Ripple Faces Existential Threat from the United States Securities and Exchange Commission
An article breaking down the current situation between Ripple Labs and the Securities and Exchange Commission relating to the sale of XRP tokens
Original date of posting: Dec 28th, 2020
In late December of 2020, the Securities and Exchange Commission announced a lawsuit against Ripple Labs, creator of the XRP cryptocurrency. Naming the current and former CEOs, Brad Garlinghouse and Christian Larsen respectively, as the perpetrators of an illegal sales of unregistered securities. Garlinghouse reiterated his belief that XRP is a currency, and made clear his intentions to challenge the accusations in court. The outcome of said case could have far-reaching repercussions for the industry as a whole.
The concept of cryptocurrency occupies a strange space within the legal framework of the United States. While most proponents consider it a new investment class, cryptocurrency depends on certain criteria to avoid legislative pitfalls. Bitcoin largely avoided scrutiny because it lacks centralized governance. It operates as more of a natural resource than a business. Ethereum, the number two cryptocurrency, can also make strong claims against classification as a security. While certainly traded like an asset, the Ethereum blockchain clearly serves as a framework for smart contract-based applications.
In contrast, Ripple’s XRP cryptocurrency stands on shakier ground. The available suite of enterprise solutions — xRapid, xCurrent and xWave — offer varying means of liquidity and payment processing. At the heart of each system lay XRP itself, operating as a gateway between various fiat currencies. On its own, this system may have avoided classification as a security — however, XRP remains widely available outside of the Ripple ecosystem. Traders freely hold XRP as a means of investing in Ripple’s success, a sure sign of a security.
The Laws Pertaining to Securities
The sale of an unregistered security is not an inherently illegal action. Rather, the point of contention lay in Ripple’s failure to restrict the sale to accredited investors. Ostensibly, this restriction prevents smaller investors from falling prey to predatory schemes. Accredited investors must possess a certain amount of capital, experience or governance such that they can make informed decisions.
Constant ambiguity and sporadic enforcement allowed Initial Coin Offerings (ICO) and security tokens to propagate — Ripple included. Questions remain as to whether cryptocurrency is a ‘Pandora’s Box’ or something that the SEC could conceivably reign in over time. The charges filed against Ripple Labs may be the opening shots of a concentrated war against unregulated cryptocurrencies.
The SEC wields less influence over cryptocurrency when compared against traditional stocks and assets. The United States slow response to the emergence of blockchain technology allowed trade to flourish in other countries. Ripple’s attempts to provide a more ‘mainstream’ offering opened them to potential litigation from the US government. Their much-maligned centralization may trigger their downfall, giving the SEC an easy target — when compared against the more resilient nature of a decentralized network.
What Makes Ripple Susceptible?
Ripple’s lack of independent, third-party verification leaves the XRP blockchain on shaky ground within the cryptocurrency community. Many critics claim that the lack of neutral validators prevents XRP’s classification as a cryptocurrency. Lacking a mining or staking system, XRP’s distribution comes entirely from Ripple Labs. This fact makes Ripple more appealing for enterprise applications and back-end banking transfers.
However, it also removes any shield of autonomy from Ripple and the XRP blockchain. Ripple’s liquidity pool provides a useful, needed service to update legacy banking software. If Ripple held XRP solely for this purpose, the SEC would have little reason to come after them. The distribution and holding of XRP for private investment greatly muddles that argument. As with any cryptocurrency, speculation runs rampant — occasionally propelling XRP above Ethereum to the second ranked cryptocurrency by market capitalization.
Other SEC Enforcement Efforts
Ripple is far from the first cryptocurrency to conflict with the Securities and Exchange Commission. Historically, excessively large ICOs frequently attracted the attention of the SEC. Block.one, operators of the EOS blockchain, suffered similar scrutiny due to their multi-billion dollar ICO. The resulting settlement took into account the conversion of EOS to a proprietary blockchain. Further, it granted a waiver to block.one, dependent on their continued efforts to adhere to US law in relation to cryptocurrencies. The settlement amounted to $24 million USD and required no admission of fault.
Privacy-focused communications firm Telegram famously raised nearly $2 billion USD in their own ICO. However, unlike block.one and EOS, the SEC actively sought to prevent Telegram from issuing their ‘Gram’ cryptocurrency. The SEC’s action resulted in Telegram returning the majority of their funds to investors — as well as an $18.5 million USD penalty.
Both cases pertain to a fraudulently operated ICO. Unlike Ripple’s current situation, the SEC went after block.one and Telegram almost immediately. Ripple and the XRP blockchain have operated for years under their current system, something that could result in a drastically larger penalty — if the SEC allowed them to continue operating within the United States at all.
The Fate of Ripple
Ripple faces an uphill battle against the SEC, one with severe potential repercussions for the cryptocurrency industry. Merely the threat of action caused most exchanges operating within the US to drop XRP as a trading option. While Ripple Labs insists that XRP exists as a means-to-an-end for their enterprise product suite, the loss of revenue and asset mobility this represents is staggering.
If Ripple manages to fend off the SEC’s assertions, they will emerge with an anemic business infrastructure. Repairing the damage done could take years, and will leave XRP in a temporarily weaker position. Long term, it would represent a much stronger foundation for their business. If Ripple Labs can prove in court that they are not an unregistered security, they would no longer suffer from legislative ambiguity.
Should the SEC win in their case, the results would be catastrophic for both Ripple and the cryptocurrency industry. Most — if not all — of the centralize cryptocurrency operators would face the same threat, with a now-established precedent. The best-case scenario, should the SEC win, would be a hefty fine and operational restrictions for Ripple. The worst case would be full dissolution. In all likelihood, Ripple will continue to exist for the foreseeable future — albeit in a starkly new dynamic.