Doc's Daily Commentary

Mind Of Mav

Why Ripple’s SEC Fight Could Be Positive For Crypto

A week ago, the US Securities and Exchange Commission (SEC) was looking into the possibility of suing Ripple, one of the top five cryptocurrency ventures in the world.

Now, it looks like “looking into” has become “taking legal action,” as the governing financial agency filed charges today against the firm for allegedly ignoring securities advice and selling unregistered tokens. The announcement caused the altcoin’s value to fall by about 50% in the space of a week — wiping out the impressive gains seen in November and December. Some exchanges even announced they were delisting XRP altogether. Ripple’s CEO Brad Garlinghouse has vowed that he isn’t going down without a fight, so expect fireworks as 2021 gets underway.

With the court showdown now official, we have to wonder: what are the larger ramifications of this?

First, let’s cover what’s actually being litigated, and the scope of how this applies to the overall crypto space.

What Is The Issue?

The SEC’s complaint is similar in nature to another one filed by XRP investors against Ripple last year. That complaint charged Ripple founders with “an intent to defraud and deceive” investors by holding an unregistered sale of securities. While the SEC’s complaint does not explicitly mention fraud, it alleges that Chris Larsen, Ripple’s co-founder, and Brad Garlinghouse, the company’s CEO, personally profited to the tune of $600 million by selling their XRP stash during upswings in its prices.

“Defendants continue to hold substantial amounts of XRP and – with no registration statement in effect – can continue to monetize their XRP while using the information asymmetry they created in the market for their own gain, creating substantial risk to investors,” the complaint states. Overall, Ripple raised $1.38 billion from investors and traders in cryptocurrency markets without submitting the proper documentation required for such sales, it claims.

The complaint also elucidates on the centralized process for creation and issuance of XRP. A total of 100 billion XRP were created in 2012 and divided between the company, which later created an escrow account to periodically release the currency in crypto markets to maintain its value, and its founders. Such arrangements violate the provisions set out in the “Howey Test,” a 1946 Supreme Court ruling that is used by the SEC to determine if a given token is a security or not.

One of the big problems with Ripple – and one of the factors probably working against it at the time of writing – is that many of the XRP units in circulation are still owned by the company, thereby suggesting that Ripple is a centralized company. The big issue behind bitcoin, Ethereum, and several other forms of crypto, is that they have been largely distributed to the public at this point, and no single individual or company owns a large majority of the units in question.

However, Ripple still possesses roughly 60 percent (more than half) of the world’s XRP units. Thus, the ones who primarily stand to gain the most out of XRP are its creators. This knocks any ideas of decentralization for Ripple to the side. In a statement, Stephanie Avakian – SEC Enforcement Division director – explained:

Issuers seeking the benefits of a public offering, including access to retail investors, broad distribution and a secondary trading market, must comply with the federal securities laws that require registration of offerings unless an exemption from registration applies.

Naturally, Ripple’s CEO Brad Garlinghouse is contesting these words and rushing to defend his company and its assets, stating:

To be clear, this is all based on their illogical claim that XRP is, in their view, somehow the functional equivalent of a share of stock.

In addition, Ripple lawyer Michael Kellogg of Kellogg, Hansen, Todd, Figel & Frederick believes that the lawsuit initiated by the SEC has no basis. He mentions:

This complaint is wrong as a matter of law. Other major branches of the U.S. government including the Justice Department and the Treasury Department’s FinCEN have already determined that XRP is a currency. Transactions in XRP thus fall outside the scope of the federal securities laws. This is not the first time the SEC has tried to go beyond its statutory authority. The courts have corrected it before and will do so again.

That, I think, is where some positive outcomes could be from this.

Given Ripple’s prominent business relationships and XRP’s market capitalization, the SEC’s case could have far-reaching implications. A flurry of moves by players in the crypto ecosystem since last week is indicative of the case’s seriousness. Luxembourg-based cryptocurrency exchange Bitstamp has discontinued trading and deposits in XRP, and other exchanges are reportedly considering similar moves.

On the surface, that may seem scary or cause uncertainty, but I believe this is the sign of the new SEC prerogative to come as the leadership changes: regulatory clarity across the board.

After all, the SEC does not make the laws; it enforces them. In a sense, they’re the police of the securities world. However, police need to have effective and clear laws in order to enforce them, and the same is true here. The jurisprudence from this case could wind up bringing the regulatory clarity that the overall crypto space has been needing for years now, and would go a long way to instilling confidence in larger institutions that they can pursue digital asset adoption.

Time will tell how things shake out, but to me the wall is coming down on the arbitrary rules that have confined the space for too long. I look forward to embracing that new Standard.

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