Ripple's recent lawsuits: illegal security or not and if so, what's next?

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Adriaan Admin

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Jan 30, 2018
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#1
The company Ripple has been in the news quite a lot in the past few months, because one after the other class action lawsuit is being filed against the company on a variety of charges, of which the main one is: the XRP ICO was an illegal offering of an unregistered security. The people that filed lawsuits (on behalf of all Ripple investors) against the company Ripple that issued and sold the XRP token in an ICO mostly had bought the XRP token around its all time highs early Jan 2018 and sold for huge losses a few weeks later. Notably the investors that filed the lawsuits didn't invest even that much compared to all investments made in XRP during that period and since the price of XRP had gone up astronomically during the end phase of last year's bull run, partly due to hyping on twitter by Ripple team and later debunked rumors about Coinbase listing that were circulating, but after the bubble popped a lot of investors lost a lot of money when the price of XRP crashed along with all other cryptocurrencies.

This year regulators all around the world are getting more and more involved in cryptocurrency trying to get a grip on the space and what regulations should apply. In the US many discussions have been going on whether cryptocurrencies and/or ICO tokens are securities or not and if some or many are, have the ICO's been illegal unregistered securities offerings? Specifically the SEC is the agency that needs determine if certain projects are indeed officially considered securities. The crypto and traditional finance industry have been waiting long for clarity from the SEC on these issues.

In 2017 the SEC came out with the DAO report about an infamous ICO that got hacked and forced the Ethereum network to fork off the original blockchain in order to roll back the transactions of lost funds. In this report the SEC stated that in order to determine if tokens (offerings) prove positive against the Howey Test standards, that they are indeed securities and would need to register with the SEC to be allowed to be offered to ACCREDITED investors ONLY. For the Howey Test the following questions need to be answered:

  1. There must be an investment of money.
  2. There must be an expectation of profits from the investment.
  3. The investment of money in a common enterprise.
  4. Any profit comes from the efforts of a promoter or third party (i.e., there are other forces at work that are responsible for the monetary gain.)
Later the SEC came with statements that according to their surveys practically all ICO's that they encountered classify as security offerings and should therefore be deemed illegal as practically none have registered at the SEC. Since the DAO report ICO's outside of the US have excluded US citizens from participating in their ICO's. Ripple however was released long before the DAO report, is based in the US and sold to US citizens, so they definitely fall within the jurisdiction of the SEC to say the very least.

Then SEC executives have made statements in the past few months that Bitcoin and other decentralized cryptocurrencies (keyword here is decentralized, without a centralized authority/company behind it) that are meant to be used as currency/means of payment are not regarded as securities, so Bitcoin for sure is off the hook. Ethereum on the other hand has been a point of discussion and uncertainty, because Ethereum did an ICO for its utility token Ether that would empower the Ethereum network, so they raised money with a centralized company with the expectation of profit by investors and the expected profit is a result of the work of others (for example the developers building and working on the platform). SO there were arguments being made for and against the security status. However a high ranking official of the SEC has more or less cleared Ethereum by stating that even if the fundraise could technically have been a securities offering, the current state of Ethereum (being a sufficiently decentralized network) would give Ethereum a pass on the legality issue. Unfortunately for Ripple (or fortunately depending on the verdict), eventhough being the number 3 cryptocurrency by marketcap in the world, the SEC has not come out with any clearing (nor condemning) statement about XRP. If the SEC would also claim that XRP is not a security and/or that the sale of XRP was not an illegal unregistered securities offering, then Ripple would be more or less out of trouble with regards to these lawsuits.

So why is Ripple being accused and sued?

The accusations are as follows:
Because the Ripple Labs company held the vast majority of XRP in reserve they were able to slowly distribute tokens by selling them in the open market in the past years in what you can basically call a never-ending ICO and by doing so basically funding the Ripple company, because the other sources of revenue were quite small compared to the token sale proceeds.
Because the aforementioned endless diluting of the circulating supply by Ripple company or the potential of dumping large loads into the market (and thus crashing the price) were rightful fears and complains from investors a long time, Ripple announced that they would lock up a large majority of their holdings in a cryptographically secured vault to prevent such large sell offs by the company. The complaints in the lawsuits were that Ripple exploited this announcement by hyping it and telling everybody how good this was for the XRP price and their strategy worked, because since then the price was surging insanely.
Other accusations were that Ripple heavily hyped and promoted partnerships for OTHER THAN XRP token/network related Ripple services, making abuse of the fact that many in the space believe that Ripple the company and XRP were per definition the same thing.

The accusations are trying to make the reasonable case to prove these accusations and making the case that Ripple did indeed sell an unregistered security by proving the points from the Howey Test. From the surface the case seems quite clear: there was an investment of money on the sale of tokens by the company, it was clearly the investment in a common enterprise, namely the Ripple company, there was a clear expectation of profits, fueled by statements by Ripple executives as well as social media posts all over internet by investors. Then the profits on XRP are depending on the work and efforts by others, because the value of the XRP token could only increase if Ripple was able to sell its XRP network to clients and also the fact that it came out that Ripple even tried to bribe Coinbase to get XRP listed there because that would massively increase the price of the token (and profits for investors); as the price already did on only the rumors of XRP's potential Coinbase listing (which was soon debunkted by Coinbase, which made the price correct heavily afterwards): this is the work, effort and promotion by others to realize profits. The other point that cleared Bitcoin and Ethereum was decentralization and this defense most likely does not apply to XRP, because Ripple company controls the vast majority of tokens and fully controls the network, so it is far from decentralized.

Ripple is hiring strong defense however, because they hired former high SEC officials to represent their case, however they have not come up with any convincing arguments against the accusations, other than saying that they have no reason to believe that they are an unregistered security and that it is up to the SEC to determine that.

I am not a lawyer by any means, but from the outside and looking at the existing evidence the case seems pretty clear cut that XRP is indeed a security according to the SEC's standards and that those lawsuits have a pretty good chance to win their case. But the fact that Ripple has deep pockets and is clearly lobbying in the banking and regulators scene, does leave the option open for surprise outcomes.

What would then happen if XRP is classified as unregistered security? It does depend a little on either the result from the lawsuits and/or of a decision by the SEC. A potential outcome is that original XRP ICO investors could roll back their purchase, but ofcourse this is going to be very hard to execute and it would hardly compensate any of the huge losses suffered by a majority of investors. Besides any form of financial compensation of investors, if indeed XRP is classified as a security and an unregistered securities offering, then the XRP token should be delisted from exchanges where it is listed on, if those exchanges don't want to get in trouble with the SEC and continue their business, especially if those exchanges offer fiat-to-crypto. This is by the way a faith that could happen to many other ICO projects as well in the time to come. If it happens to XRP then this would of course be devastating for current XRP holders, because their loss would be huge, because of its enormous market cap and exposure to the crypto market. So this could cause a huge blow to the market as a whole as well. This might also be a consideration for the people that are going to decide over the faith of Ripple/XRP's legal status.

This case in my eyes has quite some complexities eventhough from the outside it seems very simple. It is however also a ticking time bomb and pressure is increasing and the time ticking. What do you think: is XRP an illegal security because of its centralization around the Ripple company and will it eventually be classified as such with all its dire consequences and the fall of XRP+Ripple or do you think for some weird reason Ripple will get away with it and what would be the argument that could possibly be used in defense of Ripple as a decentralized currency - non-security?
 

stellarowl12

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Jan 30, 2018
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#2
Shit, this is bad. If XRP is indeed a security, I think that will cause HUGE waves in the crypto world. That means XRP a top 5 coin and a large percentage of other similar altcoins will be deemed securities, immediately banned from the U.S. Cause a multitude of class actions and what not.

THAT will be true capitulation in the market. And may bring BTC down to like $3k like Tone Vays suggested....

Scary times man.
 
Likes: Adriaan Admin

Adriaan Admin

Administrator
Staff member
Jan 30, 2018
231
44
28
www.bitcoinforbeginners.io
#3
I definitely expect huge waves in crypto market if that would happen. Which is why I think everyone involved is so reluctant to make the final decision, bc an aweful amount of people will get burned so much!

Another point I wanted to make is that because of these accusations and lawsuits and as long as they are running + not having a verdict from the SEC about Ripple/XRP, I am absolutely sure there will be no Coinbase listing, because Coinbase can't afford the risk of Ripple getting screwed which would reflect badly on Coinbase.