The SEC’s Lawsuit Against Ripple Labs Is a Pandora’s Box

For several years, cryptocurrency proponents regarded Ripple Labs as the promoter of a groundbreaking experiment. Through the XRP (CCC:XRP-USD) digital asset, Ripple essentially attempts to create a new paradigm for financial transactions. The idea: no longer must cross-border transfers be so expensive and time-intensive.

A close-up shot of an XRP token with the logo and Ripple in raised text.
Source: Shutterstock

Heck, through decentralized technologies, the blockchain innovation that undergirds XRP and other cryptos doesn’t even require human intervention past the point of introduction. That alone could save tremendous labor costs. But of course, the government cannot let any good idea go unpunished.

More specifically, the U.S. Securities and Exchange Commission (SEC) has decided that the crypto in question is actually not a virtual currency but instead a publicly traded security. As such, Ripple Labs has sidestepped deeply entrenched laws that govern the sale of business equity. Not only does this have implications for XRP, but also other coins and tokens.

The U.S. Supreme Court “established four criteria to determine whether an investment contract exists.” Investopedia list these criteria as such: “an investment of money […] in a common enterprise […] with the expectation of profit […] to be derived from the efforts of others.”

For XRP and other cryptos, the first three criteria easily qualifies digital assets as securities. People put money in a particular crypto expecting to earn capital gains. Where the question lies is the “derived from the efforts of others” qualifier. Under a traditional definition, if the success of an enterprise depends on its backers, then its underlying ownership rights do indeed qualify it as a security. For instance, a consumer-tech firm can’t survive without its innovative leadership team.

But does that same principle apply to cryptocurrencies?

If XRP Is a Security, Then Cryptos Are a Stock Market

When it comes to the SEC leveling accusations against Ripple and XRP, it seems to have a stronger case here than it has for say a similar argument against Bitcoin (CCC:BTC-USD). For one, we don’t even know who Bitcoin’s creator really is. Yes, we have the name Satoshi Nakamoto, but nothing beyond that.

With XRP, though, there is at least an “overseer” of the crypto: Ripple Labs. True, the magnitude of that oversight is debatable. However, from an objective point of view, it appears that at least part of XRP’s investment thesis involves the people closest to the project sparking interest for the underlying blockchain technology as a possible alternative to costly wire transfers.

While that might sound like a fundamental win for the SEC, in reality, this interpretation still opens up a slippery slope. After all, every crypto has to have an origination point — someone or some entity had to create the digital asset. And it would be difficult for anyone to expend the effort developing something only to walk away as soon as the project materializes.

Under that context, presumably every crypto is a security given the Supreme Court’s definition of an investment contract. Because, really, how successful would any of these coins be if it weren’t for backers and network participants promoting their asset of choice, either through marketing initiatives or via mining endeavors?

Further, as one Forbes contributor recently pointed out, many crypto-related businesses like Coinbase (NASDAQ:COIN) have sought clarity from the SEC, only to be hit with threats and subpoenas. To many onlookers, the SEC seems to only finds lucidity through penalization.

And even then, the process is haphazard. XRP backers may argue that it’s the victim of regulatory discrimination, considering that it’s hardly any different from other strongly backed cryptocurrency projects.

Ripple and the SEC Need to Live and Let Live

One last glaring problem with the SEC’s lawsuit against XRP is the basis for what an investment contract is. Specifically, the definition depends on the ruling of SEC v. W.J. Howey Co., from which we get the so-called Howey test. But the thing is, this case reached the Supreme Court in 1946.

I mean, people were still reading newspapers at that time.

Put another way, the Supreme Court could not have possibly realized what an impact decentralized digital assets would have on the financial system. Again, this was a period where the world was still exploring the potential of analog technologies.

With cryptos like XRP, we’re talking about an entirely different paradigm. Therefore, the Howey test is woefully outdated to determine how to manage cryptos. Sure, the SEC may have a point. But it’s going to set off a whole slew of ugly if it continues its aggressive approach against financial innovation.

On the date of publication, Josh Enomoto held a long position in XRP and BTC. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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.


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