Mining For Clarity In Regulatory Chaos

Ripple, the U.S. crypto giant, recently filed a formal response to a Securities and Exchange Commission (SEC) lawsuit brought by former Chairman Jay Clayton in December. Ripple categorically denies the accusations against the company and its senior executives. The complaint argues that the XRP digital currency was used as a medium of exchange for cross-border transactions in Ripple’s software products and illicitly evaded SEC registration for seven years.

The response was robust and vehement, confirming the widespread expectation that the company would fight back hard. But there was an even more interesting development: Ripple also filed a Freedom of Information (FOIA) request with SEC requesting documents related to the agency’s determination that Bitcoin (BTC) and Ethereum (ETH) are definitively not securities.  

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This move appears to be linked to the SEC’s core arguments in its lawsuit that Ripple’s currency XRP is a security and that the company and its executives should be punished for distributing it without going through the onerous registration process. Experts and analysts have long pointed out the similarities between XRP and ETH, and this begs the question: why did the SEC declare that ETH is not a security but file a lawsuit saying that XRP is?

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Professor J.W. Verret of the Antonin Scalia Law School at George Mason University was blunt about the SEC’s “haphazard and inconsistent” gyrations on this question in his Feb. 3 Law360 analysis:

• XRP relies on Ripple to make a market in the asset, a role that is common to many other commodities that are not determined to be securities. And yet the SEC targeted Ripple for failure to register XRP as a security with the SEC. There are a number of similarities between Ethereum and Ripple. A CoinGeek article points to similarities between the two cryptocurrencies with respect to continued involvement of core developers in continued maintenance of the network code that underlies the two currencies.
• In a widely covered speech in 2018, then-SEC Division of Corporation Finance Director William Hinman observed that the digital asset Ethereum should not be considered a security. He observed that if the “central enterprise” aspect of a cryptocurrency asset is not present, it may no longer be properly described as a security.
• The lines between XRP and Ethereum are much grayer than Hinman’s groundbreaking speech would indicate. This is not to argue that the SEC should also sue Ethereum, as that would cause millions in losses to innocent asset owners. It does however demonstrate that the SEC’s regulatory approach to cryptocurrency has been haphazard and inconsistent over the last four years.

Here is the crux of the contradiction in the SEC’s behavior. ETH was first sold to investors in an initial coin offering (ICO) in 2014, raising over $17 million. It was never registered as a security with the SEC. Four years later, the SEC’s William Hinman announces definitively that ETH is not a security. Fast forward to 2020. The SEC sues Ripple and two high-ranking executives for not registering XRP as a security in 2013 when it held currency sales, not an ICO. The SEC’s complaint alleged that Ripple and its senior executives pumped XRP as if it were shares whose value was dependent on Ripple’s success as a company, which Ripple’s response meticulously refutes. Comparing the SEC complaint against Ripple with Hinman’s 2018 speech on ETH lends further credence to angry XRP holders who believe the lawsuit was more than hypocrisy on Clayton’s part, but spite.

To add yet another level of absurdity, a few days after Ripple’s response was filed, Ethereum co-founder Joe Lubin and Pantera Capital, a blockchain and crypto investment fund, joined forces to pump ETH among potential investors. The invitation to the conference call was complete with a rocket ship emoji, the ham-fisted social media analogy for ETH’s “all-time high” (ATH) yet still undervalued price.

Pantera Capital @PanteraCapital on Feb 2, 2021:

“Despite #ethereum hitting a new ATH , we believe both it and #DeFi assets built on top are undervalued relative to their long-term potential. Join us February 16th for a discussion on WHY with guest speaker: @ethereumJoseph Register here:”

The SEC says ETH is not a security. This seems to undermine its credibility in the Ripple case.