Making Ripples in the Regulatory and Banking World
Outline:
- XRP is a pre-mined token that secures the Ripple payment system
- XRP is already adopted by 15 of the world’s largest 50 financial institutions to make transfers quick and easy
- The SEC alleges that XRP tokens are unregistered securities
- Projections for XRP are bullish, but its future and the regulation of many other cryptos depend on this SEC case
Ripple is a secure payment service for banks that created the XRP token to facilitate quick and cheap money transfers. In 2011, Jed McCaleb, Arthur Britto and David Schwartz took inspiration from Bitcoin to develop what would eventually become Ripple Labs. By 2013, they teamed up with a precursor service created by Ryan Fugger. As of 2014, the company began working with banks to transfer funds.
Unlike other cryptocurrencies, XRP doesn’t involve any energy-intensive mining. XRP tokens are all minted beforehand and sold off every month to raise funds for Ripple Labs. It processes transactions just as fast as Visa, but it is highly centralized. It is a little ironic that XRP is one of the ten largest cryptocurrencies by market cap, given that centralization is the anti-thesis of cryptocurrency.
Ripple Labs has also been embroiled in a lawsuit with the Securities and Exchange Commission since 2020. Along with two executives, the company is charged with offering $1.3 billion in unregistered securities. The outcome of this case will likely set a precedent for regulating future initial coin offerings.
Ripple Solves Problems for Banks
It still costs a lot of money for large financial institutions to send money between themselves. Ripple provides them with a payment platform to issue and transact in any other currency. One party issues an IOU, which the other transacting party can then fill. XRP is used as reserves for the different banks and also to pay for transaction fees.
All in all, this means that Ripple can process 1000 transactions per second while Bitcoin maxes out at 7. Additionally, it only takes 3.5 seconds for transaction confirmation on the blockchain. Fifteen of the world’s 50 largest banks are using Ripple already. Each bank also acts as a node on the network, ensuring control over the transactions. Since the only clients are banking institutions willing to use XRP, there aren’t many nodes. This heavily centralizes all the services on the blockchain.
A Brief History of Ripple
Ripple’s history sounds like a plot point cut from Succession: it is filled with family drama and disagreements. But what can you expect when 20 per cent of the total tokens are allocated to the co-founders, who gave some of it to their family members.
Origin of Ripple Labs and Early Fundraising
Jed McCaleb took the reins of Ripple’s precursor from Fugger when he merged his own bank payment company to form OpenCoin, which later became Ripple. He later brought on Chris Larsen, who was key to Ripple’s early development. McCaleb may sound familiar as he originally founded the infamous Mt Gox Bitcoin exchange before selling it to Mark Karpeles.
In 2012, it received its first investment of $200,000 from Kraken CEO Jesse Powell. XRP launched in January of 2013, after pre-mining 100 billion tokens. By April of that year, they had raised $1.5 million in funding from multiple tech venture-capital firms. In September, the company was renamed Ripple Labs.
Strife Over XRP Founder Allocation
All was not well within Ripple Labs. Some of this strife emerged from how tokens were initially distributed: 80 billion to the company and 20 billion split across the founding team of McCaleb, Larson and Arthur Britto. McCaleb received 9.5 billion XRP tokens. Powell, one of the early investors, was unhappy with the allocation and wanted them to return it to the company.
In 2015, Ripple froze the funds of one of McCaleb’s family members who attempted to trade 96 million XRP, violating agreements McCaleb signed. This led to his eventual departure in 2017 to start another competing cryptocurrency called Stellar (XLM). He signed a deal to avoid dumping all of his XRP at once. Over the course of 2020, he sold $400 million worth of XRP.
According to BitMex, more than 30,000 blocks of information are missing from the original ledger, making it unclear exactly how much XRP the company is holding.
Is that illegal? Sue me!
McCaleb narrowly avoided being an infamous part of crypto history: First with Mt Gox and now with the Ripple lawsuit. According to the 2020 suit from the Securities and Exchange Commission (SEC), Ripple sold $1.3 billion in unregistered securities. Larsen – one of the co-founders – now sits as the board’s executive chairman, and the current CEO, Bradley Garlinghouse, is also listed in the filing.
From the SEC’s perspective, pre-minting and selling tokens are equivalent to selling securities, as they were exchanged for non-cash considerations. They allege that Ripple wanted to sell securities to finance the company without registering, translating from legalese. This is compared within the filing to an initial profit offering or IPO.
“We allege that Ripple, Larsen, and Garlinghouse failed to register their ongoing offer and sale of billions of XRP to retail investors, which deprived potential purchasers of adequate disclosures about XRP and Ripple’s business and other important long-standing protections that are fundamental to our robust public market system,” said Stephanie Avakian, Director of the SEC’s Enforcement Division.
Garlinghouse believes that the suit may be settled in 2022: “Clearly, we’re seeing good questions asked by the judge. And I think the judge realizes this is not just about Ripple; this will have broader implications.”
Is Ripple Really A Security?
Ripple has requested that the SEC provide their documentation on the Howey test, established by the Supreme Court to assess whether an offering is a security. The Howey test comes from a ruling more than 70 years ago establishing two criteria to define security offerings per the test.
- An explicit promise of ownership or share of the firm’s revenues or profits
- An explicit promise of return on investment
Unsurprisingly, this practically ancient precedent is challenging to adapt in the online world and cryptocurrency space. Some people believe that XRP satisfies the Howey test and those who do not.
Here’s a thought: We should have specific financial regulations surrounding the financial tech space.
The SEC Might Ruin Their Own Case
A non-profit organization called Empower Insight is seeking communications between SEC officials regarding the matter, investigating a potential conflict of interest. Former SEC director William Hinman allegedly contributed to SEC’s crypto regulation while earning money from a law firm called Simpson Thacher, a former employer involved with the Enterprise Ethereum Alliance.
The report alleges:
“Later, the SEC sued one of Ethereum’s competitors, Ripple, declaring its cryptocurrency, XRP, was security. Shortly after that, XRP’s value plummeted 25%. After Hinman left the SEC in December of 2020, he returned to Simpson Thacher as a partner. The leader of the SEC division that brought the XRP lawsuit, Marc Berger, similarly left the SEC for Simpson Thacher.”
Former SEC chairman Jay Clayton is also under scrutiny by Empower Oversight. He claimed that Bitcoin was not a security, but after leaving the SEC, he joined One River Asset Management, a cryptocurrency hedge fund focused on Bitcoin and Ethereum. The SEC was also caught trying to delete some documents relevant to the case.
John Deaton, the lawyer for XRP Holders, also believes that this constitutes a conflict of interest.
Impact of the Future Ruling
There is currently no regulation for cryptocurrencies and no guidance or protections for investors. A ruling may set a precedent for what may legally be considered an initial coin offering versus an IPO. Additionally, it will affect how the law recognizes different types of digital financial assets.
“It’s now been more than a decade since this new asset class has been around, and we’ve yet to start focusing on creating regulations targeted to it,” said Carol Goforth, professor at the University of Arkansas School of Law.
A key part of the case involves the relationship between Ripple and XRP. Ripple’s regulatory relations director Ryan Zagone testified to Britain’s Parliament, saying: “XRP is open source, and our company did not create it, so that existed as an open-source technology. We created a company that was interested in modernizing payments and then began using that open-source tech to do so.” He added that “We do own a significant amount of XRP. It was gifted to us by some of the open-source developers that created it.”
If you recall, the XRP tokens were created while Ripple was known as OpenCoin. Additionally, since the co-founders own a substantial amount of tokens, they may have an undue influence on its price and development. Is it a security or currency? Meanwhile, Ripple and several critics pointed to potential conflicts of interest for some SEC lawyers.
It is anyone’s guess what’s going to happen, but here are a few possibilities for either verdict:
A) XRP is Declared Security
- All other ICOs will be declared securities
- Only ICOs for tokens with no apparent function will be regulated as securities
- XRP and other future ICOs are treated as distinct entities with distinct regulations
- Precedent is set for regulating DAOs and NFT projects
- The findings are appealed due to the prosecutor’s conflicts of interest
B) XRP is Not Declared a Security
- The decision holds precedence for all future ICOs
- The decision holds precedence only from some future ICOs
- This leads to calls for more regulation and legislation in Congress
- SEC adopts a more laissez-faire attitude to cryptocurrency
Who (if Anyone) Should Consider Investing in XRP?
The Crypto Idealist?
No, it’s not ideal. Bitcoin and many other cryptocurrencies were developed as decentralized peer-to-peer alternatives to large financial institutions. With multiple nodes competing to validate each transaction, it is secure and transparent.
Meanwhile, XRP is a centralized bank-to-bank financial system to bolster big banks. There are very few nodes corresponding to each bank, and transactions are not censor-proof as they may freeze them. There is a lack of transparency with potentially missing information on its ledger and large allocations to its founding team.
For the Savvy Crypto Investor?
It’s got some potential. In 2017, XRP was the second-largest cryptocurrency by market cap. It currently sits in the Top 10 with a $41 billion market cap and bolsters bullish projections. Now, each token is worth $0.80 though, at its peak, the price has hit highs of $1.30. Pending regulation, increased adoption by banking institutions could cause the current price to conceivably double or possibly triple.
Yes, it has a strong use case and has already been adopted. But on the downside, a large amount of tokens were delegated to the co-founders, giving them significant sway on the price. With the lack of transparency, it is likely that the price of Ripple will remain volatile for the next year or so. Right now, XRP has medium risk due to the pending SEC lawsuit but it could bring moderate returns.
Buying and Storing XRP
Due to the impending lawsuit, many centralized exchanges de-listed XRP. However, it is currently available on Binance and Crypto.com for purchase. Since XRP uses its own blockchain, it cannot be stored through MetaMask. Luckily, Ripple wallets are supported by Exodus.
Where to store your XRP:
Hot Wallets
Cold Wallets
Wallet
Platforms
Desktop
Mobile App
Desktop
Mobile App
Connection via
USB or Bluetooth
Supported Wallets
Trezor
Exodus
Setup
Easy
Moderate
Non-Custodial
Yes
Yes
Takeaways
Ripple is a payment platform developed for banks, allowing them to send and receive transactions faster and cheaper. All of the tokens in this ecosystem, XRP were pre-mined with 20 percent allocated between three co-founders. XRP has faced issues from within over the allocation and from external audits over the completeness of its ledger.
Nonetheless, its adoption and use by banking institutions has ballooned it into the Top 10 cryptocurrencies by market cap. But this may be undone by the SEC, who filed a court case alleging securities fraud. Basically, since the relationship between Ripple and XRP is so close, they view the selling off of XRP tokens as a securities sale. There are issues both with Ripple’s arguments and the SEC case as a whole; no matter the result – it will have a huge impact on the crypto regulation landscape.
If you’re a crypto idealist, a centralized bank-to-bank payment platform that isn’t completely transparent isn’t for you.
XRP poses a moderate risk for retail investors due to the SEC filings and many tokens distributed to founders. However, there is a chance for more considerable gains and decent returns if the ruling comes out in their favour. It’s not inconceivable for XRP to hit the $3 – $5 range if a favourable SEC ruling next year. A lot of people are very bullish on it.
Also, banks usually get their way by just paying a fine and moving ahead. I’d be surprised if Ripple doesn’t do this too.
Opinion
I’m not overly bullish on XRP, but I do think the SEC ruling could very easily go in Ripple’s favour. In that case buying in at around a dollar would probably be a pretty good deal in hindsight.
– Mark
Make your own choices. Do your own research.
