Our experts explained the ins and outs of Ripple Labs’ important lawsuit for the crypto industry and why the classification of its XRP token as a security is so important. Recall immediately that the Court of the Southern District of New York ruled in favor of the blockchain company Ripple Labs in the process against the US Securities and Exchange Commission (SEC). At the next meeting, Judge Analisa Torres delivered a verdict that neither sales nor other forms of distribution of XRP tokens issued by the company, as well as sales of these tokens to private investors, are equated to transactions with investment contracts, that is, in fact, tokens are not recognized as securities. Ownership of tokens, their placement on exchanges, payment by them, algorithmic distribution of coins and other retail operations are not equated to such operations. However, the court recognizes the sale of tokens to institutional investors under a preliminary agreement as an operation with an investment contract. The judge’s decision is not final, the case will continue to be considered in court, and the SEC may appeal.
The multi-year US SEC lawsuit against Ripple Labs is a significant process because its results can subsequently be used as a precedent when considering similar cases. At the moment, the SEC alone makes decisions on the status of a particular cryptocurrency, guided by the so-called Howey test. In theory, a victory in court will actually untie the commission’s hands and serve as the basis for even more similar claims and lawsuits.
The main US exchange regulator has been suing Ripple Labs for several years. On December 22, 2020, the agency accused the company of selling unregistered securities worth $1.3 billion under the guise of XRP tokens. Over the years, the SEC case against Ripple has become one of the most important proceedings in the crypto industry. In June lawsuits against the largest crypto exchanges Binance and Coinbase, the commission equated a whole list of crypto assets to securities. The end result of the Ripple case could have major implications for digital asset rules both in the US and globally.
Globally, the decision of the judge Analissa Torres can indeed be considered a positive decision. This may indirectly indicate that the judge really understands the process, and the case will not be considered superficially. This is generally positive for the industry itself, which is obviously experiencing difficulties in the absence of clear and specific legislation directly for a new type of asset, which is cryptocurrency. However, Ripple Labs only partially won the case. The judge ruled that the XRP token was not a security, but this only applies to those cases when it was sold on crypto exchanges to the general public or “through algorithms” (apparently, they mean mechanisms similar to airdrops – free distribution of tokens to active users of blockchain projects).
The decision is significant because it rejects the SEC’s argument that XRP should be classified as a security. At the same time, the court found that Ripple Labs violated securities law when it sold XRP to institutional investors. This means that selling the token to hedge funds or venture capital firms was considered a violation of US securities laws.
Some irony is seen in this: now the classification of an asset, its classification as securities, depends not so much on the characteristics of the asset itself, but on the characteristics of the investor who bought it. In general, the decision of the court for the crypto industry is quite important and positive, because it somewhat cools the ardor of a number of American regulators, especially the SEC. Several departments in recent months have declared a crusade against cryptocurrencies, making loud statements that all cryptocurrencies, except for Bitcoin and Ethereum, are securities. The fact that the court partly sided with Ripple Labs suggests that many altcoins, which were also mentioned as securities in the lawsuit against Coinbase, will eventually be recognized as cryptocurrencies if their main sales took place on open exchange floors to the general public or “through algorithms”. Of the non-obvious things that can be seen between the lines in the court decision are new risks for the initial placement of crypto assets (ICO and analogues), as well as the danger for cryptocurrencies operating on Proof-of-Stake (PoS) algorithms and their subspecies.
With regard to the new risks of the initial offering, the court unequivocally sided with the commission, recognizing the sale of tokens as securities transactions, in which investors were promised a profit from their investments. As an example, the documents cite the SEC case against Telegram and its Gram token, with which Pavel Durov’s messenger unsuccessfully tried to enter the ICO in 2018.
We may see some changes and subtle wording in IPO marketing in the future, but it’s hard to imagine successful promotional campaigns without a clear understanding of ROI. Much more logical here will look new formats for the distribution of tokens, for example, any variations of airdrops. There are already noticeable trends in the shift of developers’ interest towards retroactive distribution of tokens and similar emission mechanisms. It is possible that this particular mechanism or a variation of it will soon take its place in the distribution of tokens, continuing the historical series of ICOs and IEOs. Moreover, there is already a trend towards automating the emission of tokens. For example, Polygon, one of the most technologically actively developing ecosystems, announced a future transition to a single POL token, the release of which should be automated using a smart contract, against the background of the court case. The justification of the court regarding the “algorithmic distribution” of the token (with such distribution, the token may not be a “security”) was an excellent reason for Polygon to publish a new “Roadmap”
But the main danger of the Ripple case against the SEC is in the area of selling tokens on the secondary market. In the explanatory part of the published documents, the rationale for accepting the accelerated trial is given, and the notorious Howey test was the main argument in this decision. It was by referring to it that the court ruled that the primary sale of XRP to institutional investors is suitable for all four parameters of the test, while secondary sales and algorithmic distribution are suitable for only three of the four criteria. In our opinion, the wording is also important here – the court considered that investors could not expect income from such a purchase, because Rippple did not directly promise this. Buyers invested at their own risk, expecting earnings, but no one promised it. And if we consider the concept of “proof of stake”, then there is a great danger of pulling the promised returns for staking to the missing criterion of the Howey test and ban all non-registered PoS blockchains for US investors.
The final ruling in favor of Ripple Labs against the SEC could have a big impact on the entire crypto market if there is no appeal from the regulator. The court decision may help establish the legal status of cryptocurrencies, especially in the context of their classification as securities. This will create more clarity and predictability for other crypto companies and investors. The ruling in the Ripple and SEC case will set a precedent for future litigation related to cryptocurrencies and their compliance with securities laws. If other companies are able to invoke this decision in their cases, it could change the regulatory and litigation dynamics for cryptocurrencies.
The final positive result for Ripple may affect regulatory policy towards cryptocurrencies. Regulators may reconsider approaches to the classification and regulation of cryptocurrency projects based on this court decision. The correct actions of the SEC will lead to a favorable environment in the cryptosphere. However, it is worth noting that this decision is still subject to appeal, and the final state of affairs may take a long time. Therefore, it is important to monitor developments and take into account possible changes in the regulatory environment.
In any case, the XRP rate has already reacted to the news of the court decision with an increase of 80% in less than a day, and after it the price highs reached bitcoin and other cryptocurrencies. However, Ripple does not see any major partnerships or large-scale development strategies on the horizon. For the past couple of years, they have been completely absorbed in their litigation, so you should not expect new heights from XRP in the coming months. At best, the token will be able to grow and gain a foothold above $1.