Written by: Sophie Bergman

A Brief History of Ripple and XRP

Ripple’s inception as a fintech company began in 2012, with an aim to develop a digital infrastructure that support’s instant international global payment transactions. The founders set out to improve the existing state of cryptocurrency with a more scalable and decentralised solution.

Engineering their own open source blockchain, XRPL, the project has since made impressive strides towards mass adoption, with several well-known companies, such as American Express and Santander, utilising its technology.

Ripple also launched XRP, a native cryptocurrency for its digital products, to serve as an intermediate mechanism of exchange between either two currencies or networks. Ripple minted a finite 100 billion tokens which were allocated 20:80 to the founders and company, respectively. The company places XRP in an escrow account which it releases for public sale periodically.

In December 2020, the SEC filed a lawsuit against Ripple Labs and two of its executives for allegedly selling $1.3 billion in XRP cryptocurrency tokens in a series of ‘unregistered’ securities offerings.

The SEC Suit

The first thing you need to know is that securities must be registered with the SEC before they are sold.

Accordingly, when Ripple sold millions of dollars of their cryptocurrency, XRP, without registering, the SEC were not best pleased. The commission seeks unspecified damages from Ripple and hopes to ban its executives from participation in digital asset market trades. Investors, regulators and crypto-fanatics are closely watching the outcome of the case that is the first of its kind and could have a huge impact on the industry.

The ongoing litigation centres around a key question: is XRP a security or a cryptocurrency? In other words, was XRP legally obliged to register their assets with the SEC or instead, should it fall under the remit of the CFTC (Commodity Futures Trading Commission) – which is more leniently regulated.

According to Investopedia:

“A security is a fungible, negotiable financial instrument that represents some type of financial value, usually in the form of a stock, bond, or option.”

“A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend.”

There are clearly similarities between both asset classes.

Unlike Ethereum and Bitcoin, which run on entirely decentralised public ledgers, XRP is operated centrally by Ripple Labs who developed their own blockchain. Because of this, the SEC believe XRP is a security which falls under their regulatory authority. On the other side of the coin, Ripple claim XRP is a currency and therefore exempt from the SEC’s strict regulation and disclosure requirements.

In June 2021, Ripple labs added a ‘fair notice’ argument to their defence. This allows defendants to rely on the premise that no person should have “to speculate as to the meaning of statutes”. In other words, it established the right for organisations to be privy to clear guidelines regarding what they can and cannot do. Arguably, the SEC has failed to provide a clear regulatory framework for the, relatively nascent, cryptocurrency industry. In an interview, Ripple General Counsel Stuart Alderoty, explains “the SEC failed to give fair notice to market participants about which digital assets they would consider to be what’s called investment contracts under the law or, stated even more precisely, how they would go about determining which digital assets would be investment contracts under the law.”.

Case developments are being closely watched by the industry and media. Just last week Ripple surged as it emerged that U.S. District Judge Analisa Torres of Manhattan announced that memos containing legal advice given to Ripple would be publicly unsealed around February 17th. Torres stated that the 2012 memos were critical to both parties prior attempts to dismiss the case, are critical to its outcome and therefore, categorised as judicial documents which should be made public. According to Alderoty, the new evidence “will show that in 2012 Ripple received a legal analysis that XRP was not an investment contract.”, which could be a tipping point in the case. The expectation appears to have come to fruition. Though the documents remain sealed, from what can be gathered so far, their contents deeply favour Ripple’s case. Predictions about a new $30 million transfer from XRP to list on Coinbase (a popular crypto trading platform) have started to circulate. #XRPArmy began trending on Twitter on February 19th – a sign of support from crypto-fanatics and invested stakeholders

If Ripple are successful, the case will create a precedent that limits the SEC’s ability to pursue claims against other similar centralised, digital assets and fintech companies, without fundamentally changing the law. On the other hand, if the SEC triumph, these companies will likely lose substantial value. They will be required to either fundamentally adjust to SEC regulations or close down their business. If the judge rules in favour of the SEC, Ripple executives may move their operations to a different jurisdiction, indicating the scale of the cases impact.

In April 2021 Gary Gensler succeeded former SEC Chair Jay Clayton. Gensler is a co-director of MIT’s Fintech@CSAIL (who work closely with start-up’s reinventing global financial services), and senior advisor to its Media Lab Digital Currency Initiative. With his experience, Genslercould bring a fresh perspective to a case centred around novel technologies and financial instruments.

For law firm’s with fintech, blockchain or similar practice groups, knowledge of the case is essential to be best placed to advise tech-focused clients on any regulatory developments which could impact their business and customers. At present, digital currencies are generally regulated through CFTC regulations (Commodity Futures Trading Commission) which are considerably less stringent than the SEC’s.Interestingly, the SEC proposed a 654-page guidance for trading securities at the end of January which was backed in a vote last month. Although the document doesn’t explicitly mention digital asset exchanges, many believe that it intends to as it clearly states that it applies to “trading any type of security”. As the SEC v Ripple case demonstrates, the SEC now include“digital assets” under the umbrella of “any type of security”. Clearly, change is coming in the US as legislators race to keep up with the pace of global financial innovation.

Ultimately, the outcome of the SEC v Ripple litigation will most likely have big implications for the crypto-industry. Due to the international, mainstream adoption of cryptocurrency, and the subsequent necessity for governments to regulate the space, the case is an important one in the US and globally.