Why Is Ripple Being Sued? XRP SEC Lawsuit Explained
Why is Ripple being sued, and what kind of effect will it have on XRP and other cryptocurrencies in the long-term? If the SEC declares XRP a security, we may risk the chance of opening Pandora's box and handing more power to the regulators.
On December 22, a major federal regulatory agency based in the U.S. filed a complaint against Ripple, the blockchain company behind XRP. Citing that Ripple’s operators have conducted an unregistered digital asset securities offering worth $1.3 billion, the Securities and Exchange Commission (SEC) charged both former CEO Christian Larsen and current CEO Brad Garlinghouse.
At the time of the announcement, news of the lawsuit dealt a heavy blow to XRP’s price. The cryptocurrency practically halved in value and lost a significant portion of its market cap. Investors who were exposed to the assets did not have enough time to react and have most likely experienced severe losses.
While the cryptocurrency managed to recover in the past couple of months, XRP’s future position in the U.S. market remains unclear. Moreover, an unfavorable decision could potentially lead to regulatory uncertainty overseas as well.
Now that Ripple’s legal team responded to the SEC’s charges for the very first time, it is imperative to analyze the circumstances and speculate what the future holds. To help our dear readers understand what the fuss is all about, we wrote extensively about the ongoing case.
Why is Ripple being sued? A timeline of events
Before presenting any vital analysis, it is essential to review a timeline of events that occurred since the SEC initially filed its complaint. This is not only necessary for understanding the broader topic but for having enough context to understand why each party may be right or wrong as well.
SEC files complaint
As mentioned earlier, the Securities and Exchange Commission filed a lawsuit against Ripple’s leading operators last December. The event was unexpected, and the regulator shared no prior statements that have indicated a possible ‘witch hunt’ against Ripple.
The official SEC complaint notes that Brad Garlinghouse and Christian Larsen have illegally financed the blockchain company by raising capital through an unregistered digital asset securities offering. Between the period of 2013 to 2020, Ripple allegedly raised $1.3 billion by selling their tokens.
SEC’s more daunting claim is that Ripple exchanged the token for ‘labor and market-making services’ in order to promote XRP sales. As a result, the regulator charged both individuals for failing to register the token sale under U.S. federal securities laws.
Furthermore, the complaint states that while Garlinghouse publicly shared that he was ‘long XRP,’ in reality, he was selling his assets. By doing so, the current CEO profited $600 million.
According to Stephanie Avakian, Director of the SEC’s enforcement division, Ripple failed to reach the necessary levels of compliance required to host their public offering. Specifically, Avakian stated the following:
"Issuers seeking the benefits of a public offering, including access to retail investors, broad distribution and a secondary trading market, must comply with the federal securities laws that require registration of offerings unless an exemption from registration applies."
In another statement, she condemned Ripple for depriving potential investors of the adequate disclosure about XRP needed to protect market participants. For Avakian, such disclosures are vital for protecting the nation’s ‘robust public market system.’
Ripple responds...on Twitter
The official legal team of Ripple did not immediately respond to the complaint issued by the SEC. As a matter of fact, there was no official legal response for 39 days since the announcement.
Instead, Ripple’s operators moved the battle to Twitter. This was most likely done to protect the company’s image and instantly show investors that there is nothing to worry about.
On December 22, Brad Garlinghouse responded to the news by stating that the regulator attacks not only Ripple but the entire U.S. blockchain industry. He further noted that the SEC cherrypicks cryptocurrencies in a way that ‘directly benefits China,’ referring to the agency’s non-securities declaration of Bitcoin and Ethereum.
The same sentiment was repeated in a series of blog posts published by the company.
Named ‘The SEC’s Attack on Crypto in the United States,’ the first post (written by Garlinghouse) argued that XRP is a currency and not an investment asset. Ripple’s post also mentions how the company worked with the SEC for many years in order to work on regulatory questions.
To summarize, the blog post discusses how the SEC favors projects like Bitcoin and Ethereum while attacking other cryptocurrencies - which creates a terrible disadvantage for the U.S. blockchain industry.
Garlinghouse refers to crypto innovation as the new technological and economical cold war in which the U.S. is losing ground. He implies that with the recent decision, the regulator attacks innovation at home while indirectly helping out foreign governments.
The post was ended on the note that Ripple looks forward to working things out with the incoming Biden administration and a new SEC chairman. This statement implies that Garlinghouse has high hopes in sorting the situation with policymakers who might be more favorable to private blockchain companies based on U.S. soil.
In early January, Ripple’s chief executive officer wrote a series of posts on Twitter that explained the situation and showcased the company’s plans. It was stated that their legal team slowly but surely works on a response and that the community will have a chance to see it in the coming weeks.
Moreover, Garlinghouse specified that U.S. investors only account for 5% of Ripple’s entire market and that the SEC has no influence on the recent exchange delistings nor on other regulatory agencies.
Cryptocurrencies face regulatory uncertainty in three major jurisdictions: the U.S., the EU, and India. Pressured by new administrations, central-bank issued digital currencies, and restrictive policies, the rising crypto market meets an old foe.
Ripple’s first legal response
The first official response to the SEC's complaint arrived on January 29, 2021. Filed publicly in the form of a legal document, the preliminary response provided answers and arguments to the agency’s allegations.
The 93 pages long document cites four main arguments on why XRP is not a security and why the SEC has made a mistake. The following content is an official summary made by Ripple.
XRP is not an investment contract
According to Ripple, XRP represents a virtual currency that comes without an investment contract and is outside of the SEC’s jurisdiction. The company has never held an ICO, nor has it used XRP to raise money for its business operations. Additionally, their sales amounted to less than 1% of the currency’s entire market and therefore had no influence on prices or investors.
The SEC is out of step domestically and globally
Ripple’s second argument is that the SEC is overstepping its boundaries by claiming that XRP is a security. Before the lawsuit, no other regulatory jurisdiction in the world has marked XRP as a security, nor have they stated that Ripple must do so.
The document also claims that the currency’s design is incompatible with securities regulation and that it would negatively affect the project’s central utility and purpose.
Last but not least, Ripple mentions that both the Department of Justice and the FinCEN have previously determined that XRP is a virtual currency. The same is apparent with other global regulators, which include the UK, Singapore, and Japan.
The SEC is picking winners and losers
Another critical point is that the SEC picks winners and losers by attacking Ripple and declaring Bitcoin and Ethereum as non-securities. The company finds it to be hypocritical that while all three projects have no fundamental distinction, the SEC still treats XRP in a different manner.
Ripple also notes that the SEC once stated that Ethereum began as a security but eventually ‘evolved’ into a non-security. The regulator refuses to give any clear rules that indicate in what way such a process occurs and through which steps.
The SEC has distorted the facts
Ripple’s fourth main argument is that the complaint does not show the real situation and that it distorts the facts by taking certain quotes and events out of context. Garlinghouse notes that he will prove all of the regulator’s allegations wrong throughout the course of the court case.
The CEO ended the complete summary by quoting Andrew Ceresney from the NY-based law firm Debevoise & Plimpton:
“The SEC’s case is unprecedented and ill-conceived. The SEC has ignored XRP’s clear status as a virtual currency, contradicting not only the findings of other U.S. regulatory agencies but also international regulatory regimes. Over the last eight years, the XRP market, independent of Ripple’s activities, had grown to a massive scale- trading on over 200 exchanges worldwide. The SEC is now stretching the concept of an ‘investment contract’ beyond its breaking point. We look forward to presenting our case in Court.”
Is XRP really a security?
XRP was always a controversial crypto project, and it is not only because of its infamous ‘XRP Army’ community. The cryptocurrency itself is a part of Ripple’s broader payment network that supposedly features cheap and fast transactions. But while XRP is designed as a currency, numerous investors speculate on it as a crypto asset.
Despite having a big following of fanatics, XRP is commonly disliked by the community and many users prefer not to invest in it. However, it would be foolish to say that the project is not important. After all, the project stood uncontested as the market’s third-largest cryptocurrency by market cap for years.
As a reminder, the SEC made a historic decision in June 2018 by declaring that both Bitcoin and Ethereum are not securities. This is the first case of a major financial regulator from the U.S. ‘officially legalizing’ cryptocurrencies. At the time, a representative clarified that BTC and ETH are not securities because they are decentralized.
Because of this event, it is definitely unusual that the SEC explicitly targets XRP while treating other assets differently. The regulator behaved in the same exact way when filing a lawsuit against Telegram for holding its TON ICO.
It is worth noting that the company behind XRP is indeed shady, especially in regards to Ripple’s token transactions and partnerships in 2020. However, we do believe that if the SEC declared one cryptocurrency as a security, it would have to inflict equal measures onto the entire market - which makes the recent lawsuit a Pandora’s box in the making.
Is the SEC using Ripple as a scapegoat?
Following the market crash in March 2020, cryptocurrencies have, along with stocks, flourished. Bitcoin, Ethereum, and almost the entire altcoin market have not only revisited old ATHs but created new ones as well.
Since the first widespread bull run that ended in 2017, regulators have not touched the crypto market at all. The only few times that agencies like the SEC did interact with the world of crypto were when major corporations attempted to expand by offering blockchain-based services.
Two notable examples include Facebook’s Libra and Telegram’s TON cryptocurrency. Despite not being malicious in any true sense of the word, experts of all sorts have attacked these projects. The SEC went as far as to file a lawsuit against Telegram for holding an ICO in the same way that all other teams of developers did.
Now that the market is gaining more and more traction, it was only a matter of time before the SEC would strike and attempt to slow down the industry. With Ripple’s past actions making them a weak link, it is only natural for XRP to become the first target.
A key factor that most likely triggered the SEC’s decision is the fact that Ripple plans to move its headquarters to another country. Garlinghouse stated numerous times in the recent past that Ripple cannot any longer stay in the U.S. as a result of regulatory tension and uncertainty.
On that account, it is highly likely that the SEC seeks to accomplish two main objectives:
Hinder Ripple in moving HQs. A lawsuit from the SEC can affect Ripple’s acceptance in other regulatory jurisdictions and change its global reputation. Although the U.S. is a small market for XRP, it can still influence the currency’s perception in other markets.
Use Ripple as a scapegoat. The SEC can temporarily use Ripple as crypto’s scapegoat and shift everything that is wrong with the entire sector to a single project. However, declaring XRP, a non-security can also create a legal precedent and give the regulator the ground to attack other cryptocurrencies as well.
Why is Ripple being sued? And why did the SEC decide to attack crypto’s third-largest cryptocurrency, especially at this moment? The arguments above might be a good place to start.
However, there are numerous sides to this story, and it is important to note that Ripple is not without faults. Moreso, even if Brad Garlinghouse and Christian Larsen did act maliciously, the goal should not be to directly attack XRP.
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Final Thoughts
In the legal complaint filed by the SEC, the regulatory agency notes that XRP actively held an unregistered virtual currency offering that began in 2013, which collected $1.38 billion. The complaint’s second point is that both Garlinghouse and Larson have personally profited $600 million by selling XRP to the market.
It is safe to say that we do not yet know for a fact whether both the former CEO or the current one have profited by ‘manipulating’ XRP. However, we must all agree that if the assumption does end up being true, legal action should be warranted.
The question is: should XRP be the prime target of such a legal action? The SEC previously noted that projects like Bitcoin and Ethereum were ‘born’ as securities but that they later transitioned into non-securities through the power of decentralization.
If centralization is the key problem, then why not work towards decentralizing XRP’s management and prevent millions of investors from being hurt? The truth is that the damage is done and that the average retail investor is in pain.
But if we let the SEC declare XRP a security, then we risk the chance to live in an environment of constant regulatory uncertainty where any asset can be declared a security out of the blue.
Many within the community might dislike XRP and its fans, but it is finally time to stand ground and voice our dissatisfaction in unison against those in power, just like we did multiple times in the past. Because if we do not act as a single entity, a simple divide and conquer strategy can rip the market apart.
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