Flip the switch: Is Uniswap ready for the regulatory ripple effect?

Uniswap, one of the largest decentralised exchanges has announced a proposal to activate its long-debated fee switch. The proposal would see the protocol begin collecting fees and introduce a programmatic mechanism that enable users paid to burn UNI governance tokens.

How will the fee switch work?

The fee switch is a mechanism built into Uniswap’s protocol that allows governance to redirect a share of trading fees from liquidity providers to UNI token holders. Until now, this feature had never been turned on, despite being part of the protocol design since its early days.

Instead of distributing revenue directly to token holders, the proposal would allocate between one-quarter and one-sixth of protocol fees to a smart contract known as the “Tokenjar”. UNI holders would burn their tokens in the "Firepoint" contract and withdraw an equivalent amount of cryptocurrency.

The timing appears influenced by the evolving US regulatory environment and recent changes in leadership at the US Securities and Exchange Commission that have sought to position the US as a hub for crypto innovation. Uniswap founder Hayden Adams has previously expressed dissatisfaction with the former SEC chair’s approach and Uniswap Labs, the developer behind the protocol, itself was the subject of a Wells Notice indicating potential enforcement action in the final year of the previous administration which action has since been dropped .

By activating the fee switch, Uniswap is taking a step that could have implications for how UNI is classified under US securities laws and in other jurisdictions such as Australia, where the regulator has recently published its further views on the application of financial services laws to innovative cryptocurrency related offerings.

Does this make UNI a security?

Under US law, UNI tokens may be classified as securities if holders expect profits derived from the efforts of others. Distributing protocol fees to UNI holders could strengthen the argument that UNI meets this test, as holders would have a way to access financial benefits tied to the operation of the exchange.

While this does not automatically make UNI a security, the decision to activate the fee switch continues the debate over whether governance tokens qualify as securities.

What about the Australian approach?

ASIC’s recently updated INFO 225 provides guidance on when digital assets might be considered a financial product under Australian law. The key question is whether the UNI token gives holders certain rights which mean that the token qualifies as a financial product.

INFO225 provides guidance on a range of financial product definitions, including securities, managed investment schemes and financial investments. Businesses are encouraged to assess whether any tokens which they offer are likely to fall within those definitions. If a token qualifies as a financial product, a person dealing in that token will require a financial services licence and potentially other licences depending on their business model. Significant penalties can apply for offering services without a licence.

The fee switch introduces a way for governance token holders to access protocol fees, which gives them a right to vote and participate in the economic benefits of the protocol. While Uniswap’'s proposal has been broadly welcomed by tokenholders, if the proposal proceeds, the regulatory ripple effects will need to be carefully weighed for anyone offering the token given the risks of breaching financial services laws.

Written by Steven Pettigrove and Tahlia Kelly