On 26 February 2025, the Court of Appeals for the Second Circuit ruled that developers of “computer codes that facilitate the transfer of cryptocurrency on a decentralized exchange” are not liable for fraud committed by third parties on the decentralized exchange.
In Risley et al. v. Universal Navigation, Inc., No. 23–1340 (2d Cir. Feb. 26, 2025), Universal Navigation Inc. (and entities through which it operates) created a platform called Uniswap Protocol (“Protocol”) and the Protocol operates through a system of “smart contracts” that “autonomously write the terms of an agreement between traders of cryptocurrency,” which “obviates the need for lawyers, bankers, broker dealers, or accountants.” The users of the Protocol trade tokens with each other through what is known as token swaps. The smart contracts permit token swaps through a liquidity pool that matches users in a “peer-to-peer system.” When the users on the Protocol decide to trade tokens in the liquidity pool, the smart contract automatically decides the price of the tokens, the rate of exchange of the tokens, and facilitates the trade—after the trade is approved by the users. Users of the protocol have no direct contact with each other.
The Plaintiffs alleged that the Protocol allows third parties to sell scam tokens through “rug pulls” and through “pump and dumps.” In a “rug pull” scam the issuer of the token “deposit tokens in the liquidity pool but prematurely burns the pool tokens, leaving the purchasers with worthless tokens.” In “pump and dump” scams the issuer “artificially drive up the demand for their tokens and when the demand peaks, the issuers then ‘dump’ their new tokens, again leaving investors with worthless tokens.”
The Plaintiffs alleged that Universal Navigation Inc. (and entities through which it operates) and its investors were aware of and benefitted from the rug pulls and pump and dumps and should therefore be liable to Plaintiffs for the damages Plaintiffs suffered. The District Court for the Southern District of New York dismissed the Plaintiffs’ claim, and the Court of Appeals for the Second Circuit affirmed. The Second Circuit reasoned that the Protocol was like the NASDAQ or the NYSE in that the Protocol merely facilitated transactions. The Protocol neither offered nor sold the tokens itself.
The ruling was by summary order, which means it cannot be cited as precedent.
If you have questions about Risley et al. v. Universal Navigation, Inc., No. 23–1340 (2d Cir. Feb. 26, 2025), contact Williams LLP.