SEC claims XRP is a security due to centralized nature

Rick Steves

The SEC has already indicated that bitcoin and Ethereum are not securities due to their decentralized nature, but Ripple is viewed differently by the SEC, which has taken the position that the development and distribution of XRP were conducted by Ripple in a centralized way.

Nikhil Mehta, an attorney specialized in blockchain, cryptocurrency, and fintech at SmithAmundsen LLC, said the Ripple lawsuit may have a significant impact on the future regulation of not only cryptocurrencies but also blockchain and financial technology.

In a quick recap, the SEC filed an action against cryptocurrency giant Ripple alleging the firm sold XRP as an unregistered security. The SEC argues that XRP is a security, and not a commodity or other type of asset, because it was generated, distributed, and sold by Ripple Labs.

On whether XRP is an “investment contract” (and thus a security) under U.S. securities laws, Mr. Mehta says: “The U.S. Supreme Court’s decision in SEC v. W.J. Howey Co. provides that an investment contract exists when there is “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

“The SEC has already indicated that bitcoin and Ethereum are not securities due to their decentralized nature, which is a hallmark of blockchain applications”, Mr. Mehta continued. “Ripple, on the other hand, is viewed differently by the SEC, which has taken the position that the development and distribution of XRP was conducted by Ripple in a centralized way.

“One of the examples given by the SEC is that Ripple, by itself, minted the entire supply of XRP when it was first launched. For its part, Ripple is seeking to review the SEC’s internal discussions about XRP and whether the SEC believed it was an investment contract. Some observers believe that if permitted, this development could hurt the SEC’s case against Ripple and XRP.”

Critics of the SEC’s lawsuit against Ripple point to the potential crippling of a nascent industry and to the timing of its filing: one day before Chairman Jay Clayton resigned from the SEC.

Only three of the five SEC commissioners approved filing the Ripple lawsuit and the case doesn’t seem to involve any harm to investors, some argue. Others say the SEC should wait and pursue a more clear-cut case under the Howey test.

Mary Jo White, Former SEC Chair and current Ripple defense attorney, said: “There’s no way to sugarcoat it. [The SEC is] dead wrong legally and factually.”

Nikhil Mehta then concluded that “the Ripple lawsuit may have a significant impact on the future regulation of not only cryptocurrencies, but also blockchain and financial technology (FinTech) applications, which operate using similar technologies.” The parties have already engaged in settlement discussions.

Ripple argued that “utility depends on XRP’s near-instantaneous and seamless settlement in low-cost transactions. Treating XRP as a security, by contrast, would subject thousands of exchanges, market-makers, and other actors in the gigantic virtual currency market to lengthy, complex, and costly regulatory requirements.”

The case has the potential to establish additional meaningful precedent for the application of securities laws to the sale of digital assets.

Cryptocurrency trading under the SEC’s shadow

Many investors who aim to diversify their trading strategies by adding crypto CFDs to their portfolios have become apprehensive about the future of the asset class in regard to its regulatory standpoint.

FinanceFeeds spoke to Natalia Zakharova, Head of Business Development at FXOpen, a global company that offers multi-asset trading, including crypto CFDs, to ascertain her view on the future of a regulated cryptocurrency market.

“The crypto market has been very volatile and unpredictable lately, but many factors point to the fact that crypto will move into a regulated direction. At first glance, it seems like a good thing.

“However, will cryptos lose their appeal when they become just another centralized currency, possibly pegged to EUR or USD? In a market-driven by volatility will cryptos maintain their volatility and consequently their market share if regulated? This remains to be seen.

“In the meantime, I think that the traders should continue to see crypto as one of the instruments available, stick to their strategy and just determine the right entry and exit points”, Ms. Zakharova stated.

In the meantime, the UK Financial Conduct Authority has already banned the trading of crypto CFDs.

The ban announcement was issued on 6 October 2020 and retail brokers started to enforce the new restriction on 6 January 2021. The total ban will take effect on 25 March 2021.

“The FCA considers these products to be ill-suited for retail consumers due to the harm they pose. These products cannot be reliably valued by retail consumers because of the:

inherent nature of the underlying assets, which means they have no reliable basis for valuation
prevalence of market abuse and financial crime in the secondary market (eg cyber theft)
extreme volatility in cryptoasset price movements
inadequate understanding of cryptoassets by retail consumers
lack of legitimate investment need for retail consumers to invest in these products
These features mean retail consumers might suffer harm from sudden and unexpected losses if they invest in these products.”

The regulator stated that retail consumers are estimated to save around £53m from the ban on these products.

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