What The SEC Charging Ripple Means For Cryptocurrencies

The SEC has filed an action against Ripple Labs Inc. (the company behind the digital token XRP) with raising $1.3 billion in what it calls unregistered “digital asset securities”. While there was important short-term price movement across the board in terms of bitcoin, ethereum and XRP prices, the more important implications may play out long-term. It’s worth examining what this means for cryptocurrencies across the board and how theoretical and practical debates about decentralization are already playing out.

As always, this isn’t legal advice of any kind, but rather a walk-through and a bit of a deeper analysis of the news.

SEC director thinks bitcoin and ethereum are not securities for now

At a speech at the Yahoo Finance All Markets Summit on cryptocurrency, William Hinman, the Director of the Division of Corporation Finance at the SEC, specifically laid out that he didn’t think ethereum and bitcoin were securities.

Specifically, he said that “when I look at bitcoin today, I do not see a central third party whose efforts are a key determining factor in the enterprise.” He used similar logic to describe ethereum in its current state. The degree of decentralization he perceives makes a critical difference in the number of actions it can pursue — there is no CEO or organizing body with enough power in bitcoin to pursue in civil charges in the first place, something that is unlikely to change even with radically different leadership. With Ripple and XRP, this is clearly not the case.

While this isn’t a definitive ruling, and it was a speech given by somebody at a separate division than the Enforcement arm of the SEC, it does give a bit of insight into how some people at the SEC think about these matters.

It seems unlikely based on that thread of thinking that the SEC, responsible for the regulation of securities, will go after bitcoin or ethereum except for when they are used in ICOs or other security-like offerings.

In this case however, the relationship between parent company Ripple Labs and the XRP token it provides is what’s at question — and it seems clear that the SEC is investigating that very relation.

Previous SEC actions

The SEC has gone after people offering what they classify as securities in the digital assets space before. Kik, the chat app company, was forced to pay out a fine of $5 million and to inform the SEC of any future sales of digital assets in the next three years in 2017.

The US District Court for the Southern District of New York ruled that Kik’s sale and proposed ICO of “Kin” were sales of investment shares and so violated federal securities laws. Telegram settled with the SEC to pay a $18.5 million penalty, while returning $1.2 billion to investors. EOS creator Block.One was forced to settle for $24 million in penalties, though they ultimately raised about $4.1 billion through EOS.

The SEC has a dedicated page to ICOs, with updates on different charges, from issuers to promoters — including charges laid out against John McAfee for promoting ICOs.

This latest action against Ripple and XRP is simply targeting the largest digital ledger asset they could have if ether and bitcoin are not securities —as of the publishing of this article, XRP was the third largest digital ledger asset by market cap on CoinMarketCap.

The most likely outcome seems to be a similar civil penalty or settlement as EOS, but that will depend on a lot of different variables — including how hard Ripple already seems to be prepared to fight. The EOS settlement was announced after the fact, while the charges announced now seem to indicate that negotiations have ground to a halt and that a looming fight between Ripple and the SEC is inevitable.

Ripple fights back

Ripple seemed to be ready to fight from the beginning. It preempted the SEC’s official announcement with the CEO, Brad Garlinghouse tweeting out before the official announcement with media mentions in the Wall Street Journal and Fortune that the SEC “voted to attack cryptocurrencies”. It seems clear that Ripple is going to be combative and deploy some of the funds raised with XRP to fight this case — and the case might go longer with more significant penalties than with either Kik, EOS, or Telegram as a result.

The SEC has been quite aggressive with this particular suit. They’ve listed individuals (including CEO Brad Garlinghouse) as part of the suit — specifically calling him out for making $700 million of personal profit.

Bitwise, a cryptocurrency fund, has already liquidated their XRP holdings because of this suit. OSL is a Hong Kong based exchange that has suspended all XRP payment and trading “immediately and until further notice.”

It’s possible that the most impactful effect will be the delisting of XRP on common exchanges such as Coinbase. They will be leery of selling an unregistered security and the penalties associated with that, as well as further dumping by cryptocurrency funds. This could lead to price shocks and liquidity problems for XRP. This is perhaps why, among other reasons, Ripple is fighting so hard — both against the SEC and against cryptocurrencies.

“Chinese control” of bitcoin and ethereum

Part of Ripple’s argument has been a fight against a regulatory “duopoly” of ethereum and bitcoin — arguing that “China” controls both and that US policy should be geared to be more friendly to a domestically based parent company. This is a long-term thread where for many years, Brad Garlinghouse has claimed that the People’s Republic of China “really controls” bitcoin.

However, this risks alienating cryptocurrency communities, with Vitalik Buterin already commenting on this approach in a negative manner. Taking a projected unity movement and trying to turn the US government against bitcoin and ethereum will probably not win XRP many new fans in the cryptocurrency space.

Moreover, the argument about mining pool concentration is more subtle than to directly tie mining pools to the Chinese state, or to assume that mining pool loyalty is illiquid.

The long-term effects

While there will be short-term price sentiment (Ripple has already lost about $2bn worth of value after the news), the long-term effect might be a broader shakening out and differentiation between ICO products and digital tokens that resemble the analogue governance models of before versus truly decentralized modes of node governance.

This might lead to businesses who have elements of the Ripple/XRP model to further avoid the US legal system and settle elsewhere — and it might lead people to think through very clearly what implications their governance and leadership has for the problems they’re trying to solve and the digital networks they’re trying to build.