Perhaps there is no greater irony in the cryptocurrency market right now than Ripple Labs and its XRP (CCC:XRP-USD) token, also colloquially known as ripple coin. Many years ago, crypto advocates blasted XRP as a farcical coin. Yes, the project itself had utility, delivering cross-border transactions at lightning-quick speeds and at low cost. However, it’s the centralization bit that had folks miffed.
You see, most virtual currencies are decentralized. Rather than an intermediary entity such as a central bank controlling supply, the process of “minting” new tokens comes down to crypto mining. A complicated concept, the main takeaway here is that different nodes or computers compete to secure the right to store transaction data on the underlying blockchain network.
The first to win the competition receives a blockchain reward token (crypto coin).
Now, the medium of this competition is an algorithmic-based problem that requires massive computing power to solve known as proof-of-work. Gradually, the crypto market is moving toward a less-energy-intensive process called proof of stake. However, the overriding point is that there is real work involved in minting these tokens. But anybody has the right in most crypto blockchains to engage this work for the reward.
However, this is where XRP is different. Unlike other decentralized coins, XRP is a centralized process. Essentially, Ripple Labs is the ultimate arbiter regarding the supply of the cryptocurrency. While I’m not a lawyer and none of this should be construed as legal advice, I believe this is where the Ripple saga becomes problematic.
As you know, the Securities and Exchange Commission filed a lawsuit against Ripple Labs, arguing that XRP is a security, not a cryptocurrency. As a result, the company runs afoul of laws governing initial public offerings. Given the broadly negative implications, XRP tanked.
That is, until something remarkable happened.
Can Social Media Rescue Ripple?
Recently, Ripple responded to the SEC, asserting its claim that XRP is not a security but a virtual currency. In 2019, then-SEC chairman Jay Clayton explained that bitcoin (CCC:BTC-USD) was determined to be “not a security, it was much more payment mechanism and store of value.” With XRP having similar functionality with BTC, Ripple just needs to make its case.
Further, other countries regard XRP as a cryptocurrency and not a security, which may be significant to the company’s defense.
However, it doesn’t escape me that years ago, some advocates of decentralized cryptos would have seen the present troubles surrounding Ripple Labs as the organization getting its just reward. But things have changed.
As you know, social media has become a powerful platform in finance, recently playing on the theme of the little guys versus the Wall Street fat cats. As our own Sarah Smith explained, several people on the Telegram forum began bidding up XRP, briefly sending prices to a three-year high.
Where I stand currently, the ripple coin has tumbled badly from its recent summit. Nevertheless, it is mounting a gradual recovery alongside bullishness in other cryptocurrencies. But the question now is whether you should join in on the fun?
Obviously, there are two main factors here: the SEC lawsuit and the power of social media. I’m going to address the latter first. On the surface, it’s tempting to jump in. It’s not just about the profit-making endeavor, although that is the primary catalyst. Rather, the camaraderie – something that most of us are missing during the pandemic-fueled lockdowns – offers fuel to the flames.
Just as importantly, a sense of righteous indignation augments such contrarian trades. Still, I think investors need to be very careful. Emotions alone have never proven to be sustainable tailwinds.
The Legal Question Remains
In my last story about Ripple, I noted that XRP may invoke the U.S. Supreme Court case, SEC v. W.J. Howey Co. Known colloquially as the Howey test, it appears that Ripple satisfies two-thirds of the criteria that XRP is not a security.
However, it’s the final criterion, which states that an asset defined as a security has “an expectation of profit derived from the managerial or entrepreneurial efforts of others.” I believe this is where the lawsuit gets challenging for XRP because of its centralized platform.
One thing I can say for certain is that legal analysts are frothing at the mouth for explaining what’s going on. In my view, it’s going to come down to the spirit of the law versus the letter of the law. Is centralization of XRP enough to doom Ripple? Or is the broader understanding that the main purpose of XRP – a cross-border transactional experiment – convincing enough that it’s not a security?
Having looked at most of the angles up till now – I’m sure there will be other news items that could change the trajectory – Ripple just might be able to squeak out of this. However, I wouldn’t gamble your life savings on this questionable asset. It really could go either way.
On the date of publication, Josh Enomoto held a long position in XRP and BTC.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.
