- Former CFTC President Chris Giancarlo and Willkie Farr & Gallagher's Conrad Bahlke discuss Ripple and US securities law enforcement at XRP .
- The paper explains why XRP is not a security.
Regulatory clarity, or rather lack thereof, if one of the main obstacles to adoption. For XRP , since Ryan Coffey first filed a complaint against Ripple in May 2018, claiming that XRP was a security, a cloud of uncertainty hovered over the digital asset. Since then, additional lawsuits have been filed and although the SEC has clarified that Bitcoin and Ether are not securities, no indication has been given regarding XRP .
"Crypto Dad" publishes an article on the status of XRP
J. Christopher Giancarlo, the former president of the CFTC, is also known as the "Crypto Dad" after a passionate speech he made to Congress in favor of Bitcoin and cryptocurrencies. After leaving the United States Commodity Futures Trading Commission (CFTC), he joined Willkie Farr & Gallagher LLP, an international law firm headquartered in New York.
XRP is not a security - Howey test
According to the authors, even though the SEC believes that certain cryptocurrencies are securities and therefore fall within its regulatory jurisdiction, it has prudently recognized that the application of securities laws to cryptocurrencies may not be guaranteed in all cases. Senior SEC officials have publicly stated that bitcoin and ether, the two largest cryptocurrencies by market capitalization, are not securities, and even if it would be unreasonable to expect the SEC weighs on each of the more than 5,500 cryptocurrencies in circulation, noticeably absent from the agency's comments on the regulatory status of bitcoin and ether, mention is made of XRP, the third largest cryptocurrency.
In 2019, the SEC published an analysis framework for “investment contracts” of digital assets. The SEC has taken the position that certain cryptocurrencies are “investment contracts” within the meaning of “security” under the Securities Act of 1933 and the Securities Exchange Act of 1934. According to the Howey test, a “contract "investment" exists when there is investment of money in a joint venture with a reasonable expectation of profit from the efforts of others . The authors argue that even if XRP had to meet one or two of the conditions for Howey's test, it did not meet all factors such as XRPis an investment contract subject to regulation as a guarantee. The article continues to examine each component of Howey's test against XRP .
Investing money: XRP cannot be an investment contract as there is no actual contract or arrangement between Ripple and the vast majority of XRP holders . On the contrary, the contracts that Ripple has concluded explicitly exclude the general holders of XRP as third party beneficiaries.
The mere fact that an individual owns XRP does not create a relationship, rights or privileges with respect to Ripple more than the possession of ether would create a contract with the Ethereum Foundation , the organization that oversees the Ethereum architecture .
Joint venture: To determine whether there is a joint venture under the Howey test, the federal courts have required that there be a horizontal or vertical community between the parties. The horizontal similarity focuses on the relationship between investors in an economic enterprise. Courts have found such a similarity when there is a "link between the wealth of each investor and the wealth of other investors through the pooling of assets, generally combined with the pro rata distribution of profits". There is no horizontal similarity with regard to XRP , either among the holders of XRPor between the owners of XRP and Ripple. Although large price fluctuations uniformly affect those who hold the XRP , the currency is by no means pooled, let alone by Ripple or another central party.
In addition, as noted above, ownership of XRP does not confer and does not purport to give the owner rights to Ripple and an owner of XRP does not have the right to share the profits and losses of Ripple. The same goes for individual holders of XRP , none of whom is deprived of the simple ownership of XRP , more than two people holding bitcoin or ether can be considered to have "linked their fortune" to each other. to the other. On the contrary, given the juxtaposition between the intended use of XRPas a liquidity tool, its more general use for transferring value and its potential as a speculative asset, XRP holders who use the coins for different purposes have divergent interests compared to XRP .
Vertical Community examines the relationship between the investor and the promoter. While circuit courses are divided between wide and narrow approaches, vertical similarity generally requires that the investor's fortune is linked to that of the promoter's success. In either approach, there is no vertical similarity since XRP and Ripple exist independently of each other, so the XRP Ledger would continue to operate even without Ripple's involvement. Unlike stocks and other traditional securities, XRP does not represent an interest in Ripple and Ripple's performance has no bearing on the price of XRP . This separation can be seen in the price ofXRP , which historically has not responded to Ripple's developments and has generally followed the broad movements of other cryptocurrencies like bitcoin and ether.
Expectation of benefits from the efforts of others: The third and fourth parts of Howey's test (a reasonable expectation of benefits derived from the efforts of others) are also absent given Ripple's commercial tolerance and the autonomy of the XRP architecture . The expectation of profits from the efforts of others must be reasonable. Ripple has not marketed XRP as an investment product, nor has it promised XRP holders any kind of profit or return on investment. On the contrary, Ripple has repeatedly emphasized the functionality of XRP as a liquidity tool and settlement mechanism. The fact that certain parties can acquire XRP in the hope that it can appreciate in value cannot be decisive because it is the same for the large number of speculators of bitcoins and ether.
XRP buyers cannot reasonably count on Ripple's efforts because the XRP architecture is completely autonomous and exists completely independently of Ripple. If Ripple completely ceased its involvement in XRP , the XRP Ledger would continue to operate via third-party validators and XRP would continue to trade freely on exchanges.
The fact that market participants recognize the separation between XRP and Ripple is demonstrated by the fact that the price of XRP generally does not respond to developments regarding Ripple and rather follows the movements of other cryptocurrencies. Although Ripple retains a significant part of the XRP offer and certainly has a pecuniary interest in the value of its assets, it is not enough to suggest that a mutual interest in the value of an asset gives rise to an expectation of profits as Howey predicts. . In addition, most of Ripple's XRP is held in escrow and Ripple's ability to access its XRP holdings is limited by programmatic limits on the amount ofXRP which can be released from the receiver each month. Given that Ripple does not market XRP as an investment and the relative autonomy and immutability of the XRP registry ,
SEC Division of Director of Corporate Finance William Hinman believes that the status of a digital asset as security can change over time if the network on which the token or coin is to operate becomes sufficiently decentralized , a sentiment reflected in the digital published later. asset orientation. Although decentralization is an inherently difficult concept to quantify, Director Hinman cited a number of factors that the SEC can take into account in making this decision, including several analogous to the Howey elements already discussed above:
- If a promoter has raised more funds than might be needed to establish a functional network and continues to spend funds from the product to improve the functionality and / or value of the system that the tokens are working: XRP and the XRP Ledger were fully operational in 2012 when the XRP Ledger was launched . However, even if Ripple holds a significant share of XRP in escrow and finances its operations through the sale of XRP (as well as the sale and license of software), it is no different than miners of bitcoins or ether selling mined tokens or the Ethereum Foundation. using its ether funds to develop and support the Ethereum architecture .
- That there are information asymmetries between promoters and buyers, so that the application of the protections offered by the Securities Act makes sense and that the disclosure of the promoter's activities and plans is important to investors: if the SEC has found that bitcoin and ether meet this condition, the same is true for XRP . In fact, there is less information asymmetry with XRP since Ripple's activity in XRP is made public through, among other things, voluntary quarterly reports disclosing Ripple's activities in the XRP market .
- If there are persons or entities other than the promoter who exercise governance rights or significant influence: There are no third parties who exercise governance rights or significant influence over XRP . In addition, unlike bitcoin and ether, which could be subject to a “51% attack” where miners who control the majority of the computer's power over the network could rewrite the registry, the XRP registry requires an 80% “supermajority” consensus to verify transactions and modify the general ledger, thereby reducing the risk of a third party taking control of the network.
A utility token for liquidity
In recent years , the SEC has begun to explore the concept of "utility tokens", digital assets that represent a right to a product or service offered by the issuer.
In concluding that the utility tokens were not securities, the SEC cited the following factors: (i) the network, platform and applications on which the tokens exist were fully developed and operational at the time of their release issue and funds from the sale of tokens would not be used for the development of the above; (ii) the tokens were immediately usable at the time of the sale; (iii) the tokens were limited to the network and could not be transferred to external wallets; (iv) the value of the tokens was fixed at a predetermined rate and represented a corresponding obligation of the issuer or other parties on the platform to provide services at the value of this amount; (v) the tokens can only be redeemed by the issuer at their nominal value, and (vi) the tokens were marketed in a way that emphasized their functionality and not the potential for appreciation. In addition, the no action letter to Pocketful of Quarters specifically noted that service providers were subject to an initial and continuous anti-money laundering control (AML) and were aware of your client's controls (KYC) and that service providers services were able to liquidate the ether tokens at a predetermined exchange rate.
XRP , given its purpose as a liquidity and settlement tool for financial institutions, could be considered a utility token regarding the specific use of XRP for the on-demand liquidity solution ( ODL) by Ripple.
Although the XRP used for ODL is not entirely analogous to utility tokens for which the SEC previously issued letters of no action (i.e., XRP is neither limited to the ODL platform nor inherently fixed at a fixed price), most of the factors are present. The network ( XRP Ledger) and platform (ODL) are currently fully functional and developed so that Ripple does not need to use the sale of XRP for further development and, as a result, the tokens ( XRP ) are immediately usable at the time of acquisition. Throughout the transaction, the value of XRPis essentially fixed, although it is possible that there will be price fluctuations for the few seconds required for the transaction.
Ripple has also marketed XRP for ODL in a way that emphasizes its functionality (secure, almost instant liquidity without transaction fees or delays imposed by traditional financial intermediaries) and has not market XRP as an asset whose value can appreciate, although the second half of this factor is irrelevant given the limited time that counterparties hold XRP by design. Finally, with regard to AML and KYC considerations, XRP II, the subsidiary through which Ripple sells XRP, is registered with the Financial Crimes Enforcement Network (FinCEN) and manages a solid AML / KYC / OFAC compliance program. In addition, Ripple also performs due diligence on its customers.
In any event, there is little cause for concern as Ripple's ODL customers are themselves regulated financial institutions and additional diligence will be exercised either by the exchanges on which the XRP is converted into currency trustee, or by the banks to which the resulting funds are transferred. . The fungibility of XRP used for ODL and XRP used for other purposes distinguishes XRP from other digital assets that the SEC has considered utility tokens, but the brief period of time during which ODL counterparties hold XRPmust be taken into account as the platform is designed to allow users to liquidate their XRP holdings in local currency almost immediately after taking possession. As indicated above, the XRP does not fundamentally correspond to the definition of an investment contract according to the Howey test. Furthermore,
The document concludes that under a fair application of the Howey test and the SEC's currently expanding analysis, XRP should not be regulated as a security, but rather viewed as a currency or a means of 'exchange. As the chairman of the SEC noted, some cryptocurrencies are “replacements for sovereign currencies, replacing the dollar, euro, yen with bitcoin . This type of currency is not a security ”.
Note : Willkie is Ripple's lawyer on certain issues and relied on certain factual information provided by Ripple in the preparation of this article.
Our point of view
Coming from the former president of the CFTC, this document has a little extra "weight". His experience and knowledge help break down all of the components of Howey's test, arguing why XRP is not a security. The fact that the article's authors work for a law firm that advises Ripple does not negate the article's arguments or the stature of the author. The timing of the document allows us to speculate that the security trial against Ripple may be coming to an end.
Just a week ago, Ripple filed a motion to dismiss allegations of fraud against him and filed the recent rule recognizing the benefits of Ripple and XRP for remittances by the Office of Consumer Financial Protection (CFPB) ) for judicial advice.