Welcome to our new series, Node Notes, where we’re spotlighting topics from our bi-weekly research piece, The Node Ahead. If you want to read the full piece, you can check out our blog or sign up to receive The Node Ahead straight to your inbox. This edition of Node Notes is an excerpt from Node Ahead 47.
In 2020, the SEC sued Ripple for allegedly selling billions of dollars worth of unregistered securities. Rather than settling with the SEC, Ripple chose to spend nearly three years and over $200 million in legal fees to defend itself. In past issues, we covered the details of the lawsuit, why the outcome could have major ramifications for the industry, and explained in depth how the Hinman emails undermined the SEC’s case. Last week, the judge for the case made a landmark ruling that significantly changes the landscape for the crypto industry.
The court ruled that while Ripple’s institutional sales of its token XRP were found to constitute an unregistered securities offering, the token itself and the programmatic sales of XRP are not securities.
What on earth does that mean? Well, there are two parts to the ruling, and they could benefit multiple parts of the crypto ecosystem, from exchanges to DAOs.
When Ripple initially launched its token, the company sold $729 million worth of XRP directly to institutional investors (VCs, Hedge Funds, Banks, etc…) who knew they were investing in Ripple. Since the initial sale, Ripple also sold an additional $14 billion worth of XRP directly to institutional buyers over the years. The court deemed this initial sale and subsequent sales directly to institutional investors to be securities. Thus, Ripple was found guilty of selling unregistered securities, just as the SEC had claimed.
However, the judge also ruled that the token by itself is not an investment contract, meaning XRP is not a security. This is akin to the difference between investing in an orange grove and the oranges themselves. Investing in a company that runs an orange grove is an investment contract (and thus a security), but the oranges themselves are commodities. The judge ruled the same principle applies to XRP.
Furthermore, the programmatic sales of XRP did not violate securities laws. These were sales made by Ripple on crypto exchanges where the buyer did not know who they were buying from and could not know they were investing in a common enterprise. If you buy XRP on Coinbase, you don’t know who you are buying that token from, just that you now own a certain amount of XRP. So, the sale of XRP on crypto exchanges was ruled not to be a security offering.
According to the ruling handed down by U.S. judge Analisa Torres, “XRP, as a digital token, is not in and of itself a ‘contract, transaction, or scheme’ that embodies the Howey requirements of an investment contract.” In short, selling digital assets to institutional investors without going through proper registration violates the law, but the trading of XRP on exchanges is fair game.
While Ripple may face legal action for the initial sale, this is an enormous victory for the crypto industry as a whole because the judge just shot down Gensler’s long-standing position that all cryptoassets other than bitcoin are securities. It is now a matter of law that XRP is not a security, and the sale of XRP on exchanges does not make XRP an unregistered security. The only thing the Court found constitutes an investment contract is the direct XRP sales to institutional clients. The ruling lends further support to the view advanced by Director Hinman that a cryptoasset may initially be sold as part of an investment contract and then later be resold as a non-security (a view in stark contrast to Gensler’s public comments).
There is now legal precedent that crypto tokens other than bitcoin aren’t securities, thereby crippling the SEC’s stance that token marketplace operators are inherently violating federal securities laws. If a token isn’t a security, any exchange that lists that token can’t be considered as operating an unregistered securities exchange (which just so happens to be the exact accusation the SEC made against Coinbase and Binance).
Ripple is a traditional, centrally run business with a CEO which had standard sales via exchanges and formal distribution programs. If XRP isn’t a security, it’s hard to imagine that many cryptoassets would be classified as securities since most crypto projects are far more decentralized than Ripple. If XRP isn’t a security, it only makes common sense to conclude that ETH, SOL, MATIC, FIL, AAVE, COMP, UNI, and many more aren’t securities. That includes many of the tokens the SEC specifically named in their lawsuits. And if a token isn’t a security, the SEC has no jurisdiction over it or the venue it trades on. This watershed ruling significantly undermines the SEC’s power over the crypto industry, as well as the SEC’s case against both Coinbase and Binance.
Understandably, XRP nearly doubled in price in less than 24 hours. Other blue-chip cryptoassets targeted by the SEC’s previous enforcement actions have also pumped with SOL and MATIC, achieving double-digit gains. Coinbase’s stock rose over 25% on the day.
The ruling also has big implications for mining rewards and staking services (which, again, the SEC went after Kraken and Coinbase for). Both mining and staking rewards are much more akin to programmatic sales or “other distributions” under the Ripple judgment. It’s very hard to apply the logic of the Ripple case and conclude that either mining or staking rewards are securities.
The judge also ruled that employee payments made in XRP, investments in other projects using XRP, and grants using XRP are not deemed securities. This is a huge win for DAOs and DAO contributors who are largely paid in project tokens. Additionally, this potentially has positive implications for airdrops as there is no payment from the receivers of the tokens.
While the ruling opens up clearer pathways to token distribution and secondary market trading that the SEC was systematically trying to shut down, the ruling doesn’t provide clarity on everything. The most obvious question remains, does a token that was part of an institutional sale remain a security if it is then later sold on an exchange? If it’s fungible with a token that came from a programmatic sale, is one sale a securities sale and one not? Right now, there is no regulatory clarity to that question. Hopefully, this will motivate Congress to step in and pass laws defining exactly when a token is and isn’t a security.
It’s entirely possible the SEC will go scorched earth against Ripple for its institutional sales as a way to save face. It’s unclear at this time if Ripple will be able to weather this enforcement action or if it will ultimately mean its downfall. It’s also likely that the SEC will appeal Judge Torres’s ruling in hopes of overturning it, preventing it from being used as the basis for future legal arguments. But regardless of what happens to Ripple or the appeal, the genie is out of the bottle. Exchanges like Coinbase, Gemini, and Kraken have already re-listed XRP back onto their exchanges, and they’re showing no fear of keeping any of the tokens the SEC has previously listed available for trading.
Because Gary Gensler refused for years to write clear rules for the industry, the court system is now doing it for him. This marks just one of the multiple times a judge has ruled that the SEC’s legal theories on crypto are incorrect. It’s becoming harder and harder for Gensler to argue with a straight face that the law isn’t ambiguous, given that judges keep dismissing his legal analysis as incorrect, leading to growing political pressure. Whereas Republicans previously sent a letter calling for an investigation into the SEC, now even Democrats are coming after Gensler. Following the XRP ruling, representative Ritchie Torres publicly called for not one but two investigations into Gary Gensler, claiming he is “acting like an overzealous traffic cop arbitrarily ticketing drivers while keeping the speed limit a secret.” The first investigation concerns the SEC’s enforcement approach to crypto, and the second concerns the special license granted to Prometheum (we covered this ridiculous story in the last newsletter). You would be hard-pressed to find another institution in the U.S. that has lost more credibility than the SEC has under Gary Gensler.
This ruling likely increases the odds that a market structure bill will get passed in Congress. One reason many democrats have been hesitant to support the passing of a comprehensive crypto bill was the SEC’s claims that new regulations weren’t needed. This ruling highlights how much the SEC overstepped its authority and the lack of regulatory clarity in the market. If the tokens are not themselves investment contracts, as found in this ruling, then the SEC does not have jurisdiction over the sales of digital assets on exchanges. If the SEC doesn’t have oversight, there is no federal regulatory regime to supervise and regulate the trading of digital assets. This is a gap in consumer protection that the SEC cannot fill (as the Hinman documents revealed that many within the SEC knew to be the case years ago). This ruling could shift the narrative in Washington from a sole focus on jurisdiction to exploring how best to provide consumer protection, making crafting legislation a far less contentious exercise than it has been previously. Both the Lummis-Gillibrand bill in the Senate and the Waters-McHenry bill in the House likely have a better chance of passing now.
Having weathered multiple frauds, an unprecedented regulatory onslaught, and widespread disillusionment over the past 12 months, the sentiment around the crypto industry is beginning to shift for the better. Bitcoin is up 80% year to date. Blackrock recently filed for an ETF (which could bring billions, if not trillions, of new capital into the space). The judgment in the Ripple case is another indicator that maybe the industry has rounded an important corner. The fact is, we now live in a significantly different regulatory environment than we did a week ago, and that is very bullish for crypto moving forward.
Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.