The outcome of Ripple’s XRP investigation by the SEC may cause a major “ripple effect” for the crypto industry.
In December 2020, the SEC announced its investigation of Ripple Labs Inc. and two of its executives for violating the Securities Act of 1933. In a press statement from the SEC, they assert that since 2013, Ripple sold XRP to raise funds for the company. In response, Ripple says that XRP should be treated more like alternative currency such as Bitcoin or Ethereum. The SEC maintains that by not registering XRP as a security, Ripple did not provide the financial and managerial information expected to prevent asymmetric information between the firm and investors.
Specifically, the SEC believes that XRP should be an investment contract. In 2018, the SEC explained its positions at the Yahoo Finance All Markets Summit: Crypto. The SEC observed that “…simply labelling a digital asset a ‘utility token’ does not turn the asset into something that is not a security”. In its speech, the SEC explains the difference between Bitcoin, Etherium and other tokens. The SEC sees Bitcoin and Ethereum as existing on a successfully decentralized network that does not rely on a single group for success, making it not an investment contract. In the case against XRP, the SEC cites how investors bought XRP with the purpose of speculating on its price.
Another issue XRP will have to answer for is the nature of the offering. Ripple states that they created XRP as a way for companies to source liquid assets using blockchain technology. In this way, no investor should have expected to make money off of XRP. However, XRP created a fixed amount of tokens during its ICO and releases 1 billion tokens for sale every month. Bitcoin and Ether are still mineable, but XRP is released periodically, with Ripple owning 80% of XRP available.
With President Biden in office, he has appointed a new Chairman of the SEC. His pick is Gary Gensler, a professor at MIT who teaches courses about blockchain and financial technologies. Before Ripple gets its hopes up that Gensler will side with the DeFi space, in a 2018 lecture from his Blockchain and Money course at MIT, Gensler expresses his belief that XRP is unregulated security due to the Howey Test. The Howey Test is a Supreme Court case that outlined a four-pronged test for defining if something is a security. It appears likely that Gensler will continue to pursue the SEC case against XRP.
Ripple will continue to fight the case against Gensler in February 2021. If the SEC successfully proves its case against Ripple, platforms that host XRP will have to file as security exchanges. Also, companies will have to be cautious to not suffer the same fate as XRP. On the other hand, if Ripple wins, it could be argued that the diversity of the DeFi space will continue to flourish. The outcome of this case will have a “ripple” effect through the DLT/DeFi industry.