SEC vs. Ripple

This court verdict will decide if cryptocurrency should be seen as a security or commodity

What Is the SEC vs. Ripple Lawsuit?

SEC vs. Ripple is an open court case in the United States Southern District Court of New York that could decide the future of cryptocurrency regulations and determine if it is a security or a commodity.

In 2020, the U.S. Securities and Exchange Commission (SEC) alleged that Ripple, the blockchain developer and creator of the XRP cryptocurrency token, raised more than $1 billion in 2013 through the sale of XRP in an unregistered security offering to investors. Ripple, relying on the previous comments of an SEC director to support its case, argues that XRP should not be treated as a security.

Key Takeaways

  • Ripple Labs is a blockchain developer and creator of the XRP token.
  • The SEC has accused Ripple of selling XRP in an unregistered security offering.
  • The outcome of the U.S. regulator’s court case against Ripple will have far-reaching consequences for the cryptocurrency industry.
  • An SEC win in court could make the SEC the primary crypto regulator.

Why Is the SEC vs. Ripple Case Important?

The SEC vs. Ripple case sent shockwaves through the cryptocurrency sector when blockchain projects had been operating with little regulatory oversight. There had been fears of future regulatory action, but this was the most high-profile example of a securities regulator targeting an initial coin offering (ICO).

If Ripple loses the case, it could open the floodgates for similar actions against other crypto projects, likely leading to tighter regulation of the industry. The SEC’s argument is that Ripple’s ICO—and, by extension, other ICOs—is the sale of a security that must be registered.

An SEC victory in court would effectively make the SEC the main crypto regulator.

What Are Ripple and XRP?

Ripple Labs was founded in 2012 as OpenCoin, but later changed its name and launched the XRP token. At the time, there were fewer cryptocurrencies, so with its large coin supply and fast transaction speeds, XRP was seen as a new solution for cross-border remittances.

The XRP token grew from millions to billions in terms of market capitalization in 2017, with continued growth in the following years. However, once the SEC filed suit in December 2020, crypto exchanges such as Coinbase suspended trading in XRP, and that added to the negative sentiment surrounding the coin.

The timing for Ripple Labs was terrible. The suit was filed just ahead of the largest bull market in cryptocurrency history—when Bitcoin (BTC) eventually soared to highs above $64,000 per token in 2021. XRP’s price remained depressed throughout that rally, with investors spooked by the SEC court case’s outcome.

The final ruling could also be unfortunate for Ripple, as it comes as the market has been hit by a series of frauds and scandals, including the late 2022 collapse of cryptocurrency exchange FTX and criminal charges of fraud, conspiracy, campaign finance law violations, and money laundering against former FTX CEO Sam Bankman-Fried. As the fallout from the FTX bankruptcy spreads throughout crypto markets and beyond, market participants and government officials call for stronger regulations.  

Understanding the SEC’s Ripple Lawsuit

The SEC charged Ripple—and two of its executives, Brad Garlinghouse and Christian Larsen—with selling unregulated securities valued at more than $1.3 billion to the public over the years via their company-offered XRP.

Included in the SEC filing were transactions from 2013 through late 2020, which accounted for more than 14.6 billion XRP sold in return for cash.

It has been commonplace for cryptocurrency projects to fund their staffing and operations from the sale of their tokens, while executives also benefited from cash sums brought in. The case hinges on the definition of a coin sale. The SEC contends that if it’s a security, it must be registered. Ripple argues that a crypto coin isn’t a security.

The SEC said Ripple never filed a registration document, which is a requirement for companies in the stock market when they are seeking to raise capital from the public. The regulator complained in the lawsuit that Ripple had “created an information vacuum” and only shared information that it felt necessary.

The outcome has large implications for both parties and the broader crypto market. The SEC wants to bring the cryptocurrency industry under its regulatory umbrella, and a win against Ripple would start the ball rolling. Ripple would likely face a hefty fine, but there could also be further action against key executives. All of this could impact development at the project.

What the Ripple Suit Means for Cryptocurrencies

In September 2022, SEC Chairman Gary Gensler said that many cryptocurrencies are securities.

That was backed up by proposed legislation from U.S. Senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) in June 2022, which seeks to designate most cryptocurrencies as commodities. If that bill becomes law, then the SEC would oversee the broader sector and the Commodity Futures Trading Commission (CFTC) would handle the trading and derivatives aspect.

Next Steps in the SEC vs. Ripple Case

As the long-running case continues, the defense has maintained that there are no grounds for the action, and Ripple CEO Garlinghouse also has weighed in on what he saw as obstructive behavior by the SEC during the case.

In September 2022, the Chamber of Digital Commerce (CDC) filed a “friend of the court” brief on Ripple’s behalf after that was approved by the U.S. District Court for the Southern District of New York, where the case is being heard.

In the brief, the digital advocacy group said the far-reaching consequences of the court decision—namely, whether the law applicable to the securities transaction is properly distinguished from the one applicable to secondary market transactions—mean that a clear line has to be drawn over what represents a security in the crypto sector.

Ripple’s general counsel, Stuart Alderoty, has been vocal on Twitter about the lawsuit. Alderoty said that the SEC has been unable to “satisfy a single prong of the Supreme Court’s Howey Test.” That test is a standard tool used by the SEC to determine if an asset can be classed as a security. Alderoty added that Ripple felt “confident” that it could be the start of the end for the long-running dispute.

Garlinghouse has tweeted that the SEC’s actions make it clear that the agency is not interested in applying the law but instead “want[s] to remake it all in an impermissible effort to expand their jurisdiction far beyond the authority granted to them by Congress.”

What Is the Howey Test?

The Howey Test refers to the U.S. Supreme Court case (SEC v. Howey) that's used to determine whether a transaction is deemed an “investment contract,” and therefore would be considered a security under the Securities Act of 1933 and the Securities Exchange Act of 1934. Importantly, an investment contract exists if there is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Is XRP a Security?

Based on the Howey Test, the most important issue is whether the U.S. Securities and Exchange Commission (SEC) classes the investment in XRP as a contract where profits are “derived from the efforts of others.” This is a gray area at present due to the decentralized aspect of cryptocurrencies.

Will Other Cryptos Be Classed as Securities?

The SEC has already launched investigations into the BNB token of the Binance exchange, and the ApeCoin token that backs up the ecosystem for Bored Ape non-fungible tokens (NFTs). The SEC is looking across the board at token launches, and a win against Ripple could open the floodgates to further action.

The Bottom Line

The end result of the SEC vs. Ripple lawsuit could change the regulatory outlook for the entire crypto industry. It is clear that the SEC is looking to be the chief regulator for the industry, and the move against Ripple is the first step to classifying all tokens as securities.

If Ripple loses the case, the SEC could levy fines on a large number of crypto projects. For Ripple, a loss could negatively impact the project and its executives and open the door to a stricter industry environment.

Article Sources
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