cryptocurrency tokens need to be analyzed using the same criteria as securities when sold to VCs or institutional buyers. However, when these tokens are sold anonymously through cryptocurrency exchanges or distributed to employees or insiders, they are considered something else entirely.
This distinction, as determined by Judge Analisa Torres of the Southern District of New York (SDNY) in SEC v Ripple Labs et al, has created significant uncertainty in the cryptocurrency markets. The ruling suggests that while XRP may be an unlawfully sold investment contract when sold to certain buyers, it may be considered a lawful product when sold anonymously or distributed to employees or insiders.
The issue at hand in this case is whether Ripple Labs’ decade-long token distributions should be classified as securities, as defined by the “Howey Test” established in SEC v W. J. Howey Co. This test stipulates that a contract, transaction, or scheme involving the investment of money in a common enterprise with an expectation of profits derived from the efforts of others should be regulated as a security.
To conduct the Howey analysis, the court in Ripple Labs divided the sales of XRP tokens into three categories. First, they examined the institutional sales to hedge funds and venture capital firms, where Ripple was found to have sold unlawfully. This decision aligns with the consensus among legal experts.
However, the court ruled in favor of Ripple Labs when it came to programmatic sales of XRP. The court argued that the “expectation of profits” element of the Howey Test was not met in these cases. It noted that programmatic buyers could not have known if their payments of money went to Ripple or another seller of XRP. The court concluded that programmatic buyers purchased XRP with an expectation of profit, but not necessarily because of Ripple’s efforts. Instead, their expectation was influenced by general trends in the cryptocurrency market.
The court’s interpretation of the “expectation of profit” prong in this case is contentious. Critics argue that the expectation of profit should be tied to the efforts of the seller, in this case, Ripple Labs. They contend that regardless of whether buyers were aware of purchasing tokens from Ripple Labs, the company has always been the principal promoter of XRP.
Interestingly, a similar ruling was recently made by Judge Kevin P. Castel in a case involving the SEC and the Telegram messenger app. Judge Castel granted the SEC’s motion for a preliminary injunction, establishing that tokens sold by Telegram should be considered securities. This decision further exemplifies the complexity and lack of clarity surrounding the legal classification of cryptocurrency tokens.
The outcome of SEC v Ripple Labs et al highlights the urgent need for congressional intervention. As long as there is no clear regulatory framework for cryptocurrencies, issuers will continue to face uncertainty in the market. Congress must address this issue to provide guidance and stability to the industry.
In conclusion, Judge Analisa Torres’ split decision in SEC v Ripple Labs et al has brought about confusion within the cryptocurrency markets. The ruling suggests that the legal classification of XRP tokens sold to the public depends on the buyer’s identity and the circumstances of the sale. As the debate goes on, the only certainty for cryptocurrency issuers is the ongoing uncertainty they face. Congressional action is imperative to bring clarity and stability to the industry.