December 16, 2018
Uniswap Experiment - Legal Considerations
Meisser Economics has bought a few crypto francs in November. While I believe that stable coins will be an important future pillar of the blockchain economy, the crypto franc is not very useful yet. In particular, it would be desirable for it to be tradable by smart contracts. That means that smart contracts should not only be able to send crypto francs around, but also to buy and sell them when necessary. Thus, we need a smart contract that acts as a market maker. Uniswap provides such smart contracts out of the box, using constant product market making. Market making is one of the research areas of my phd, so I’d like to test it out myself by providing some liquidity on Uniswap and see what happens. However, before doing so, I wanted to quickly assess whether this is legal to do. In finance, one never can be sure about whether the most basic activity requires a license as the regulation is extremely dense.
According to Finma’s token classification system, the crypto franc is both a payment as well as an asset token. Thus, we need to look at the laws governing the trade of currencies as well as those governing the trade of securities. Fortunately, Swiss laws are comparitively short and easier to understand than those of other countries, allowing me to gain enough confidence to dare this experiment after a quick Sunday-morning analysis of the relevant articles, the findings of which are described herein. Also, most laws contain exceptions for those who act without commercial intent. Nonetheless, it cannot hurt to study the exact conditions in more detail.
First, let’s look at the regulation the governs the trading of currencies. Fortunately, Meisser Economics does not qualify as a financial intermediary as long as the trading is not done at a commercial scale, which is defined as making over 50’000 CHF of trading profits or over 2 million in trading volume per year. There is no such limit when offering money transfer services, but all we do is providing liquidity for the swap. Uniswap allows the user to directly send the proceeds of the swap to a new address, but since we have no discretion whatsoever over where that money goes, such a transfer should be considered executed by the user, and not by us. To conclude: as long as we stay below the volume limits, we seem to be safe, at least from the currency-trading perspective.
Second, we need to check whether this activity requires a securities dealer license, as crypto franc classify as securities in Switzerland. Here, the relevant law is the Börsengesetz (exchange act), which governs exchanges and securities dealers until the end of 2019, when it is replaced by the Financial Institutions Act. At first sight, the considerations herein apply to both the old and the new law, as the relevant regulations do not seem to change materially. Most people and firms do not need a securities dealer license as proprietary trading up to a volume of 5 billion per year is exempt. Unfortunately, there is no such exemption for market makers and given that we are doing market making - or at least providing the liquidity for it - this might be a problem. However, the constant product market making of Uniswap is fundamentally different from traditional market making. The original reason to regulate market making was to prevent market makers from exploiting information-asymmetries, as documented in the Botschaft zum Börsengesetz. (A cynic might say that the law ensures that only big banks can exploit the common investor.) Unlike traditional market-making, on-chain market making by smart contracts is completely transparent and predictable. Thus, it is actually the counter-party that has the informational advantage, and not the market maker, who carries a significant inventory risk. If anyone needs protection in this case, it is the market maker, and not the investor.
The question of course is: are the laws written in a way that they match this original intent? Uniswap style market making could still fall under the law “by accident”, as it could be too similar to traditional market making. Looking more closely, we are lucky again and the law leaves three ways to get out. First, the law only applies to market making that is done commercially. Given that this is an experiment with unknown outcome and not motivated by making profits (at least for now), I should be fine already thanks to a lack of profitability. Second, the law defines market makers as short-term traders that continuously offer to buy and sell one or more securities. On stock markets, “short run”, “medium run” and “long run” typically refers to time-scales in the order of days, months, and years. The typical market making companies (e.g. the International Market-Making Company) even operate only intraday at time scales of milliseconds and less. In today’s financial markets, information spreads very quickly and any advantage due to privileged market access only lasts for a few seconds. In contrast, the market making done by a Uniswap contract is for the long run. I would expect that the provided liquidity is turned over less than once per month. If demand goes up significantly, average holding period might fall down to a few days, which still should be considered medium-term in comparison to professional market makers. Third, the Finma definition of “short-term trading” requires an active management (“aktive Bewirtschaftung”) of the securities, which is not the case here as my involvement is passive. Thus, I believe that acting as a market maker on Uniswap neither fulfills the definition according to the law-makers intent, nor does it fulfill the literal definition due to its medium-term time horizon.
One remaining aspect, and this might be the most risky one, is that this offering of crypto francs might be seen as a primary offering, thereby turning Meisser Economics into a emission house. If Meisser Economics was completely unrelated to the crypto franc, this probably would not be an issue. However, Meisser Economics AG and Swiss Crypto Tokens AG have a common share-holder, so there could be the suspicion that there is an informal agreement to distribute the Crypto Tokens. And of course, testing new ways to distribute the crypto franc and other blockchain-based securities (which I believe will have a bright future) is part of the purpose of this experiment. However, the main intention is to prepare the gounds for the planned share dispenser by Alethena, a company I advise and which has put all its equity onto the blockchain this week. Also, Meisser Economics acquired its crypto francs as part of a public, primary-market emission and it only acquired 1% of the total emission volume, which would be untypical for an emission house. Thus, selling some of the acquired Crypto Francs und Uniswap should not be considered a primary, but a secondary market transaction.
All in all, I conclude that feeding some liquidity to the ETH-XCHF Uniswap contract should be fine.
To actually trade the token on Uniswap, go to Uniswap and select XCHF as input or output. Then, assuming you have installed metamask, you can start your first swap.
Update 2019-07-11: Thanks to the Uniswap ROI Calculator, I can calculate at anytime how much I made so far doing market making at Uniswap. Currently, I’m at a loss of 16% compared to holding onto the assets. Legally, that’s good news, as it means I am far away from making any profit-oriented activity.
Update 2019-11-28: Due to falling Ether prices, my loss on uniswap is now only 0.01%. As it is not my intent to make a profit, I hereby pledge to donate all gains to Bitcoin Association Switzerland. The reference date is 31st of March (that’s when the accounting year of Meisser Economics AG ends).