The court proceedings between Ripple Labs and the Securities and Exchange Commission haven’t come to a conclusion, and we won’t be able to provide any definitive answers to what we as here today, but we can speculate based on the existing information.
Determining whether or not the XRP cryptocurrency is a security is really beyond the purview of this article, we don’t intend to try. Our intention here is to provide some clarification, and clear up some of the confusion surrounding the issue, and maybe shed a little light on what we might be able to expect in the future. So let’s get the ball rolling with some definitions.
Securities versus Commodities
Here’s how investopedia defines a security:
“The term “security” refers to a fungible, negotiable financial instrument that holds some type of monetary value. It represents an ownership position in a publicly-traded corporation via stock; a creditor relationship with a governmental body or a corporation represented by owning that entity’s bond; or rights to ownership as represented by an option.”
And since we’re on the topic, here’s how they define a commodity:
“A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. Commodities are most often used as inputs in the production of other goods or services. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they are traded on an exchange, commodities must also meet specified minimum standards, also known as a basis grade.”
And here’s an elaboration on commodities.
“Some traditional examples of commodities include grains, gold, beef, oil, and natural gas. More recently, the definition has expanded to include financial products, such as foreign currencies and indexes. Technological advances have also led to new types of commodities being exchanged in the marketplace. For example, cell phone minutes and bandwidth.”
Got it?
Good.
By definition, the governance coin issued by a DeFi project like Uniswap could be considered a security by the above definition. It represents ownership privileges in a corporation, holds monetary value. That’s definitely something to watch for in the future.
What’s the relationship here to XRP?
Not much.
Owning XRP gives you zero ownership cachet or voting rights, or any other kind of rights regarding Ripple, the company. Ripple is its own autonomous company, complete with their own stock, and there are legit and legal ways to own chunks of Ripple Labs through buying some of their stock, but not through XRP.
The SEC uses a different rubric for determining what is and is not a security, though. Let’s discuss that next.
What is the Howie Securities test?
The Howey Test refers to a Supreme Court case for determining if a transaction qualifies as an ‘investment contract’ and therefore a security, and whether or not it falls under the purview of the disclosure and registration requirements put forth by the Securities Act of 1933 and the Securities Exchange Act of 1934.
More specifically, the Howey Test refers to SEC v. W.J. Howey Co, which came before the Supreme Court of the United States in 1946. Howey Company sold citrus groves to buyers in Florida, who would then lease back the land to Howey. After which, company staff would maintain the groves and sell the fruit for the owners. Both parties made money off the deal. Howey didn’t register the transactions, and the SEC had something to say about that. The court ruled that the leaseback arrangements met the qualifications for investment contracts.
This set the standard by which the SCOTUS would use to determine the existence of an investment contract. According to their definition, an investment contract is:
The case didn’t work out so well for Howey. The folks who bought the Florida citrus groves derived value from the transactions due to the labour and expertise provided by others. Buyers only needed a capital investment to access an income stream, which classified the transaction as an investment under what’s now called the test, and therefore should have been registered with the SEC.
What’s this got to do with Cryptocurrencies?
Digital currencies don’t fit well into existing categories, and as such they’re notoriously regulation resistant. That’s not going to stop the SEC from trying to shove cryptocurrencies square-peg into existing regulations round-hole, though.
How does XRP fit into this rubric?
The SEC contends that the ‘investment of money’ test is easily satisfied with digital assets because fiat cash or other digital assets are exchanged.
Secondarily, the SEC asserts that every XRP holders has engaged in ‘common enterprise’ test is almost a lock, but certain lawyers (and Ripple themselves) disagree. Common enterprise is defined as a way for common objectives to be followed by two or more firms. Thereby the profits of the investor are combined with and depend on the success of third parties which are hired or those offering or selling the investment.
As far as the utility of XRP is concerned, the asset has found uses in cross-border remittances payments. Ripple’s on-demand liquidity solution uses XRP as an intermediary currency between fiat currencies across the world.
“The open-source nature of XRP allows users throughout the world to use the token to pay for goods and services without any connection to or reliance on Ripple. According to Cryptwerk, over 1,300 companies currently accept XRP for payment across industries from business services to tourism and travel,” said John Deaton of the Deaton Law Firm, in his blog.
Deaton has also filed a motion in the Ripple v. SEC case on behalf of XRP holders to state that they were not in ‘common enterprise’ with Ripple, in contravention of the SEC’s claims.
Finally, in most cases, the determination of whether a digital asset can qualify as an investment contract hinges on whether or not there is an ‘expectation of profit to be derived from the efforts of others.’ In this case, it’s a curious question.
Are the purchasers of a digital asset relying on the efforts of others if they’re depending on the project’s backers or development team to develop and maintain the digital network, especially in its early stages? Possibly. The test could theoretically also be met if the project’s backers support the price of the asset, such as controlling scarcity and supply through token burning, or maybe through acting as asset managers.
What does this mean for the future of cryptocurrency?
Again we can only speculate here, but if the courts come down in favour of the SEC’s claim and Ripple has to show up to register XRP as a security (and then deal with class action suits) in theory it could produce a more cautious approach towards centralization than presently exists. It’ll definitely reinforce the notion that centralization leads to government overreach for some, and we’ll see a cautious retreat into DeFi, with many organizations pushing full decentralization ahead in their timelines.
Stablecoins, like the United States-based stablecoin USDC, backed by an American company, Circle, could be in a bit of a tight spot.
The court case continues.
—Joseph Morton
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