Readers are not to construe the contents of this brief as legal, business, tax, accounting, investment, or other advice. Each UNI token holder should consult its own advisers as to legal, business, tax, accounting, and other related matters concerning the proposal in light of such token holder’s particular circumstances.
As many in the community know, a proposal was kicked off over the summer to activate the Uniswap Protocol’s fee switch. As discussed in this Technical Breakdown of the fee switch, its activation would allocate a small percentage of the swap fee collected from each transaction on the Protocol to the control of Uniswap Protocol governance. You can read more about the proposal in these Temperature Check and Consensus Check posts.
The UF aims to do our part to ensure the community is prepared to make informed decisions on all governance votes put forth. In that spirit, we have spent some time thinking about legal and regulatory considerations that may be relevant to this vote, and have compiled this thinking into the brief below. Note that many of these considerations might be considered relevant to the Protocol regardless of whether or not the fee switch is turned on.
In putting together this brief, we took into account public discourse, relevant open source materials (some of which are listed below), and the guidance of a set of trusted advisors, many of whom have expertise at the intersection of crypto and U.S. law and regulation.
Brief: Uniswap Protocol Fee Switch Considerations
The regulatory and private litigation climate for DeFi in the U.S. has been incredibly fast-moving and challenging, and there has been an uptick in regulatory attention and legal activity related to DeFi projects, including to the Uniswap Protocol.
We have seen and heard community discussion concerning whether this proposal presents any potential regulatory and other legal risks, notwithstanding that the fee switch has been part of the Protocol since v2.
Many of these regulatory and legal concerns and discussions exist across DeFi projects, DAOs, and web3-based communities in general. For instance, we have heard questions about whether the proposal could make it more likely that UNI is scrutinized more closely under federal securities laws in the U.S. We have heard concerns that regulators or private litigants could bring lawsuits against the DAO, and seek to hold UNI token holders liable. We have also heard discussion about whether the proposed fee switch raises U.S. income tax questions for both the DAO and UNI token holders.
We have made efforts to be thoughtful and analytical about these issues. And we believe that, in light of the uncertainties which exist in this realm today, there may be ways to design proposals that minimize these types of concerns.
We note that the ideas which follow are only intended for any proposals put forth in the short term. They are potentially overly conservative, and provided out of an abundance of caution.
One way to minimize any potential or theoretical regulatory concerns is to only activate the fee switch for liquidity pools for tokens that have not been the subject of public regulatory scrutiny on the question of whether the tokens are securities, such as stablecoins or ETH. The proposal could also specifically delineate that the fees allocated to protocol governance would be put to use for the public good of the community and Protocol. Again, over time, as conditions change, it may become apparent that these suggestions are overly conservative.
On the topic of taxes, fees directed to the Protocol pursuant to the proposal do fit within the broad definition of income for U.S. (and possibly other jurisdictions’) tax purposes. But, the current proposal as it stands does not address whether or how the Protocol should compute, report or pay any U.S. federal, state or foreign tax that might be due on the fee income that is directed to the Protocol. The proposal, if approved, will highlight existing uncertainty around these tax issues, which are also likely to be raised by tax authorities.
Further, the community might consider additional steps outside of the design of this particular proposal. For instance, it might consider taking steps to wrap the DAO, or certain UNI token holders or smart contracts, in a limited liability entity, so as to limit the personal liability of any individual token holders for protocol activity.
We anticipate that many community members may bring forth proposals suggesting other ways to limit potential concerns. And we also anticipate community disagreement and debate over our considerations above – we welcome those thoughts and feedback as well.
The considerations above are not, of course, a complete list of all possible legal issues presented by DeFi activity. This proposal in itself highlights many existing uncertainties around the relevant issues mentioned. We strongly encourage all community members to do their own research, and consult with their own legal, professional, and tax advisers in their own jurisdictions.
Relevant Open-Sourced Resources
Digital Asset Transactions: When Howey Met Gary (Plastic), SEC, William Hinman, June 14, 2018
Framework for “Investment Contract” Analysis of Digital Assets, SEC
Legal Options for DAOs, Paradigm
DAO Entity Features & Entity Selection, a16z Crypto
CFTC v. Ooki DAO, 3:22-cv-05416 (N.D. Cal., Filed 9/22/2022)