Is it a Currency, Utility Token, or a Security?

In the last week of December 2020, XRP lost close to 40% of its market capitalization. It is not unusual for a cryptocurrency to gain or lose that much value in a week. It can happen even in a day, and it will not be out of the ordinary given the volatility levels in the crypto markets.

Is it a Currency, Utility Token, or a Security?

However, there was a peculiarity to this drop. It happened when the rest of the crypto market experienced what could be described as the most bullish cycle since the end of the crypto winter at the beginning of the year.

XRP chart from CoinMarketCapXRP chart from CoinMarketCap

In the same period, Bitcoin, which usually charts the way for the rest of the digital assets in the space, gained close to 30% of its market value. Indeed, it achieved the newest all-time high price point of slightly over $28,000. Meanwhile, Ethereum added about 20% to its capitalization, and Litecoin about 15%.

Indeed, in the top ten CoinMarketCap list, only XRP didn't gain, and instead lost by a lot.

Bitcoin chart from CoinMarketCapBitcoin chart courtesy of CoinMarketCap

It is important to point out that XRP has for the longest time been the third-largest cryptocurrency in terms of market capitalization, after Bitcoin and Ethereum. It is technically still in the third position because the coin that overtook it is the stable coin, Tether. Stablecoins are pegged on the value of other assets, and in the case of Tether, it is the US dollar. Given this nature, it can be argued that a stable coin is not a cryptocurrency in the strict use of the term.

So, What Happened to XRP?

On December 22, the Security Exchange Commission (SEC) announced that it had filed legal action against Ripple Labs Inc., Christian Larsen, and Bradley Garlinghouse for raising capital through an unregistered securities offering.

"We allege that Ripple, Larsen, and Garlinghouse failed to register their ongoing offer and sale of billions of XRP to retail investors, which deprived potential purchasers of adequate disclosures about XRP and Ripple's business and other important long-standing protections that are fundamental to our robust public market system," Stephanie Avakian, Director of the SEC's Enforcement Division is quoted saying.

Ripple Labs Inc. is the company that issued XRP and is behind the cross-platform payment solutions that use the currency. Meanwhile, Christian Larsen is its co-founder, current executive chairman of the board, and former CEO. Bradley Garlinghouse is the current CEO.

Prior to this announcement, XRP was experiencing considerable growth. Its price went up by about 230% in November.

The action by SEC has been followed by others that are likely to hurt the cryptocurrency for a long time. For example, on the 29th, Coinbase, the largest American crypto exchange, delisted the coin. Earlier, Bitstamp, the largest European crypto exchange, had removed it from assets whose trading it supports.

Coindesk, the leading news site specializing in cryptocurrencies, has reported massive liquidation of XRP futures contracts.

What Does This Mean for the Crypto Market?

The SEC’s actions bring forth a debate that many had for a moment forgotten, and that is what makes a blockchain asset security, utility token, or a cryptocurrency. This debate raged during and in the period that followed the ICO craze of 2016 and 2017.

As the number of startups that created tokens and sold them to the public to raise capital to fund their projects grew, pressure mounted on the SEC to clarify what the tokens issued were before the law.

The regulator did warn the startups that most of them qualified to be considered securities, and those who issued them were likely breaking investment laws. It also issued guidelines, which, to no small extent, halted the ICO movement.

The regulator also took legal action against some of the entities that raised capital during the ICO craze period. In October 2019, the regulator filed a complaint against Telegram, which had raised about $1.2 billion. In the end, Telegram opted to refund the money it collected to investors.

Ripple Inc. was founded in 2012 and minted 100 million XRPs, a significant portion of which remained held by the founders. The rest went into an escrow account that releases them to the market when the need for liquidity rises. In 2012, few thought much about whether a cryptocurrency was security or just a currency that would function like Bitcoin or the US dollar.

The actions of the SEC could have huge ramifications going forward. Their initial target has been on startups that have issued tokens that cannot be clearly considered utility tokens or currency.

This is the first time they have gone after tokens that can easily be argued to be a utility token. XRP is the value unit critical in the cross-platform payment settlement solutions Ripple offers its users, particularly RippleNet.

The question, in particular, is whether the SEC is opening a floodgate. That is because some of the largest blockchain projects we have today came into being through public token crowdsales. In 2014, Vitalik Buterin and his team of developers resorted to funding the Ethereum blockchain building through a crowdsale.

Today Ethereum is the second-largest blockchain in terms of the capitalization of its native coin, Ether. However, the blockchain could be near equal in value or even more than Bitcoin, when you consider all the other tokens and assets that have been created on top of it through its smart contract application.

With SEC going after XRP for a crowdsale that happened in 2012, is it possible that we could see Vitalik Buterin and others in his team being hauled before a court of law for carrying out an unregistered security offering?

If that happens, it will be a massive blow to the industry. On the other hand, if it does not happen, then the debate of what is a security and what is not will remain a complex one for many years to come. And that is because the lines that stand between securities, utilities, and digital currencies remain elusive.


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