On December 21, 2020, the United States Securities and Exchange Commission (SEC) launched a lawsuit that could have a significant impact on the understanding of cryptocurrencies in the United States and, consequently, the entire cryptocurrency market. The lawsuit against Ripple Labs and Chris Larsen, co-owner of Ripple, as well as Brad Garlinghouse, the company's current CEO, concerns the sale, as defined by the SEC, of unregistered securities by these entities in the form of the XRP token created by Ripple Labs. Ripple Labs is responsible for creating a real-time settlement system, i.e., an international network of currency exchanges and money transfers, with the XRP token enabling international transactions within the so-called XRP Ledger. According to the information available on the ripple.com website, the idea is to create a service that will provide financial institutions and other market participants with the ability to conduct cheap and almost instant cross-border money transfers, and it is for this reason that the RippleNet network was created, in which transactions in the form of the XRP cryptocurrency can be settled and validated in real time.
The SEC's indictment alleges that Ripple Labs and its management conducted an Initial Public Offering of the XRP token, which, according to the SEC's standards, constituted an unregistered security at the time of the fundraising. According to the complaint, Ripple Labs raised funds by selling XRP tokens in unregistered securities offerings targeted at investors in the United States and around the world. At the same time, the company offered XRP within pre-defined token pools for marketing the project, creating a market for the cryptocurrency, and providing services or work for the company. It should be noted that this practice is extremely common in the cryptocurrency community. Nearly every startup project raises funds through token sales at some stage (for example, under Simple Agreements for Future Tokens (SAFTs)), while those supporting the project from the outset, whether as advisors, marketers, or legal counsel, settle their accounts in the project's tokens using a so-called advisory pool. According to the SEC, XRP constitutes a security. Generally speaking, a security is a financial instrument that is traded, representing ownership, but has no utility. A prime example is publicly listed shares of publicly traded companies, issued by a given entity to obtain financing. Each share represents a percentage of ownership in a given company. While it can be traded and typically carries a range of rights, such as dividends or voting rights, shares cannot be used to obtain a specific service, such as instant international funds transfer, which is the main functionality of the XRP token. In the United States, the Howey Test, developed based on the United States SEC vs. Howey Test case, concluded with a 1946 ruling by the U.S. Supreme Court (the American equivalent of the Polish Supreme Court), is crucial for determining the characteristics of a security under the aforementioned test. If an investor has no real control over the value of a given asset, meaning it depends almost exclusively on the actions of the issuer, then we are dealing with a security. This can certainly be applied to some extent to the XRP token and the vast majority of other tokens, whose value depends primarily on the development of the project and planned tokenomics, which are beyond the investor's actual control. On the other hand, it should be noted that the SEC does not recognize Bitcoin as a security. Furthermore, Ripple Labs obtained evidence during the proceedings in the form of a speech by William Hinman at the Yahoo Finance All Markets Summit in 2018, when he served as Director of the SEC's Division of Corporate Finance, during which the then-Director indicated that the office does not treat the Ethereum cryptocurrency as a security. Although the US commission appears to have completely reformed its position since then, William Hinman's statement regarding the 2013 Ripple Labs fundraiser may be crucial to the final resolution.
At this stage, it's still difficult to clearly predict the outcome of the legal battle that began almost two years ago. Nevertheless, everything indicates that a conclusion will be reached in the coming months, which will undoubtedly significantly impact the cryptocurrency market landscape in the United States and, inevitably, globally. A ruling consistent with the SEC's motions will lead to further lawsuits against leading global cryptocurrency projects, including those that have impacted American soil. A successful defense of the XRP token will significantly weaken the commission's position vis-à-vis other token issuers. Regardless of the direction the U.S. court chooses, the outcome of this hearing will be crucial for the further adoption of blockchain technology in the United States and globally.
This alert is for informational purposes only and does not constitute legal advice.
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