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Crypto Regulations
For the crypto market, regulation continues to be a large gray area. As the crypto market continues to grow, so too does the attention being paid to it by governments and regulating agencies. In the U.S., crypto is at the mercy of the Financial Services Oversight Council (FSOC) and its 10 voting members. There’s the Federal Reserve (Fed), the Department of Treasury, the Commodities and Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Commission (FDIC), the Consumer Financial Protection Bureau (CFPB), and a couple of others that are less directly relevant to crypto.
FSOC is a byproduct of Dodd-Frank, responsible for identifying risks and emerging threats to the financial system. That means it has the statutory authority to organize a policy response to emerging tech like crypto. The committee is chaired by the Treasury Secretary and aims to ensure there are no blind spots in the U.S.financial regulatory framework. As the U.S.makes up 38% of the world’s financial market, FSOC’s impact is effectively global.
The SEC announced in Q3 2022 that they're doubling the personnel within their Crypto Assets and Cyber unit in a move intending to fortify their position as a crypto regulator. Talks of regulation have increased dramatically following the 2022 collapse of the Terra Luna ecosystem.
SEC vs Ripple Labs
In December 2020, the SEC filed a lawsuit against the executives of Ripple Labs & the company itself. Most entities generally settle with the SEC to ensure they can continue operations. Ripple did not, instead choosing to actively defend themselves in court against the SEC. The case is ongoing but the SEC's stance is clear below:
Ripple Labs raised at least $1.38 billion “over a years-long unregistered offering of securities. Ripple used this money to fund its operations without disclosing how it was doing so, or the full extent of its payments to others to assist in its efforts to develop a ‘use’ for XRP and maintain XRP secondary trading markets.”
It is expected that the SEC will make its case for XRP to be deemed a security based on the common definition and interpretation of the Howey Test, the most common legal test applied to securities. The four-component questions of the test are listed below:
- Is there an investment of money?
- Is there an expectation of future profits?
- Is the investment of money in a common enterprise?
- Do any profits come from the efforts of a promoter or third party?
When examined through the lens of the Howey Test, XRP passes or narrowly skirts the line on at least two points. The first failure (i.e., being classified as a security) is the investment of money and the expectations of profit. Retail users undoubtedly invested money into XRP, and now Ripple is left to defend that they did so for some other reason besides speculation. XRP’s intended use case is as a bridge currency for banks in cross-border payments; therefore, no average person needs to own XRP.
The second issue with XRP deals with numbers three and four of the Howey Test questions concerning a common enterprise and Ripple’s control over XRP. The connection between the activities of Ripple Labs Inc. and the market price of its native token has been put under question. This report has covered the multitude of ways in which Ripple Labs Inc. has an overly-centralized control over XRP; ultimately, it may be Ripple themselves that makes the case against them.
Since late 2018, Ripple has tried to distance the company from the XRP token, although, in the early years of Ripple’s development, they appeared to state clearly that Ripple Labs created XRP. More recently, the Ripple website has changed that language to directly contradict their original statement and now claim that Ripple did not create XRP. If XRP is ultimately deemed a security, it means Ripple Labs would be considered the “common enterprise” and retail investors would be seeking “profits from a third party.” Ripple is currently engaged in a federal lawsuit over this very issue of its relationship with XRP and whether its sales of XRP constitute unregistered securities. The case is ongoing, and no timetable has been set for a decision.
Over the past several months, Ripple has been slowly putting more and more pressure on the SEC in this case. While Ripple and the SEC have been engaged in a heated legal battle, recent rulings from an overseeing judge have backed the SEC up against a figurative wall. U.S.Magistrate Judge Sarah Netburn called the SEC hypocritical as the organization tried to distance itself from comments made by formal official Bill Hinman that Ethereum (ETH) was not a security. This comment was done based on the advice and guidance from the SEC itself.
The SEC has tried to argue that the speech was not relevant, but the judge has declined. This places a pivotal victory in Ripple’s column because if Hinman’s comments are legally deemed relevant, Ripple may be given the upper hand and help confirm XRP is not a security either. This would deal a great blow to the SEC’s ability to regulate other similar assets within the cryptocurrency space. This also comes after the SEC attempted to keep its ‘key experts’ in the case confidential - a move Ripple has challenged outright. With pressure mounting against the SEC, there is a growing sentiment within the cryptoeconomy that Ripple may win the case. This issue is still ongoing as of Q3 2022.
