could spur innovation overseas and leave U.S. markets vulnerable to bad actors. Mersinger also expressed concern about the settlement’s penalty, calling it disproportionate and warning that it could discourage compliance efforts by DeFi platforms. She noted that Uniswap attempted to block some leveraged tokens, but the CFTC still penalized the platform for the period before those tokens were blocked. She questioned the agency’s priorities, noting that no harm or fraud was alleged in the case.
Pham’s dissent focused on the lack of clarity surrounding the “leveraged tokens” in question, saying that without specific details, the CFTC’s jurisdiction over the case was unclear. She argued that the CFTC’s enforcement action was legally unfounded and could set a dangerous precedent for DeFi and traditional commodities markets, potentially stifling innovation and endangering small businesses.
Both commissioners urged the CFTC to engage in rulemaking rather than relying on enforcement actions to combat DeFi, emphasizing the need for regulatory clarity to promote responsible innovation.
