#259—Crypto isn’t inherently a security

What people are saying about the SEC v. Ripple

Jul 17, 2023

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This week:

Crypto isn’t inherently a security
What people are saying
Everything Ripple
This week in Threads v. Twitter
Stuff happens

1. Crypto isn’t inherently a security

As we outlined on Friday, the primary takeaway from industry proponents is that crypto isn’t inherently a security, according to Judge Torress’s summary judgment ruling last week on the SEC v. Ripple case.

At a time when legislation has stalled and the SEC is regulating by enforcement, it’s the courts that have signaled the first bit of clarity for crypto in the U.S.

Here’s the WSJ:

SEC Chair Gary Gensler has said that most crypto tokens are investment contracts, citing the Howey test. Gensler has said that people buy crypto assets hoping to profit from them and rely on crypto companies to make the tokens more valuable.
But tokens aren’t intrinsically, or always, an investment contract, Torres wrote. The judge said it is how tokens are sold that matters. One sale can be an investment contract, while another isn’t.
Ripple’s sales of XRP to institutional investors qualified as an investment contract, she wrote. The company marketed directly to those investors, promising that it would work to make XRP more valuable. That part of her opinion sided with the SEC’s view of XRP.
But people who bought XRP on digital-asset exchanges didn’t know they were buying from Ripple since trading is anonymous, Torres wrote. It wasn’t enough that they were speculating on XRP to rise in value because people buy all types of commodities hoping they will rise in value, and that doesn’t make those things securities.
“The court is saying, ‘Look, this is a test that is personal between the buyer and the seller,’” said Lee Schneider, general counsel for the crypto software developer Ava Labs.
“So you have to look at not just what Ripple says generally, but specifically at whether Ripple was saying that effectively to induce the buyer to buy from Ripple.”
The decision underscores the need for Congress to create a clear regulatory structure for the digital-asset industry, according to some lawmakers.

Since then, exchanges including Coinbase, Kraken, Crypto.com, and Bitstamp have already decided to relist XRP.

While the battle has only just begun, it’s still a big blow for the SEC, according to Dave Michaels and Paul Kiernan over at the WSJ.

The Securities and Exchange Commission thought it had a way to regulate crypto—a 77-year-old Supreme Court test that created a catchall definition for obscure securities.
The SEC applied the so-called Howey test to go after crypto startups that issued tokens, exchanges that traded them, and even parties that pool investors’ coins and lend them out. The test became the linchpin of the SEC’s strategy to regulate cryptocurrencies, even though the laws the agency enforces are decades older than the internet.
That strategy backfired on the SEC this past week when U.S. District Judge Analisa Torres decided the test doesn’t cover more than $1.4 billion in sales of a token known as XRP. Whether the tokens are securities depends on how they are sold, she said.
The decision was a big loss for the SEC on its home turf of the Manhattan federal courts where it tries most of its cases, attorneys said.
The SEC could appeal Torres’s ruling, which isn’t binding on other district courts. Some attorneys said the judge’s decision opens a major loophole in investor-protection laws that regulators must challenge. The agency might also feel compelled to appeal because other crypto defendants will cite Torres’s decision in their own court fights with the SEC.
“I’m confident the SEC will appeal,” said Rep. Brad Sherman (D., Calif.), a critic of crypto companies. “This process will drag on for a long time.”

2. What people are saying

Senator Cynthia Lummis:

“I applaud the decision,” Sen. Cynthia Lummis (R., Wyo.) said. The ruling “confirms the need for Congress to deliver a clear regulatory structure for the crypto asset industry.”

Kenneth Worthington, JPMorgan:

JPMorgan analyst Kenneth Worthington wrote Friday that Torres’s decision “appears on the surface to be a win for Coinbase.” If an appeals court doesn’t overrule Torres, that would damage the SEC’s chances of convincing a court that tokens listed on Coinbase’s platform are securities, he wrote.
“This is a very good thing for Coinbase if it holds up,” Reiners said. “Certainly they are going to cite and reference it as much as they can, so it really makes the SEC’s job harder. But I think she got the legal reasoning wrong.”

Bernstein:

The ruling reduces the “securities overhang on tokens sold on exchanges,” and is a “major relief for all tokens sold on secondary platforms,” analysts led by Gautam Chhugani wrote.
The court’s decision emphasizes the need for a separate digital assets framework, and given its interpretation it is clear that the “Howey test cannot be straight applied to tokens on exchange platforms, and thus the context of the transaction matters,” the note said.
“This weakens the U.S. Securities and Exchange Commission’s (SEC) stance that the securities law is clear and no separate clarity is required for digital assets, given the contextual interpretation required in every case,” the analysts wrote.
Bernstein says this is a landmark judgement and significantly shifts the “regulatory cloud over the crypto industry”, and it expects institutional investors who have steered clear of digital assets due to regulatory challenges to reconsider the asset class.

Matt Levine, Money Stuff (who believes the SEC will appeal):

More broadly, if you take this decision seriously, it means that the SEC has essentially no jurisdiction over crypto. Most token sales will either be (1) direct to institutional investors or (2) on exchanges. Sales on exchanges, says Judge Torres, are not securities offerings, because the buyer doesn’t know that she is giving money to the issuer. Sales to institutional investors are securities offerings, but anyone selling anything to institutional investors in 2023 can do so under an exemption from securities registration. (Securities registration is only for public sales, not sales to big institutions.) So basically no crypto sales will ever require SEC registration, no crypto exchange or brokerage will be a securities exchange or brokerage,[12] and the SEC is out of crypto entirely.

Former SEC official John Stark Reed:

The bottom line: Stock is always stock – it can’t transmogrify into “not stock.” So my take is that at some point, the SEC will appeal the Ripple decision to the 2nd Circuit and the 2nd Circuit will overturn the District Court’s rulings related to “programmatic” and “other sales.”
Otherwise, get ready for a new crypto-iteration – PBTs – programmatic buyer tokens, available on your friendly neighborhood (and unregistered and unregulated) crypto-trading platform.
Per the Ripple Court, PBTs will be exempt from securities regulation because programmatical buyers don’t read anything about the PBTs, don’t know who their buying their PBTs from and don’t know who is issuing the PBTs.
The Ripple Decision holds that the same exact token can be a security sometimes but not a security other times. And the more ignorance and willful blindness by retail investors, than the less protection the retail investors will receive. And the less disclosure about the token, then the less liability for the token issuer. That just can’t be right.

Ripple CEO Brad Garlinghouse:

“As a matter of law, the law of the land right now is that XRP is not a security. Until there is an opportunity for the SEC to file an appeal, which would take years, frankly, we are very optimistic.”

Ethereum co-founder and Cardano founder Charles Hoskinson:

Well done XRP. One Small step for XRP Nation, one Giant leap for Cryptocurrencies!

3. Everything Ripple

4. This week in Threads v. Twitter

Here’s Hard Yaka co-founder and partner Greg Kidd, speaking with the FT:

But it is too early to crown Zuckerberg the social media victor. Threads still lacks vital functionality and a plan for wooing the journalists, academics and news outlets that drive many Twitter conversations. The pair may also battle over video and artificial intelligence. “In a [WWE] wrestling saga I consider this spectacle as an equal match, both at an ego level and tech level,” says Greg Kidd, one of Twitter’s early investors.

Elsewhere:

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