The price of XRP, the digital currency striving to corner the payments space, spiralled on December 21, after the US securities and exchange commission (SEC) filed a lawsuit against XRP issuer and fintech payment protocol Ripple.
The financial watchdog alleges that Ripple’s 2013 sale and distribution of XRP, which raised approximately $1.3 billion, was, in effect, an unregistered security offering, calling XRP’s utility classification into question. Here’s what that means for the future of XRP and the cryptocurrency industry in general.
Ripple Vs the SEC
The allegations arrived as a parting gift from the now-former chair of the SEC, Jay Clayton. With just hours until the end of Clayton’s tenure, the agency made it clear that action would be taken against what was dubbed an “unregistered, ongoing digital asset securities offering.”
Per US federal securities laws, all digital assets offerings should be registered or qualify for an exemption from registration.
The SEC allege that Ripple founders Brad Garlinghouse and Chris Larsen failed to qualify for an exemption or register sales of XRP, despite receiving legal advice as early as 2012 affirming that XRP could be considered a security.
The charges sent XRP into a nosedive, erasing 25% off the digital asset’s value in less than 24-hours. Over the following weeks, a host of crypto platforms, including Coinbase, halted trading for XRP, with 26 other exchanges, such as Binance US, Crypto.com and Bittrex opting to delist the embattled crypto altogether. The same goes for digital asset managers Bitwise and Grayscale, which both chose to oust XRP from their respective funds.
To add to the company’s grief, Tetragon—one of Ripple Lab’s biggest financial supporters—opted to enforce its right to a stock redemption.
As of writing, XRP is down around 40%, falling from $0.51 on December 21 to a current price of $0.30—losing the token its position as the third-largest cryptocurrency by market cap.
XRP’s classification woes
The battle over XRP’s official classification has waged for years, acting as the crux of litigation and lawsuits aimed at Ripple. While Garlinghouse claims that XRP classifies as a currency separate from the achievement of Ripple. Others—including multiple investors and the SEC themselves—argue that XRP is a security‚ intrinsically tied to the company’s success.
The issue remains, however, that no established crypto security requisites concretely exist, muddying the waters as to XRP’s security classification. At present, the SEC leverages an 80-year old securities law called the Howey test to determine whether or not a digital asset should be categorised as a security or not.
Designed by the US Supreme Court in 1946, the Howey test outlines several factors for designating assets as securities. These include:
- An investment of money in a common enterprise
- An expectation of profits from the said investment
- Any profits come from the efforts of a third party promoter
While the test’s vagueries are hotly contested within the crypto industry, bitcoin and ethereum have been given the all-clear from the SEC. Per the commission, the two crypto frontrunners are sufficiently decentralised and cannot satisfy the Howey test.
Ripple argues much the same, asserting that due to the decentralised and open-source nature of the XRP ledger, XRP is neither in Ripple’s control nor does it classify as an investment contract in the company. As such, per Ripple, owning XRP is not analogous to having a share in the company and cannot be considered a security under the Howey test.
Moreover, Ripple notes that by using XRP to remedy liquidity challenges faced by financial institutions, the token provides additional utility not typically found in stocks and shares.
The silver bullet argument reiterated by Garlinghouse over the years is that XRP would continue to exist despite the firm’s existence.
“If Ripple the company shuts down, XRP trades on over a hundred exchanges around the world and XRP will continue to trade,” the Ripple CEO said during an ask me anything session in 2018.
However, Ripple detractors contend that due to its reliance on the token for funding as well as its massive XRP holdings (estimated at around 6.4 billion XRP, currently worth $2.1 billion), Ripple is more centralised than it lets on.
Nevertheless, as part of a 2015 settlement with the Financial Crimes Enforcement Network (FinCEN), the US Departments of Justice and Treasury designated XRP a currency. Moreover, the Financial Conduct Authority (FCA) wrote in a 2019 consultation paper that XRP could be viewed as a means of payment or an “exchange token,” akin to ethereum and bitcoin.
Despite the precedents, the SEC still asserts that Ripple’s XRP dealings amount to investment contracts under the Howey test.
The Ripple effect
Ripple losing the lawsuit and XRP’s subsequent de facto security classification could have grave repercussions on the broader crypto sector.
This isn’t the first time the SEC has brought suits against cryptocurrency offerings. In 2018, messaging app Telegram settled with the SEC, after its own digital sale was similarly deemed an unregistered securities offering. Telegram was made to return $1.2 billion to investors and pay the commission a hefty $18.5 billion penalty. EOS parent company Block.One suffered a similar, if slightly less severe, fate, settling on a relatively paltry $24 million fine despite raising $4.1 billion via EOS sales.
Should Ripple settle, the penalty would hardly make a dent in its multi-billion-dollar war chest, that is unless the SEC decides to make an example of them.
However, the real implication for XRP and Ripple is the mass delisting and shunning of the token. Not to mention the $13 billion in value wiped from XRP’s market cap thus far.
Moreover, Should XRP be assigned security status, there’s a real risk of liquidity drying up—not only in the US but worldwide as more exchanges distance themselves from regulatory risk.
As for the wider ecosystem, a SEC victory could create a dangerous legal precedent allowing the commission to go after a litany of other—less well-funded—cryptocurrencies. As Garlinghouse and several other crypto pundits have suggested, with this action the SEC is straying far from their promise of fostering crypto innovation.
One integral takeaway for crypto business worldwide is the importance of legal opinion. While regulatory demarcation differs from jurisdiction to jurisdiction, a well-founded legal opinion that takes into account the Howey test and other regulatory requirements (no matter how archaic they may be) is essential while the sector finds clarity and establishes itself.
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