The U.S. Securities and Exchange Commission (SECSEC US government agency that regulates securities markets.) is pursuing a hefty fine of nearly $2 billion against Ripple Labs, as revealed in court filings. Ripple Labs’ Chief Legal Officer, Stuart Alderoty, disclosed the SEC’s proposal for the fine on social media, indicating that redacted versions of the court documents would be released by March 26.
The SEC’s proposal entails Ripple Labs paying $876 million in disgorgement, $198 million in prejudgment interest, and an $876 million civil penalty, totaling $1.95 billion. The legal dispute originated in December 2020 when the SEC filed a lawsuit against Ripple Labs and its executives, alleging violations of federal securities laws through the sale of XRP to both institutional and retail customers.
A significant development in the case occurred last July when New York Judge Analisa Torres ruled that while the sale of XRP on exchanges and through algorithms didn’t breach U.S. law, Ripple’s institutional sales of XRP did.
The SEC’s filing underscores the importance of deterring similar conduct in the cryptocurrency space and emphasizes the need to send a robust message against such abuses. Alderoty criticized the SEC’s stance and stated that Ripple Labs would file its response to the SEC’s motion the following month. The SEC specified that Ripple Labs’ response should be submitted no later than April 22, 2024. (Source: CoinDesk)
What we think:
The U.S. Securities and Exchange Commission (SEC) took legal action against Ripple Labs, a company that develops and manages the cryptocurrency XRP, as well as its executives. The SEC accused them of breaking federal securities laws by selling XRP tokens to both institutional investors (such as banks or investment firms) and individual retail customers (regular people buying and selling cryptocurrencies). This allegation suggests that the SEC believes Ripple Labs and its executives engaged in activities related to XRP that were not compliant with regulations governing securities tradingTrading Trading is a speculative activity of buying and selling financial assets aimed at profit..
Regulations governing securities trading refer to laws and rules set by government agencies, such as the U.S. Securities and Exchange Commission (SEC), to ensure fairness, transparency, and investor protection in financial markets. These regulations outline requirements for companies issuing securities (like stocks or bonds) and those involved in trading them. When it comes to selling securities, including certain types of cryptocurrencies like XRP, there are specific rules that companies must follow to comply with securities laws. For example:
- Registration: Companies issuing securities typically need to register their offerings with the SEC unless they qualify for an exemption. This registration process involves providing detailed information about the securities being offered, the company’s financial condition, and its operations.
- Disclosure: Companies must disclose relevant information to investors, including financial statements, risks associated with the investment, and information about the company’s management.
- Anti-fraud Provisions: Securities laws prohibit fraudulent activities in connection with the offer, sale, or purchase of securities. This includes misleading statements or omissions of material facts.
In the case of Ripple Labs, the SEC alleged that the company violated these securities laws by selling XRP tokens to both institutional and retail customers without complying with the necessary regulations.
Therefore the SEC classifies the cryptocurrency XRP (operated by Ripple Labs) as a security. Why? Are XRPs really securities?
Traditionally, securities refer to financial instruments like stocks, bonds, and investment contracts that represent ownership or debt and are subject to regulations designed to protect investors. Cryptocurrencies, on the other hand, are digital or virtual currencies that use cryptography for security and operate independently of a central authority. So, again, why are BTC considered cryptocurrencies, while XRP is considered securities? Here’s a breakdown of why Bitcoin is generally considered a commodity, while XRP has faced scrutiny as a potential security:
Decentralization:
- Bitcoin: Bitcoin operates on a decentralized networkNetwork The set of computers connected to each other, called nodes, on which the blockchain of a specific cryptocurrency is based. where transactionsTransaction Exchange of value, property, or data between two parties. are verified by a distributed network of nodesNode Device connected to a blockchain, which makes up the network., and no single entity controls its issuance or operation. This decentralization is a key factor in considering Bitcoin as a commodity, similar to other commodities like gold or oil.
- Ripple (XRP): Ripple operates a more centralized network compared to Bitcoin. The company, Ripple Labs, plays a significant role in the development and distribution of XRP. This centralized control has led to questions about whether XRP should be classified as a security, given the potential for investors to rely on Ripple’s efforts to generate profits.
Use Case:
- Bitcoin: Bitcoin is primarily used as a decentralized digital currency for peer-to-peer transactions and as a store of valueStore of value An asset or commodity that maintains its purchasing power over time., similar to gold. Its primary function as a medium of exchange and a store of wealth aligns with the characteristics of a commodity. Bitcoin has gained recognition as a store of value due to its limited supply (capped at 21 million coins) and its decentralized nature. Many investors perceive Bitcoin as digital gold, a hedgeHedge An investment used to reduce the risk of another investment. For example, gold is often seen as a hedge against inflation because its price tends to rise when the value of currency falls. against inflationInflation A sustained increase in the general price level of goods and services in an economy over time., and a long-term investment assetAsset An economic resource with value that an individual or organization owns, controls, or expects future benefits from. Examples of assets: gold, stocks, cryptocurrencies, etc..
- Ripple (XRP): XRP, on the other hand, was initially created to facilitate fast and low-cost cross-border payments through Ripple’s network of financial institutions. The use of XRP within Ripple’s ecosystem, combined with its centralized distribution and potential reliance on Ripple’s efforts for profit, has raised questions about whether it should be classified as a security.
So, let’s see why the use of RIpple (XRP) has raised questions about whether it should be classified as a security:
Supply of XRP: Ripple’s control over a large portion of the XRP supply gives it influence over the market dynamics, including the potential impact on price movements and liquidity.
Distribution Strategies: Ripple Labs employs various distribution strategies to manage the release of XRP into the market. These strategies include institutional sales: Ripple has engaged in direct sales of XRP to institutional investors, financial institutions, and strategic partners. These sales are often conducted through over-the-counter (OTC) transactions and aim to support XRP liquidity and ecosystem development. Direct sales of a cryptocurrency to institutional investors, especially if conducted by a company with significant control over the cryptocurrency’s supply and distribution, can raise questions about whether the cryptocurrency meets the definition of a security. Such sales may indicate an investment contract where investors expect profits from the efforts of others, which is a key element in the Howey Test used to determine whether an asset is a security under U.S. securities laws.
In conclusion, the classification of XRP as a security remains subject to ongoing legal and regulatory proceedings. As the case between Ripple Labs and the SEC continues to unfold, the outcome will have significant implications for the cryptocurrency industry and the regulatory treatment of digital assetsAsset An economic resource with value that an individual or organization owns, controls, or expects future benefits from. Examples of assets: gold, stocks, cryptocurrencies, etc.. According to the Howey Test, a security qualifies as such if it involves all of the following four elements: an investment of money, in a common enterprise, with an expectation of profit, derived from the efforts of others. In 2019, the SEC ruled that bitcoin does not pass the Howey test; according to the ruling, bitcoin only complies with the first point, but not the others. Additionally, in 2023, Gary Gensler, Chairman of the SEC, has repeatedly reiterated that practically all tokens based on Proof-of-Stake could be considered as securities. Are all cryptos using PoS as a consensus mechanism at risk? Keep on following us because we will keep you updated on these issues.