Top Stories of the Week - 4/12

This week in the newsletter, we write about the SEC preparing legal action against Uniswap Labs, Solana core developers rolling out patches to address network congestion, and EigenLayer launching the first actively validated service (AVS) on their restaking protocol, EigenDA.

Subscribe here and receive Galaxy's Weekly Top Stories, and more, directly to your inbox.

Uniswap "ready to fight" SEC on behalf of DeFi

The SEC is preparing legal action against Uniswap Labs. On Wednesday, Uniswap Labs revealed that it had received a Wells notice from the SEC, warning of potential enforcement action against the software development team. (Wells notices are sent to inform recipients that the SEC is planning to bring charges against them). The potential charges have not yet been specified, but Uniswap's Chief Legal Officer told reporters that the notice was focused on Uniswap acting as an unregistered securities broker / exchange, adding that he believes that "the Uniswap Protocol, web app, and wallet don't meet the legal definitions of securities exchange or broker". Uniswap Labs CEO Hayden Adams posted on X, "I’m not surprised. Just annoyed, disappointed, and ready to fight."

Many market participants viewed the notice as an attack on the rest of the DeFi industry with many expressing support for Uniswap Labs. Jake Chervinsky, the Chief Legal Officer at Variant Fund (formerly at the Blockchain Association), responded to Hayden's tweet, "I'm sorry you have to fight this battle on behalf of everyone in DeFi, but I couldn't possibly have more confidence in you and your team to prevail". Coinbase's Protocol Specialist Viktor Bunin tweeted, "Uniswap is literally the textbook definition of a perfect protocol. 100% permissionless, decentralized, and credibly neutral. No upgrade keys, no multisig, no shenanigans. Very limited governance. They will prevail in court and set precedent for the rest of the industry."

OUR TAKE:

The SEC continues its attack against crypto, this time targeting the face of DeFi. Uniswap is Ethereum's most popular dApp by lifetime users and has facilitated ~$2 trillion in lifetime trading volume. In addition, Uniswap Labs is one of the more prominent DeFi teams still based in the US, which has been experiencing a brain drain of talent driven by the lack of regulatory clarity and the SEC's sustained regulation-by-enforcement approach.

While the SEC's high-profile crypto cases against centralized exchanges like Coinbase and Kraken primarily revolve around what falls crypto assets under the definition of a "security" or "investment contract", the merit of its expected legal action against Uniswap will likely extend further on what persons/entities meet the definition of a regulated "exchange" - specifically as it relates to DeFi systems and software developers. It's clear from the SEC's proposed changes to expand the definition of an "exchange" that the agency believes autonomous code developers should be regulated under the Exchange Act, even for deploying immutable, non-upgradeable smart contracts (i.e., code that cannot by controlled or upgraded via an admin key owned by the deployer), such as those that power the Uniswap protocol. We firmly disagree with the SEC's proposed changes to the "exchange" definition (as argued in our SEC comment letter filed in June 2023).

Discussions around the SEC's exchange definition are currently on hold and the specific Uniswap products that the SEC may be targeting are still unknown (e.g., the Uniswap protocol, web app, or wallet), so it will likely take some time before any potential lawsuit against Uniswap will be resolved. However, the recent court dismissal over the SEC's claims that Coinbase Wallet acted as an unregistered brokerage (discussed in our prior newsletter) should similarly extend to Uniswap's wallet product. In the meantime, the Uniswap Labs team is putting their heads down and continuing to build. - Charles Yu

Solana Congestion Updates Begin Rolling Out

After weeks of congestion, Solana core developers have begun rolling out patches to address issues in its networking layer. Solana users have experienced degraded performance over the past month, with transactions either failing to be included in blocks or becoming un-executable by the time they were processed.

As highlighted previously, spam has been a significant problem for Solana. In response, developers have been working to improve Solana’s scheduler to reduce the incentive for spamming. However, in March, Solana's founder revealed that insights from the MarginFi team—one of Solana's top lending/borrowing applications—suggested that the main issues were within the networking layer, not the scheduler.

Solana’s networking layer is necessary for participants in the Solana protocol, such as validators and RPCs, to communicate with each other by sending packets of information. In 2023 Solana implemented a new networking layer called QUIC to improve performance. While this led to a huge improvement in performance over the past year, the surge of activity over recent months has rendered it ineffective.

On April 5, Anza Labs announced that a preliminary patch was under development and undergoing effectiveness tests. By April 11, a team member revealed that initial improvements were starting to be implemented on testnet and devnet. These updates primarily focus on enhancing Solana’s Stake-weighted QoS reliability. Although these patches are expected to gradually improve Solana’s usability, they do not completely resolve the network issues and mark the beginning of a series of steps to address the challenges facing Solana.

OUR TAKE:

The congestion underscores Solana's current limitations in servicing products at scale, yet it hasn't deterred demand for Solana's blockspace. Daily active addresses and transactions both reached year-to-date highs in April (though the accuracy of these metrics is unclear, they are useful directionally). Additionally, tips to Solana’s Jito client, indicative of economic activity on the network, are at all-time highs.

This is especially notable given how degraded the onchain experience has become for both applications and users. Drip, a leading consumer application on Solana, expressed frustration over its inability to serve its creators and users adequately. Similarly, DeFi protocols have had to caution users about potential losses due to failed transactions when managing their positions.

For all the struggles, however, coordination across the ecosystem to marshal all available resources and quickly fix the problem has been impressive. In this case, Solana’s shift toward a multi-client network helped accelerate progress. Teams from Anza, Firedancer, Jito, and Margin worked closely to diagnose the issue, identify the fix, and implement it. Moreover, applications continually updated their infrastructure to increase their chances of landing transactions, providing marginal improvements to the user experience.

In addition to current repairs at the networking layer, Solana is planning further updates to tackle persistent congestion. Later this month, an update to Solana’s scheduler that reduces jitter will be released as part of validator client v1.18. Over the longer term, additional validator clients like Firedancer are developing custom networking solutions, and discussions about potential economic measures to alleviate pressure are ongoing. - Lucas Tcheyan

The First 7 EigenLayer AVS’ Go Live

On April 9, the EigenLayer team announced the launch of the first actively validated service (AVS) on their restaking protocol, EigenDA. Two days after, on April 11, the team also announced the launch of six more AVS’ on EigenLayer. An AVS is any blockchain or blockchain-based service secured by EigenLayer restakers. Prior to April 9, EigenLayer was in Phase 1 of its development roadmap, meaning the protocol’s functionality was limited to supporting deposits of ETH and liquid staking tokens (LSTs). Out of an abundance of caution, EigenLayer, during its initial Phase 1 launch, allowed deposits of three types of LSTs and only up to a certain capped amount. Since then, the EigenLayer team has incrementally increased these LST deposit caps and expanded the types of LSTs accepted by the protocol. Because of this, EigenLayer has risen in the ranks to become the second largest decentralized finance (DeFi) protocol operating on Ethereum by total value locked (TVL) after Lido. Lido’s dominance has decreased since EigenLayer’s mainnet launch last year in June 2023 (which you can read about more in this Galaxy Research newsletter), declining from a high of 32% of total ETH staked to roughly 29%, as of April 11.

Now that EigenLayer has progressed from Phase 1 to Phase 2, and evidently also Phase 3, of its development roadmap, users that have deposited assets in EigenLayer can delegate these funds to an AVS of their choice. The first seven AVS’ to receive restaked funds from Eigenlayer fulfill a wide array of services from blockchain data availability, decentralized public infrastructure (dePIN) coordination, oracles, rollup finality, and more. Importantly, users have the ability to restake through EigenLayer’s handpicked list of 200 node operators that are actively running the infrastructure to secure different AVS’. The EigenLayer team is expected to add more AVS’ to its protocol in the coming weeks and months. They are also expected to introduce restaking rewards and penalties at some point in Phase 3 of its development. About 3% of total ETH supply is restaked on EigenLayer and 14% of total ETH staked is locked in EigenLayer.

OUR TAKE:

Due to the lack of any real cryptographic incentives or penalties for misbehaving in the EigenLayer protocol today, it is important to understand that the security of the protocol is primarily dependent on social trust. There are no payouts from AVS’ to operators that is motivating operators and therefore users to participate in restaking. There is, however, confidence from operators and users in the EigenLayer team that eventually payouts from AVS’ will be enabled and these payouts will be sufficient for the costs of operating AVS infrastructure and locking up assets in EigenLayer, respectively. There are also no penalties such as slashing that an AVS can apply to operators for misbehaving on their protocols. There is, however, confidence from AVS teams in the EigenLayer team that they have vetted their 200 operators thoroughly and will likely take some amount of responsibility in the event of any major loss or damage due to a malicious operator. There is a great deal of trust in the EigenLayer team to ensure smooth restaking operations in lieu of smart contract-enforced rules and behaviors.

This is of course a temporary reality as the EigenLayer team is working to set up the right frameworks that will enable trustless restaking on Ethereum. There are several edge cases that make trustless restaking extremely difficult to achieve. (Some of them are outlined clearly in this CoinDesk article.) But until restaking rewards and penalties are enabled on EigenLayer, it is difficult to assert that the economic security of Ethereum is being repurposed and used to secure other blockchain-based protocols, a.k.a. AVS’, given that there are no assets technically “at stake” to gain or lose by restakers and operators. As a side note, one could argue that the points issued by the EigenLayer team for early participation in their protocol is a type of rewards motivating behaviors on the platform. While points may be effective in influencing behaviors on EigenLayer, there are no guarantees points will be redeemable for EigenLayer tokens and absolutely no certainty in what they will be worth. Therefore, again, the basis for what is motivating people to earn points on EigenLayer is not points themselves, but rather what the EigenLayer team will, or will not, decide to do with them in the future.

EigenLayer is a nascent cryptographic protocol with the potential to revolutionize the Ethereum ecosystem and the crypto industry at large. Its reliance on a centralized development team is not unlike what other major applications being built atop Ethereum rely on as well. For example, nearly all Layer-2 rollup projects rely for now on trust in a centralized block producer for processing user transactions. It will likely be a long time, five years or more, to realize a future where Ethereum and the applications built atop do not need to rely on high degrees of coordination and therefore centralization to function. It's important not to sugarcoat the important role of social trust in people, as opposed to code or cryptography that so much in this industry relies upon. The hope is that the EigenLayer team reaches a point of strong confidence that code and cryptography can reliably replace the role of trust, business relations, and the rule of law as it is traditionally enforced by state authorities in large parts of their protocol. - Christine Kim

Charts of the Week

Stablecoin lending rates have been consolidating around 14.5% for the last three weeks, marking a 158 basis point (12.2%) increase since the start of the year and an 84 basis point (5.45%) decrease from their year-to-date highs of 15.34%. The cost to borrow on-chain has been steadily rising since bottoming in September/ October of 2022. From that point, the average cost to borrow the stablecoins pictured below has risen nearly ten times from ~1.5%. Note, the chart below observes USDT, USDC, DAI, and FRAX across Aave v2/v3 and Compound v2/v3 on Ethereum Mainnet only.

The steadiness in rates comes even as the amount of stablecoins borrowed continues to climb. Combined, the observed stablecoins have $3.37b in active borrows. This amount of borrows was last observed in February 2021 as the previous bull run was heating up and more recently in May 2022 as the bear market set in. Inflows of stablecoin deposits into lending apps has offset the continuously growing amount of borrows. This has kept net utilization of the observed stablecoins flat around 90% for the last month, in turn holding rates steady.

Other News

• Worldcoin-compatible wallet surpasses 10 million users

• Circle launches USDC smart contract support for BlackRock BUIDL holders

• Bitcoin mining difficulty hits fresh all-time high in final pre-halving adjustment

• MarginFi sees $155 million outflow amid leadership shakeup

• Controversial Sushi DAO treasury proposal passes signal vote

• Nomic and staking protocol Babylon team up to offer liquid bitcoin staking

• Sui launches new handheld gaming device - The SuiPlay0x1

• Fidelity’s FBTC spot Bitcoin ETF surpasses 150,000 BTC within three months