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One of the most intriguing and closely watched topics in the cryptocurrency world is the consequential lawsuit of Ripple and the U.S. Securities and Exchange Commission (SEC).
Even though this is not the first lawsuit against a crypto company, it is the first time a company decides to fight the war, and considering that the SEC has gotten much more aggressive while regulations remain unclear for this industry, there is a lot of expectations put into the ruling of Ripple’s case and what it might mean for the wider crypto space in the US.
Before we jump into it, if you haven’t read my previous articles on the chronicles of the banking crisis, crypto choke point 2.0, and some more drama, I’d recommend you reading these:
Now, first things first - What is Ripple?
Ripple Labs is a US technology company that was founded in 2012 by Chris Larsen and Jed McCaleb.
It provides global financial settlement solutions: the Ripple payment protocol enables banks and financial institutions to facilitate real-time, secure, and low-cost cross-border transactions.
Ripple's solutions, including the use of its cryptocurrency XRP, aim to address some of the inefficiencies and high costs associated with traditional international money transfers.
It runs its transactions on the XRP Ledger, an open-source blockchain with a special consensus mechanism called “Federated Consensus”.
The company has formed partnerships with various financial institutions worldwide to promote the adoption of its technology and XRP.
An overview about XPR
XRP is the native cryptocurrency of the XRP Ledger, which was created by developers David Schwartz, Jed McCaleb, and Arthur Britto.
The total supply of XRP is capped at 100 billion coins.
Unlike some cryptocurrencies, XRP's total supply was pre-mined when the network was launched, meaning that all 100 billion tokens were created from the outset.
XRP is used as a bridge currency in Ripple's payment protocol to facilitate fast and low-cost cross-border transactions.
XRP was created before Ripple the company existed. there was never an ICO: the cofounders gifted 80% of XRP to Ripple when the company was created and kept the remaining 20%.
This is why Ripple Labs has faced criticism for holding a significant portion of the total XRP supply, raising concerns about centralization and its potential impact on the market.
XRP has managed to maintain its position within the top 20 throughout these 3 years of a court battle against the SEC, which is commendable. And thanks to the latest ruling from the judge, it has made its way to the top 4th largest crypto by market cap globally.
Now that we established some basic knowledge of who is who… what happened with Ripple and the SEC?
In December 2020, the SEC filed a lawsuit against Ripple Labs, along with two of its executives Brad Garlinghouse and Chris Larsen.
The SEC's lawsuit alleged that Ripple's sale of XRP tokens constituted an unregistered securities offering, making it subject to federal securities laws.
What’s the Howey test?
Here is a quick reminder: the Howey test is used to determine whether an asset qualifies as a security.It contains 4 criteria, and if an asset meets all of them, then it will be considered to be a security:
Investment of money (you buy it with money)
Expectations of profit (you are expecting to make money out of it).
In a common enterprise (meaning the price action is the same for everyone who invested in the same asset).
Derived from the efforts of a promoter or a third party (be it an individual, institution, or some combination of both).
The first 3 criteria are fairly straightforward, and it is safe to say that almost all cryptocurrencies meet them.
However, it’s the last one that makes it complicated because sometimes it is not easy to identify a third party creating an expectation to profit from a particular coin or token.
Based on this, the SEC alleged that Ripple as a company is this third party creating that expectation of profit, and therefore XRP is a security.
What’s the outcome?
After 3 years of back and forth, there is finally a ruling which can be classified as a partial victory for both sides, as the judge granted and denied different motions put forward by both parties:
Ripples sales to institutional investors is indeed considered an unregistered security offering, because these institutions had an expectation of profit from ripple.
Sales on exchanges is not unregistered security - as you may not necessarily be buying for Ripple.
Ripple sales on secondary sales did not constitute for the same logic.
Executives’ sales also did not constitute an unregistered security offering (because they sold everything on exchanges) - so the Ripples executives are off the hook.
Ripples fair notice defense is insufficient though, at least when it comes to sales to institutional investors.
Now, the big win for Ripple is the below quote from the judge’s ruling:
“XRP as a digital token is not in and of itself a contract, transaction or scheme that embodies the Howey requirements of an investment contract”.
However… the judge rejected Ripple’s attempt to modify the criteria of what constitutes a security - which means that the Howey test will remain the mean by which the court will decide if crypto is a security or not.
Final Thoughts
All in all, the case is far from over. The actual trial might not happen until 2024.
The good news is that XRP has regulatory clarity which is extremely rare, it is pretty much the only cryptocurrency other than BTC that has this luxury. This is why the US exchanges did not hesitate to regiter XRP right away, and the market also reacted very positively with a great rally for it’s price.
However, how much of this is going to benefit the larger crypto space is still a bit unknown. XRP is a very different project compared to the rest of crypto: it does not run on a Proof of Stake blockchain, it did not go through ICO, and it does not offer Staking.
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