Ripple (CCC:XRP-USD), the cryptocurrency created by Ripple Labs in 2012, is tainted with lawsuits from both the Securities and Exchange Commission (SEC) and private investors. As a result, Coinbase (NASDAQ:COIN) stopped allowing people to buy or sell Ripple in January 2021. Although the lawsuit has not yet slowed the crypto down, conservative investors should take caution.
Other exchanges still allow buying and selling Ripple. In a sort of contrarian manner, the crypto has skyrocketed from 22 cents on Dec. 31 2020 to $1.37, as of the morning of April 19, 2021. One would have thought that the lawsuit might end up diminishing the trading in XRP.
Looking at the Allegations
A close look at the SEC allegations shows that the U.S. Government is not going to settle anytime soon. This is because the government claims the Ripple is an investment security. Ripple should have been sold to the public only by registering with the SEC as such. The company claims XRP is a currency and that there is no investment contract, even an implied one, involved in buying Ripple.
The Financial Times highlighted various sections of the 71 page SEC lawsuit against Ripple Labs. Here are some of the allegations:
- The defendants knew their venture potentially fell under federal securities laws.
- The entire business model of Ripple Labs depended on selling more and more XRP. A private 2018 class-action lawsuit sad it had “what is essentially a never-ending initial coin offering.”
- Ripple made many of the XRP institutional sales at a discount from XRP market prices, without disclosing this to the public (required for securities sales).
- It emulated a central bank in how it regulated its distribution of XRP tokens.
- Ripple used buybacks to raise the price of XRP.
- They knew that these actions had to be publicly disclosed to be considered legal.
The fallout from this lawsuit has extended beyond just Coinbase dropping XRP, although other exchanges have kept it. On Jan. 13, 2021, Grayscale Investments started the liquidation of its fund Grayscale XRP Trust. They believed “it will likely be increasingly difficult for U.S. investors, including the trust, to convert XRP into U.S. dollars.”
Also, on March 8 MoneyGram Int’l (NASDAQ:MGI) dropped its partnership with Ripple to effect money transfers. Analysts argue that MGI stock will suffer since it loses a stable and recurring source of revenue in its deal with Ripple Labs. The same is probably true for Ripple.
Where This Leaves Potential Investors in Ripple
The word uncertainty comes to mind. And that is just what Wall Street hates in an investment, even a cryptocurrency. Maybe investors believe the SEC lawsuit will drag on for a long time, and so there won’t be consequences in the near term. Or maybe they believe that President Joe Biden’s Administration will take a more benign view of the situation.
After all, Ripple points out that the SEC has previously indicated that both Bitcoin (CCC:BTC-USD) and Ethereum (CCC:ETH-USD) are not securities, but currencies. That may be the case, but the Internal Revenue Service (IRS) does not see it that way. Any realized gain in cryptocurrencies leads to long- or short-term capital gains tax.
Barron’s reports that the crux of the defendants’ case is that the Howey test has not been violated, a 1946 Supreme Court case. The Howey case established that an investment is a security “when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” Ripple General Counsel Stuart Alderoty has refuted that XRP fits this description of a security.
Expect a long, drawn-out battle. The fallout on other altcoin cryptos could also be dramatic. Investors in Ripple should be very careful, as the SEC lawsuit makes it difficult to accurately determine the value of the cryptocurrency.
On the date of publication, Mark R. Hake held a long position in Coinbase, Ethereum, and Bitcoin.