Image credit: Ekaterina Bolovtsova
“XRP, as a digital token, is not in and of itself a “contract, transaction[,] or scheme” that embodies the Howey requirements of an investment contract”
In essence the ruling means XRP is legally considered not to be a security, the ruling also clears the way for secondary market sales and trading of the XRP token on US exchanges.
Despite the major win on the main parts of the case, not all sales of XRP by Ripple have been cleared by the court and parts of the case will go to trial. The types of sales found to constitute sales of unregistered securities provide major lessons and have wide implications for the entire digital asset sector.
What constitutes sales of securities?
To understand the ruling’s implications we first need to consider the distinctions between the three major ways Ripple conducted sales of the XRP token.
First were the ‘Institutional Sales’ where the SEC alleged Ripple sold $728.9 million of XRP directly to counterparties like institutional buyers, hedge funds, and ODL customers. Second, were the ‘Programmatic Sales’ where the SEC alleged Ripple sold $757.6 million of XRP programmatically on secondary markets among the bids and asks of regular traders of the token. Finally, Ripple also distributed $609 million of XRP tokens as payments for services or compensation to individuals and other entities.
The judgment ended up hinging on the third prong of the Howey test, being the ‘expectations of profit’ test. Did purchasers of XRP tokens have a reasonable expectation of profit derived from the efforts of Ripple when they purchased the tokens.
Institutional Sales
Sales of XRP tokens directly to institutional investors from Ripple were classified as sales of securities. The final ruling on these sales will go to a jury trial which will determine the outcome regarding penalties. This means that it wasn’t a complete win for Ripple and some fines are expected down the line, the balance sheet of Ripple is expected to be able to absorb these.
Programmatic Sales
Other sales coined as ‘programmatic sales’ where Ripple sold XRP on public exchanges were not considered securities. These sales composed less than 1% of the XRP trading volumes on secondary markets. As buyers of XRP could have no idea they were funding Ripple with XRP purchases rather than trading with other participants, it was ruled that they could not have had a reasonable expectation of profit from Ripple’s actions.
Other Distributions
Furthermore, the XRP distributed by Ripple for ecosystem development, salaries, bonuses and as payment for other services were also not deemed to be sales of securities.
What does this mean for XRP and other digital assets?
XRP is now the only digital asset with legal clarity in the United States, and the token itself is deemed not a security. An appeal is still possible, but will be difficult for the SEC to execute and will require them to bring new evidence. The token has been relisted for trading on all major US exchanges with XRP trading volumes matching those of Bitcoin in the week since the court’s decision.
The fact that it wasn’t a complete victory means it is likely that Ripple may still be liable to pay a fine and possible disgorgement related to the institutional sales. Ripple’s balance sheet is expected to be able to cover this, while also having the option of selling some XRP to raise funds if needed.
The court’s decision has provided a framework for analysis of digital assets in the market, specifically how they conducted their initial sales and distributions. This research can highlight which tokens in the market are at risk of further legal action from the SEC. However the SEC’s ‘regulation by enforcement’ approach has been dealt a major blow, with the agency and Gary Gensler now facing political pressure to adopt a more measured approach.
Disclaimer and Disclosure:
DigitalX Asset Management Pty Ltd is a corporate authorised representative (CAR) of Boutique Capital Pty Ltd AFSL 508011, CAR Number 1270748. To the extent to which this document contains advice it is general advice only and has been prepared by the CAR for individuals identified as wholesale investors for the purposes of providing a financial product or financial service. The information herein is presented in summary form and is therefore subject to qualification and further explanation. The information in this document is not intended to be relied upon as advice to investors or potential investors and has been prepared without taking into account personal investment objectives, financial circumstances or particular needs. Recipients of this document are advised to consult their own professional advisers about legal, tax, financial or other matters relevant to the suitability of this information. Past performance is not indicative of future performance.
