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SEC plans to sue Ripple for selling unlicensed securities

Other major branches of the US government have already declared XRP as a currency, argues Ripple 

The United States Security and Exchange Commission (SEC) will be suing Ripple for the alleged sale of unlicensed securities in the form of XRP tokens. Ripple CEO Brad Garlinghouse and co-founder Chris Larsen are expected to be named as defendants in the suit along with the firm. Ripple’s cryptocurrency, XRP, currently valued at $23 billion, is the third-largest cryptocurrency by market cap and has lost its price by over 9% after the planned move by the SEC was announced.

While explaining its position, Ripple argued that “By alleging that Ripple’s distributions of XRP are investment contracts while maintaining that Bitcoin and Ether are not securities, the Commission is picking virtual currency winners and losers, destroying the US-based, consumer-friendly innovation in the process”.

The decentralised nature of Bitcoin (BTC) and Ether (ETH) has saved the cryptocurrencies from the crosshairs of SEC enforcement. However, XRP’s association with Ripple has often led to criticism for its highly centralised nature.

Further, unlike its blockchain-based counterparts, XRP’s ledger does not reward participants for validating transactions with coins and hence prevents the generation of XRP through third-party mining. This means that a finite supply of XRP was initially created, around half of which is maintained in an escrow account and released periodically by Ripple. The question then arises whether XRP is a security and subject to SEC regulations.

The SEC has primary regulatory authority over the issuance and resale of any token or digital asset that constitutes a security. In the famous SEC v. Howey case, the Supreme Court set four major criteria for determining whether an asset is a security.

The first element of the Howey test is that there must be an investment of money. The second criterion involves an expectation of profit from the investment. The third states that there must be an investment of money in a common enterprise and the last test is that an enterprise should derive profit from either the promoter or a third party. Ripple argues that it has already established that XRP does not meet these criteria and thus cannot be considered a security.

“This complaint is wrong as a matter of law. Other major branches of the US government, including the Justice Department and the Treasury Department’s FinCen, have already determined that XRP is a currency. Transactions in XRP thus fall outside the scope of the federal securities laws. This is not the first time the SEC has tried to go beyond its statutory authority”, Ripple’s outside counsel explained.

Arguments on the Howey test were seen recently when the SEC won its lawsuit against Kik Interactive for conducting an allegedly illegal initial coin offering in 2017. The major issue with Kik’s position was that it had advertised its KIN tokens as securities in the initial pre-sale. However, in this case, though the court ruled in favour of the SEC, Kik later settled the case after agreeing to pay a $5 million penalty to the SEC and continues to operate.

Despite Garlinghouse’s statements that Ripple would continue to thrive even with a security designation for XRP, the company recently claimed to be seeking new headquarters outside of the United States citing a lack of regulatory clarity.

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