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SEC action on XRP can have rippling effects on the future of cryptocurrency

SEC action on XRP can have rippling effects on the future of cryptocurrency

SEC action on XRP can have rippling effects on the future of cryptocurrency

Many investors, traditional and progressive, are looking hard at cryptocurrency investments as a way to diversify their portfolios. However, there are still multiple known “unknowns” about this new market, including the impact of existing and future government regulations concerning investment advisor requirements, export controls, and anti-money laundering. The Securities and Exchange Commission (SEC) filed a complaint against Ripple Labs Inc. (Ripple) and two of its top executives for conducting unregistered, digital securities offerings valued at over $1.3 billion. The SEC’s action could be an indication that the SEC is expanding the scope of its pressure on virtual currency companies, as other government agencies, including the Financial Crimes Enforcement Network (FinCEN) and the Office of Foreign Assets Control, has done over the past few years.

At present, similar to other regulatory agencies, the scope of the SEC’s cryptocurrency regulation is ill-defined. In various agency publications and statements, the SEC has indicated that it will assert jurisdiction over initial coin offerings (ICOs) and securities linked to cryptocurrencies, such as Bitcoin-linked exchange-traded funds. The SEC Chairman Jay Clayton stated Bitcoin was not a security because cryptocurrencies “are replacements for sovereign currencies, replace the dollar, the euro, the yen,” meaning that it’s a “type of currency and is not a security.” This statement seemingly placed Bitcoin-like cryptocurrencies outside the purview of the SEC.

But that may change with the SEC’s lawsuit against Ripple. Ripple operates a network allowing for cross-border payments using its cryptocurrency, XRP, to facilitate transfers of different fiat currencies on the Ripple network. Critically, the SEC action challenges whether XRP is a currency or a security—a question that will likely have major implications for other cryptocurrency companies.

The SEC has taken the position that XRP is a security because it is an “investment contract.” In its complaint, the SEC applied the well-known Howey investment-contract test to argue that XRP is a security. Under that test, an investment contract exists when an entity invests money in a common enterprise with the expectation of profits from the essential managerial efforts of others. The SEC alleges that XRP meets these criteria because purchasers are able to buy unlimited XRP for investment purposes and the value of their purchases is tied to XRP’s market value. It also alleges that Ripple did not create XRP to allow consumers to buy and sell goods—which shows it’s not a currency—and that individuals connected to Ripple suggested that XRP is an asset that will appreciate. In the SEC’s view, XRP—and possibly many other cryptocurrencies—would be subject to the SEC’s regulatory power and required to comply with the SEC’s securities registration requirements.

In its answer, Ripple firmly denied the SEC’s allegations. Ripple has argued that XRP does not meet the Howey test because Ripple does not enter into contracts for investments with purchasers of XRP, purchasers do not receive a portion of Ripple’s revenues or profits, and Ripple operates on a completely decentralised ledger. Ripple has also pointed out that other global regulators, including those in the United Kingdom, Singapore, and, Japan, recognise XRP as a currency. In addition, Ripple has noted that, as part of its settlement with FinCEN in 2015, the US Departments of Justice and Treasury concluded that XRP is a currency. As this case heads to the discovery phase, the court has yet to issue a substantive ruling.

Companies and individuals in the crypto asset community should consider closely monitoring the development of this case to evaluate the government’s evolution of regulatory oversight. It is clear that any court opinion will likely have far-reaching consequences for the SEC’s treatment of other cryptocurrencies. In addition, cryptocurrency companies should consider assessing their compliance programs as a whole. This may include AML/CFT and OFAC compliance programs. A robust compliance program may help companies mitigate the uncertainty of the increased agency regulatory oversight and as-yet-unknown enforcement priorities of the Biden Administration.*


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