Though there is no express declaration that cryptocurrencies are security by the SEC, there is a heated debate as to whether Ripple (XRP), which is developed by Ripples Labs, should be classified as securities by the SEC or not. It is similar that of other virtual currencies like Bitcoin (BTC) and Ethereum (ETH).
Though the XRP have a slight deviation from the crypto norm, it is pre-mined, and its decentralization is still a subject of debate. However, some experts in the crypto sector have stated that the XRP is not decentralized owing to its inability to fulfill specific criteria. XRP prices also experienced a drastic change after the rumor of it being classified as security by the SEC erupted.
What SEC Defines as Security
According to SEC, a financial asset which has some value in the traditional currency and is fungible will pass for security. ICOs SEC chairman, Jay Clayton, stated that; “It has been asserted that cryptocurrencies are not securities and that the offer and sale of cryptocurrencies are beyond the SEC’s jurisdiction.” He shed more light on the subject, stating that;
“By and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws.”
At Yahoo financial summit, Mr. William Hinman, who is the Director, Division of Corporation Finance, gave another definition of security and what it is not, dwelling on the latter, he said;
“The token (or coin) or whatever the digital information packet is called, all by itself is not a security.” He further buttressed his point using Howey test when he said that; “Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchasers.”
How Crypto-asset becomes a Security (Howey Test)
An asset in virtual currency will pass for security if its transactions qualify as an investment contract. The Howey test is a ready tool to determine if an operation can be referred to as an investment contract or not. If the transaction involves an investment of money, it might be regarded as an investment contract under the Howey test.
If the investment is beyond the investor’s control, that asset deemed as security, while a venture will not be classified as an investment if the profit is based on the actions of the investors. The next step is to consider if XRP will pass the Howey test.
The SEC is applying the Howey test as a criterion to judge an asset as security or otherwise. The company expressly stated that XRP is not an investment which implies that XRP holders have no stake in the company, by this, Ripple is not a security. There is also not an expectation of profit as Ripple has never indicated that there might be a price increase.
Ripple does not have a major holding of the currencies, and the XRP can be purchased on exchange platforms that are not related to Ripple. The Howey test also determines that the profit arising from the investment is due to a third party or not, in this instance, XRP is not an equity share sold by Ripple Labs which implies that holders have no right to claim any dividend. However, Gary Gensler, former chairman of the Commodity Futures Trading Commission is adamant on the claim that Ripple will pass for a security.
Consequences of XRP Classification as Security
XRP is classified as security might find it difficult if not impossible to meet up with its primary objective of providing cross-border liquidity owing to the legal issues surrounding the securities, it would also imply that being a holder of XRP makes one a ‘shareholder’ in Ripple company.
Making every holder of XRP a shareholder would no doubt give them control of the company however indirect. It would also imply that Ripple would contend with class action suits filed against it, that is including a risk of fines and prison sentence for its top officials as the umbrella company might have to compensate investors under the Mandatory Victims Restitution Fund Act.
Also, the classification will not only affect XRP or Ripple alone but the whole Cryptocurrency ecosystem because it might open doors for future Digital tokens sold through ICOs to be declared as securities. This would further compound the SEC’s operation on the ICO industry as it has started shutting down fraudulent ones.
Likely Future Occurrences
With the situation of things, the whole crypto community can be rest assured that the likelihood of XRP being classified as security is slim. However, with the modus operandi of some virtual currencies, they might be declared as security in the future, the only escape route for these founders of ICO that might be classified as security would be to dump the project if they choose to escape legal challenges.
Ethereum, being declared as not a security, will have an adverse effect on the crypto market on a short term but in the long run, many crypto projects erupting would evolve the blockchain technology and make it more law compliant.