Ripple XRP is ‘unregistered security’ and here’s our suit: SEC

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Is Ripple’s XRP token a digital currency unit, or a security? We may be about to get a definitive answer on that, after the U.S. Securities and Exchange Commission (SEC) revealed plans to file a suit against the company, its CEO Brad Garlinghouse and founder Chris Larsen.

The SEC reportedly informed Ripple (the company) on Monday that a suit was imminent. It claims XRP is an unregistered security (an “investment contract”) and that Ripple’s selling it to the public violated investor protection laws. The securities regulator confirmed on Tuesday it has filed the complaint in federal district court in Manhattan, and seeks injunctive relief, disgorgement and prejudgment interest, and civil penalties.

Ripple, for its part, has replied with a terse six-page submission in response by calling the SEC’s action “unprecedented and ill-conceived,” and “wrong on the facts, the law and the equities.” The SEC, it said, “is picking virtual currency winners and losers, destroying US-based, consumer-friendly innovation in the process.”

Not only is XRP a currency, Ripple countered, but “a fully functional currency that offers a better alternative to Bitcoin.” Moreover, it said, if XRP is an investment contract then the same definition should apply to Bitcoin and Ethereum (which it called “two Chinese-controlled virtual currencies”) and thousands of others like it.

It also said the sale of XRP differs from the many initial coin offerings (ICOs) and simple agreements for future tokens (SAFTs) of the past few years, which the SEC has targeted and sanctioned for similar violations. Those token sales were direct to the public, involved projects with no developed ecosystem, and often came with promises of profits, it said.

Though the market value of most digital assets has fallen over the past couple of days, XRP and its “twin” asset XLM (called Lumens, from Stellar) have lost 15.7% and 9.7% of their value in the past 24 hours, along with EOS (down 10.3%). XRP remains the third most valuable digital asset by market cap on aggregator charts, behind BTC and ETH.

Joseph Dever, a former assistant director with the SEC Enforcement Division and current securities counsel at Cozen O’Connor, told CoinGeek: “The SEC is coming off litigation victories this year in the cryptocurrency space, including their big win against Kik Interactive. So I’m not surprised to see the SEC continue to bring cases where they believe the distribution of cryptocurrencies falls under its jurisdiction.”

So how is Ripple XRP different from Bitcoin or Ether?

CoinGeek has argued in the past that XRP is more similar to an illegal ICO than a currency, and Ripple itself has faced several legal challenges such as inadequate AML procedures, fraud charges, and individual suits from investors. There have been rumblings within regulatory bodies like the SEC and CFTC that XRP is more of a security than a currency.

I think Ripple is a long running illegal ICO among other things.

— Calvin Ayre (@CalvinAyre) June 10, 2020

On the surface, it would appear that XRP is just like any other digital asset on the market. However it differs in the way it operates, and the way it was initially issued. Bitcoin is distributed as it was minted and issued in 2009, while BTC was created in 2017 but its development was never decentralized.

Although Ripple refers to its XRP ledger as a “blockchain” and has long bristled at any suggestion it isn’t, it doesn’t operate in quite the same way. Transactions on the network are validated by a consensus mechanism in which network nodes agree with each other on which are valid. XRP record-publishing services online usually refer to themselves as “account explorers” or “ledger explorers.”

Rather than having its nodes “find” new units on a timed basis like Bitcoin and Ethereum, Ripple issued its entire supply of up to 100 billion tokens at launch—45.4 billion of which are “circulating” with the remainder held in reserve by Ripple itself, ostensibly to fund development and the XRP ecosystem. Garlinghouse and Larsen themselves are also said to personally have XRP holdings worth billions of dollars. Ripple says 90% of company XRP holdings are “held in an inaccessible escrow.”

Who issued, who sold, and who bought, XRP?

Then there’s the issue of who released the tokens. Ripple is a corporation, Bitcoin and Ethereum are not. So there is no question of who first “sold” Bitcoin units, and how—they were traded on the open market by whoever mined them.

XRP, Ripple said, has a “massive” secondary market and trades on over 200 exchanges worldwide, “separate and apart from Ripple.” It also claims it sold the units initially via third-party entities such as OTC brokers, and to markets outside the US. There was no “contract” with investors, it added, and the disconnect between Ripple and those initial investors makes a difference to the level of control the company had (and continues to have) over the market.

It appears the SEC has finally prepared enough material to formalize its claims that XRP is in fact a security, sold as a security by Ripple the company as issuer.

It’s now up to Ripple and the SEC to present their arguments in a legal setting and the decision will finally define what XRP actually is.

“I would expect to see the SEC’s case against Ripple challenge whether XRP is a security and whether its distribution is a securities offering that should have been registered with the SEC,” Dever said. “The SEC will need to prove that XRP is more like stock in a public company and less like Bitcoin which the SEC has concluded is not a security. The case may come down to the Court’s interpretation of who has control over XRP and whether it is decentralized.”

Either way, regulators have begun to apply an increasing amount of heat on digital asset projects in the U.S. and around the world. Cases will become more frequent as more judgments are made. Even Ethereum, if it switches to a proof-of-stake (POS) validation algorithm, could well find itself in the crosshairs. CoinGeek has an ongoing series titled “Crypto Crime Cartel” with more details on individual projects, and where they could fall foul of the law.

Bitcoin was created and its software released with all this in mind, and is structured the way it is for a good reason. Those who came later and attempted to emulate its success may discover that some of the subtleties in the process were important. BSV is now the trading ticker of the only platform that uses the original Bitcoin protocol and is the only platform that massively scales and can do data management

Follow CoinGeek’s Crypto Crime Cartel series, which delves into the stream of groups—from BitMEX to Binance, Bitcoin.com, Blockstream, ShapeShift and Ethereum—who have co-opted the digital asset revolution and turned the industry into a minefield for naïve (and even experienced) players in the market.