In an unprecedented move, in December 2020, the US Securities and Exchange Commission (SEC) filed an action against Ripple Labs, Inc., suing the company for $1.3bn. Ripple is accused of knowingly offering and selling unregistered securities. We’re still in the early years of negotiating crypto regulations, and legally defining activities on the blockchain is a difficult task. President Joe Biden has been widely praised for showing confidence in the future of blockchain in the US, signing an Executive Order on Ensuring Responsible Development of Digital Assets on March 9 2022. As we edge towards mass adoption, landmark cases like these have the potential to drastically change the crypto landscape going forward.
So, what is Ripple? And why is it being sued?
Originally called Opencoin, the company was renamed Ripple in 2013. Ripple is a digital payments settlement platform and cryptocurrency exchange. XRP is its native token, used for projects on the platform. It’s now ranked as the 6th largest coin, gaining popularity as a quicker and cheaper method of making global transactions.
The trial is attempting to discern whether XRP should be identified as security or currency.
Simply put, a security is any tradable financial asset that has value. Examples of securities include equities or debts; stocks, bonds, or certificates. Ripple v. SEC is calling to question how the term ‘security’ might be applied to transactions on the blockchain.
So, how is the SEC arguing its case against Ripple?
The SEC is an independent agency of the US federal government that handles market regulation and prevents market manipulation. It argues that XRP is a security, and that the term ‘investment contracts’ therefore applies to transactions involving XRP. The SEC claims that XRP is a security; that it was sold to investors and that Ripple used those funds to finance their platform. It argues that that amounts to illegitimate funding and a violation of The Securities Act of 1933. Selling securities is one way in which institutions generate new capital. For example, in an IPO (initial public offering), a company may sell shares in stocks to buyers (investors) to raise funds.
If you’re inviting investors under the reasonable assumption that they’ll profit from the efforts of others, the SEC argues, then you must register securities. It’s trying to establish the legal precedent that companies trading in cryptocurrencies (digital or virtual) are not exempt from the same laws and standards that apply to companies trading in traditional fiat currencies. In other words: form is not as important as substance.
So far, the SEC is having trouble arguing its case. So, what is Ripple’s counterargument?
Rather than being a digitized version of a traditional currency, Ripple is proposing that its XRP coin is a ‘virtual currency’. It states that XRP is a substitute for traditional fiat currencies so, unlike the sale of stocks or bonds, it’s not required to offer an investment contract to buyers.
What does this mean for the crypto landscape then? Well, as CEO Brad Garlinghouse notes, if the SEC wins, “that’s cost, that’s friction”. He adds that, “if you determine XRP as a security of Ripple, we have to know every person that owns XRP”. It would call to question the decentralized status and fundamental cryptographic anonymity of the blockchain, as the SEC requires that companies offering securities know all of their shareholders, which Garlinghouse believes is “not possible”. Critics have questioned whether all cryptocurrencies could be considered securities in the US should the SEC win this case. On the other hand, a victory for Ripple could mean less friction in crypto regulation and lower costs for users. That’s good news for the future of blockchain adoption in the US and worldwide.
President Biden’s well-received Executive Order on Ensuring Responsible Development of Digital Assets came into force on March 9 2022. Two days later, an SEC motion to strike Ripple’s Fair Notice affirmative defense was denied. Both of these events are signs of hope for the future of cryptocurrency in the US.
Given the control that agencies like the SEC can legally enforce, the Ripple v. SEC case brings into question the decentralized status of cryptocurrencies. It’s a potential game-changer, determining the future of cryptocurrency legislation and that of Ripple Labs, which is expected to encounter financial problems should the SEC win the case.
As often in times of uncertainty, the case has brought about investor speculation and so we’ve seen fluctuations in XRP’s market valuation. It’s the SEC’s responsibility to protect investors against market manipulation, but Ripple is leveling the argument that its case is doing more harm than good to its investors. That’s why Ripple’s General Counsel is accusing the SEC of a ‘rug pull’ on US citizens. That’s when a company, or in this case an enforcement agency, halts or reverses its plans and leaves with investors’ funds.
The SEC must now prove its case, releasing historic documents of investigation into XRP, and demonstrate that it has acted fairly and not enforced regulations in the crypto world selectively.
It also has to prove that the laws are sufficiently clear regarding securities and that well-defined regulations are in place that Ripple knowingly violated.
The motion means that the SEC has to show that it hasn’t previously defined XRP as a cryptocurrency. That could be difficult, considering the comments made by William Hinman, the Former Director of Corporate Finance. Hinman previously declared that Bitcoin and Ethereum were not securities; a detail that strengthens Ripple’s claim to Fair Notice. While internal documents relating to Hinman’s speech were not immediately made available to the court, the Fair Notice appeal brings them into question. Hinman’s declaration conflicts with the SEC’s accusation: that Ripple knowingly offered and sold unregistered securities. Brad Garlinghouse’s recent confidence of a positive outcome has been followed up by comments suggesting that the lawsuit was proceeding “exceedingly well”, thus far.
Clearer laws are needed going forward, but it’s currently looking good for XRP holders and members of the broader crypto community alike.
Both parties have agreed on a detailed timeline that’ll see summary judgment briefs delivered by September 13th 2022 and full briefs by November 15 2022, meaning the case could be over as early as Christmas 2022. Needless to say, the entire crypto community is awaiting the result and hoping that Garlinghouse was right about the positive status of the case.
Whatever the implications of the result, cryptocurrencies are here to stay. Mass adoption is on the horizon and companies continue to find innovative ways to incorporate crypto and blockchain technology into their business plans.
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