Uniswap’s removal of a set of assets from its interface has the community asking just how decentralized is the platform.

This episode is sponsored by NYDIG.

On this episode of “The Breakdown,” NLW addresses the recent wave of increased regulatory scrutiny, one that has prompted the crypto industry to prepare itself for the possibility of legislation. The discussion includes:

  • A distinction of regulatory categories
  • Exchanges altering leveraged trading rules
  • Uniswap’s token removal decision

The increased regulatory scrutiny is a culmination of a number of factors, including the most recent bull run and institutional adoption. As policymakers discuss crypto more frequently it becomes helpful to separate such discussions into categories: implemented legislation, regulatory narrative battles and crypto self-regulation.

Leveraged bets, an inherently risky venture, only become riskier with the addition of crypto’s volatility. Last weekend, exchanges FTX and Binance announced a cap on leverage at 20 times. Was this voluntary action an attempt by the exchanges to get ahead of possible incoming legislation?

Uniswap Labs announced an upcoming removal of over 100 tokens from its interface, including tokenized stocks, mirror stocks, options and derivatives. This decision seems to hail from a SEC statement that tokenized versions of securities are still securities. The specifics of the decision aside, the community finds itself asking: Does Uniswap’s ability to make a decision of this nature violate the principles of decentralization?

The Breakdown is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Razor Red” by Sam Barsh. Image credit: http://www.fotogestoeber.de/iStock/Getty Images, modified by CoinDesk.


What's going on guys? It is Wednesday, July 28 and today we are asking how decentralized is decentralized finance and why does that matter? So yesterday, I did a show on three separate hearings on the hill that related in some way to digital currency. That show also covered a letter sent by Senator Elizabeth Warren to Treasury Secretary Janet Yellen, in the context of her role with the Financial Stability Oversight Committee. This is hardly the first time I've had multiple regulatory topics to cover on the same day. And that I think, reflects just how much discussion of these issues is now happening at the highest levels of government. In some ways, this was an inevitable byproduct of the most recent Bull Run, not just in the sense that higher prices and more attention bring more scrutiny. Although that's part of it. It feels inevitable in the particular composition of this bull run. It's one thing if crypto is a siloed-off segment of weirdos and malcontents and internet people, even if they keep getting richer and raising the value of their magic internet monies. It's something different when, all of a sudden, the participants are traditional financial institutions. The concern starts to magnify both from a consumer protection standpoint, as well as from a systemic risk standpoint. If banks are allowing people to access bitcoin buying, selling and holding from their accounts, is there a greater consumer protection challenge? If hedge funds, which have historically been points of failure for the larger financial system, suddenly start to opaquely load up on crypto, does that mean a new type of systemic risk? Are stablecoins being adopted actually a threat to the dollar system that the government currently controls? For regulators, these seem like reasonable questions, and thus, we're seeing much, much more scrutiny. To some of the points I'm trying to make, we were never going to have bitcoin and crypto move into the mainstream without a commensurate level of increased regulatory scrutiny. 

Now, when we discuss regulatory stories, given that there's such a growing feature of this landscape, I think it might be worthwhile to break them apart into a few different categories. There are the most significant, which is actual new regulations coming online or new government policies being enacted. An example of this would be the Vice Premier of China discussing bitcoin mining bannings, and then the subsequent actions of the provincial governments to actually halt that mining activity. 

Another category of story we cover are regulatory narrative battles. These are stories where someone is trying to shape the tenor of the conversation in order to advance a particular regulatory agenda. Elizabeth Warren right now is a great example. She's not even at the stage yet of proposing some specific set of policies, with the possible exception of rolling crypto into some of the other specific policies she had previously proposed, such as her wealth tax. Instead, what she's doing is trying to shape the policy discussion around crypto in such a way to both force the issue and to have people see things from her perspective, which so far as I can tell right now, is that crypto is a wolf in sheep's clothes, not a break from the financial past of overly powerful banks and hedge fund managers, but simply a new version of that same thing. Given what narrative battleground regulations are right now, these sort of represent the vast majority of stories that I end up covering here. 

However, there is a third category as well. These are stories of the crypto industry self-regulating in some way in order to stave off what they perceive to be new regulatory headwinds. I think these are interesting both to see the actions of crypto companies but also to see how crypto companies are interpreting what might come next. It's almost like a preview of the future. There were a few of these from the past few days that I wanted to mention. 

So first, let's talk about leverage. You might have noticed that on a lot of the shows where I discuss big market moves, we're talking about how leveraged trading amplifies those moves. By way of quick recap, leverage allows people to bet on crypto with more money than they actually have. They have to put up a small portion of their bet as collateral. This means that they can make a lot more if the bank goes their way. They're literally increasing the value of that bet. However, if the market starts moving in the opposite direction of whichever way they're betting, it can get bad for them very, very quickly. They take on proportionally more risk. For example, if someone is levered long bitcoin and bitcoin's price drops quickly, they either have to add more collateral to keep their leverage trade open, or they might get liquidated. Every exchange has different margin requirements that need to be maintained regardless of how the price fluctuates. When someone does get liquidated, their collateral is fore sold and they lose everything. The reason that this is riskier in crypto is that market moves can be so sudden and abrupt. There's also a cascading effect with those liquidations, selling tends to be price insensitive. And if the liquidation mechanism bids lower than the current price, it can drive the prices down further, which then causes more liquidations and thus you see this cascade happen. We famously saw this on the weekend after the Chinese vice premier's mining comments. Bitcoin dropped from about $42,000 all the way to under $29,000 for a time and some of that was natural. It was people reacting to the news, it was minor selling but especially from around $39,000 down, it was almost entirely liquidations and for sellers. 

So, the point of this is that leverage has a big impact shaping the industry. It's also historically been something of a draw of a meme with exchanges across the industry offering up to 100x leverage. Last weekend, though, a couple of exchanges decided to change that. FTX was the first to announce that they were voluntarily removing all leverage above 20x disclosure, as I've said a couple times now I help run marketing and Blockfolio which is owned by FTX. But as is the case you'll often see I had no part in this particular decision, and actually didn't even know it was happening until I read the thread that announced it. Anyway, a few hours later, Cz and Binance followed suit and made the exact same change. The cynic might say lol there's still 20x leverage available. But, I don't think really the specifics are the point, what's more relevant is voluntary action by crypto exchanges to rein in some of the more extreme features of the industry, particularly those that contribute to volatility, right as that volatility is being discussed more deeply by those in positions of power. 

The leverage conversation wasn't the biggest self-regulatory discussion from last week, that came from Uniswap. On Friday, July 23, Uniswap announced that they would be restricting access to some tokens and they're announcing post is only a few paragraphs so let's actually just read it. "Uniswap Labs — a software development studio that contributes to the Uniswap Protocol — is proud to play a part in creating a better, more equitable financial system. One of Uniswap Labs’ contributions is the portal it provides at app.uniswap.org — an open source interface — for reliable, trustworthy interaction with the Uniswap Protocol. To continue to innovate and provide this tool for the Uniswap community, we monitor the evolving regulatory landscape. Today, consistent with actions taken by other DeFi interfaces, we have taken the decision to restrict access to certain tokens through app.uniswap.org. These tokens have always represented a very small portion of overall volume on the Uniswap Protocol. Importantly, the Uniswap Protocol — unlike the interface — is a set of autonomous, decentralized, and immutable smart contracts. It provides unrestricted access to anyone with an Internet connection. Similarly, this action has no impact on the Uniswap Interface code, which remains open source, or the many other portals or locally run instances used to access the Uniswap Protocol. Moving forward, we will continue to develop products and contribute to the Uniswap Protocol, in a way that is consistent with the broader DeFi industry’s values — to provide safe, transparent, and robust financial infrastructure that can empower users around the world." And that's the end of the statement.

The crypto industry was instantly aflame with discussion of this and there are a few pieces to unpack here. First is the question of which assets were removed. And here's how The Block describes the 100 plus tokens targeted quote, "These range from tokenized stocks, mirror stocks, options and derivatives. Examples include Tether Gold, opyn options on ETH at different strikes and expirations, synthetix products on other coins and stocks, tokenized versions of Zelda and Mini Mario Cash, UMA yield dollars, and stocks like 'mirror Amazon' and 'mirror Tesla.'" 

I think in many ways, the tokenized stocks piece is the most significant. Earlier in the week, Gary Gensler had given a speech where he seemed to explicitly discuss synthetic versions of regulated securities as something on their regulatory radar. He said, "It doesn't matter whether it's a stock token, stable value token backed by securities or any other virtual product that provides synthetic exposure to underlying securities." In short, the SEC was saying that a crypto-ized version of a security is still a security and Uniswap got that message loud and clear. And by the way, Uniswap getting the message was sort of the bigger hullabaloo than the specific assets that were targeted. 

The whole value proposition of a decentralized exchange is supposed to be that by virtue of being decentralized, it doesn't have a central decision maker, a single point of failure who can make the decisions to censor a certain asset or a certain type of trading. That's the idea, right? Well, sort of. Here's how Hayden Adams, the founder of Uniswap describes this. "Just a reminder, Uniswap Protocol equals fully decentralized permissionless smart contracts on Ethereum. Uniswap Interface equals open source GPL code base. app.uniswap.org equals Uniswap Labs' own domain that points to an IPFS hosted instance of the Uniswap interface. Now is a good time to learn the difference between an interface and a protocol in how decentralization works. Decentralization doesn't mean Uniswap Labs lets you do whatever you want on its website. It means you don't need a single interface instance to access the protocol. In fact, the majority of the volume doesn't come through app.uniswap.org today. This is due to a proliferation of on-chain integrations and alternative interfaces including trading bots, wallets, interface forks, other interfaces, decks, aggregators. In my opinion, the Uniswap Protocol remains the most decentralized of the top DeFi protocols by a wide margin. Why? Non-upgradable and permissionless smart contracts with no admin keys or ability for Uni holders to steal underlying liquidity."

Erik Voorhees from ShapeShift, who are themselves in the process of completely decentralizing right now, reiterated this tweeting "Uniswap the company is centralized and delisted some tokens. Uniswap the protocol is decentralized and did not delist anything. Both points are newsworthy." Some people however, weren't buying it. Alex Gladstein of the Human Rights Foundation retweeted a conversation between himself and Ryan Sean Adams of Bankless from January where Ryan had said: "The government can stop bitcoin from trading by choking out liquidity on a few exchanges. Uniswap on Ethereum is unstoppable. If you're a friend of democracy and civil liberties, why aren't you a friend of DeFi?"

In his retweet, Gladstein added: "Turns out that Uniswap was quite stoppable, this isn't some kind of game, it's a matter of what can be stopped by nation states and what cannot." This led to a ton of discussion and fighting with Alex Gladstein. Some made the point like Ryan's original point that this is the equivalent of a government forcing an exchange to delist bitcoin, in that it would suck but it wouldn't stop bitcoin. Gladstein's counter was basically that that comparison is not apt, because of how much more significant Uniswap the company, i.e. the interface, is in the Uniswap Protocol's existence. Still others pointed out that there were a significant number of other ways to access the Uniswap Protocol with even more popping up after this happened. 

So, I think in many ways, one of the key things that the discussion, particularly around Alex Gladstein's tweet brings up is, what is the purpose of decentralization? And how much is enough? If you were a DeFi protocol, do you want to be resistant to nation state level pressure? If that's the case, it's going to come with a very different set of trade offs than if you just want to nominally remove intermediaries, and centralized points of control from an ecosystem for, for example, efficiency or cost reasons. As you might guess, I tend to be in the camp of there aren't right or wrong answers to this type of question a priori, it's just about figuring out what the real priorities are, and then designing backwards against them. I do also think that this whole thing highlights what a potentially complicated set of regulatory battles are going to come. In other words, will regulators accept this distinction between interface and protocol? Will they accept it for all protocols? Or just some that have reached a certain level of maturity? If they don't accept it, how will they try to exert pressure on the leaders of the related centralized entities? How much of this will be about assets? In other words, what's the security versus processes? In other words, know your customer and anti-money laundering. I don't bring this stuff up to FUD DeFi, by the way, I'm a supporter of the decentralization of financial rails. And I also think the pace of development in the DeFi space is phenomenally interesting. I'm merely pointing out that it feels inevitable and it seems like these decentralized exchange companies agree that DeFi has regulatory challenges to come. I think those will go better the clearer-eyed about them we are but for now, guys, let me know what you think. I'm super interested. And as always, I appreciate you listening. Until tomorrow guys, be safe and take care of each other, peace!