Just before the end of 2020, the SEC filed a lawsuit against Ripple Labs and its two top executives with claims that they unlawfully sold over 14.6 billion units of the digital asset "XRP".
The lawsuit targets conduct dating back to 2013 where per the SEC's claim, Ripple sold over USD$1.38 billion in XRP to fund Ripple Labs' operations. The SEC allege that this sale was required to be registered as a sale of securities.
The suit is premised on the SEC's position that the cryptographic token XRP is a security. If this is correct, then Ripple Labs would have evaded the requirement to provide investors with material information that other issuers are required to provide - the SEC say this benefited Ripple's founders to the tune of over $600 million in personal profits.
The discussion over whether XRP may be considered a security, due to its close ties to Ripple Labs, is not a new matter. The connection with Ripple Labs implies more centralisation than, for example, Bitcoin or Ethereum where the SEC has previously stated that the lack of a third party "whose efforts are a key determining factor in the enterprise" mean those tokens are not likely to be considered securities under US law.
The SEC says that in 2015 Ripple requested that the issuer of an investment fund (created to generate exposure to XRP) add the following to the disclosures for the fund:
The Ripple ecosystem's reliance on the efforts of Ripple Labs - the single largest holder of XRP- to promote and expand the ecosystem creates greater risk that XRP might be deemed a security compared to other virtual currencies and Ripple Labs might be deemed to be operating as an unregistered securities exchange, broker, or dealer under federal and state securities laws.
The SEC asserts this demonstrates Ripple Lab's awareness of the risks. The SEC also cites repeated warnings to Ripple Labs about XRP. Ultimately the SEC is seeking orders to:
Order the payment of 'ill-gotten profits' from the Ripple founders and Ripple;
Prohibit Ripple Labs (and its executives) from participating in any offering of digital assets securities; and
Impose civil penalties.
While the lawsuit continues, many digital currency exchanges have suspended trading of XRP, likely out of fear that they in turn might be accused of trading a security without proper licensing.
This has resulted in significant impacts on one of the largest digital currencies in the market with a market value, as reported by Bloomberg, which has previously had a market cap of $21 billion, ranking near Bitcoin and Ether in size.
Ripple has not hesitated to attribute the lawsuit to regulatory uncertainty in a recent statement stating that:
We have always said there is a dangerous lack of regulatory clarity for crypto in the U.S.
Considering the 8 years of XRP's operation and the strong moves by the SEC to condemn its operation, as well as past settlements by projects which raised funds by selling tokens (noting such settlements were on a "without admissions" basis), this lawsuit may well be a tipping point for more digital assets, linked to more centralised governance models, to move outside the U.S. for their distribution, to jurisdictions which are providing a framework for the issuance of tokens.
The US, like Australia, has taken a position of not seeking to create any specific framework for the issuance of so-called "utility tokens" either as a security or not, leaving a grey area which focuses on the activities being conducted.
This grey area and moves by the SEC may also hasten a faster drive to blockchain businesses engaging in highly decentralised models which mimic Bitcoin and Ethereum more closely, leaves regulators with no individuals to pursue even if they believe an offering is one of securities.
Ripple Labs appears ready to defend the suit vigorously and leading US lawyers are in debate on the outcome, with traditional securities lawyers taking the view Ripple will likely lose, and many Blockchain lawyers emphasising the uncertainty around the historical tests under US law.
The outcome of the case, whether by settlement or a full hearing, is going to cause more than mere ripples in the Blockchain pond.