Even if Ripple Wins Its Case Against the SEC, It Could Lose

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Earlier this week, former chair of the Securities and Exchange Commission (SEC) Chief Robert Cohen publicly stated that if Ripple loses its lawsuit with the SEC, the regulator will likely continue pursuing its case against Ripple until it wins. Cohen based his opinion on a previous case the SEC pursued against Blockvest LLC.

In the Blockvest case, the U.S. District Court for the Southern District of California denied the SEC’s motion for a preliminary injunction against Blockvest. The SEC filed for a partial reconsideration. The court granted, in part, the SEC’s request and was able to continue prosecuting its case against Blockvest. In December 2020, the SEC won its case against Blockvest and the company was forced to pay $700,000 in fines.

Of course, the case against Blockvest had to do with the company’s initial coin offering (ICO) whereas the SEC’s case against Ripple is concerning the ongoing sales of XRP, Ripple Labs’ cryptocurrency.

 

What’s At Stake in SEC v. Ripple Labs

The SEC’s case against Ripple could be a game changer for the entire cryptocurrency industry. SEC Chair Gary Gensler has already publicly declared bitcoin to be a commodity and most other cryptocurrencies in the category of securities. While there is no case law that backs up his opinion, once the Ripple case is decided, there will at least be a legal precedent to use existing law to make that determination. It will then only be a matter of time before the SEC goes after other prominent cryptocurrencies, such as BNB, Cardano, Solana, and TRON. 

Ripple Labs CEO Brad Garlinghouse has argued that XRP is not a security because if Ripple Labs were to disappear, then XRP would continue to operate.

While Garlinghouse presents a compelling argument, there are other details the court will consider to determine whether Ripple Labs influences the price of XRP. One of those is the relationship of the firm to the currency.

XRP is a bridge currency used by institutions to facilitate cross-border payments between different fiat currencies. Since XRP is open source and its blockchain is decentralized, anyone can use it—including Ripple Labs. As it turns out, Ripple Labs is the largest holder of XRP, owning about 60 billion of the 100 billion XRP minted at the point of creation. Ripple placed most of that into an escrow account and has the option of releasing up to 1 billion XRP into the market every month. This ability certainly affects the price of XRP from month to month.

Of course, there are other forces that play on the price of XRP from day to day, and the court will consider those as well. At the end of the day, whichever way the court decides in the case—whether XRP is a security by the legal definition of security—will have a bearing on other cryptocurrencies issued by or in association with a centralized company.

 

Who Should Determine Whether XRP is a Security

The court’s job is to interpret the law, not create it. In that regard, the U.S. District Court for the Southern District of New York will look at four criteria that are often used to determine whether an investment is a security. Those criteria include:

  1. Does it involve an investment of money

  2. In a common enterprise

  3. With an expectation of profit

  4. Determined by the efforts of others

Called the Howey Test, the test is used to determine whether an investment’s substance makes it a security. The court can use other tests to determine whether the form of an investment makes it a security. With blockchain technology, form is certainly just as important as substance.

One of Ripple’s primary arguments against the SEC is that the commission failed to issue a fair notice to the company. The SEC tried to have Ripple’s motion to that effect dismissed, but the court sided with Ripple and allowed the argument to move forward.

Garlinghouse has said that Ripple Labs will leave the U.S. if it loses to the SEC. But the firm could appeal its case to a higher court. While the SEC is pursuing cryptocurrency companies in an attempt to classify them as securities, some legislators are attempting to write the law on cryptocurrencies that future courts will have to interpret. In March, the president signed an executive order to direct government agencies to investigate ways to regulate cryptocurrencies. 

It’s clear there is a push to regulate and legislate cryptocurrencies. Until there is effective legislation in place, the crypto industry may have to abide by judgements in cases like SEC v. Ripple Labs and the opinions of executive branch regulators. The case against XRP is, at heart, a struggle for regulatory clarity.



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