Reducing XRP Consumer Risk, Commodities, and the My Big Coin Ruling

[ICookinBrine]

I’ve been confident in XRP; Ripple; and, as more details emerge (or at least as I better understand them), the transformative effects of XRP and ILP.  This site, at its best, enables cooperative dialogue to better understand XRP’s role.  Part of that is its risks and what mechanisms exist to mitigate them.

The largest driver of risk mitigation thus far has been Ripple’s substantial stake. That, for instance, is what indirectly put a stop to a 9 billion XRP sell-of by one of the founders in 2014.  As has been observed by others, there remain ~60 billion reasons why Ripple would fight moves that produce short-term benefits to individuals at the expense of the long-term value of XRP. 

Still, I’m interested whether additional tools to address those risks would help the XRP ecosystem and its consumers (or not). 

As I understand it, XRP consumers include those who directly or indirectly seek to make low-value, low-cost payments and perhaps, eventually, high-value, low cost payments.  XRP holders could be consumers (if they hold XRP in order to facilitate payments) or XRP holders could be speculators who are merely self-interested components of the product. Consumers, however, need not necessarily hold any XRP.  Defining whose interests we’re considering helps generate appropriate questions and facilitates a critique of any observations or oversights to the extent interests do or do not overlap.  In other words, put yourself in the mindset of a holder and a non-holder to more fully determine what is in the consumer’s best interest.

As for the question whether more can be done to safeguard consumers, it’s early enough that I would prefer to start with a descriptive rather than prescriptive approach (i.e., keep your expectations low on the value of all of this).  We seem to be trending toward commodity in the United States, so let’s take a look at what’s happening on that front.

“Commodities” Defined Under U.S. Law

In the United State, the Commodities Futures Trading Commission (“CFTC”) has authority over contracts for the purchase and sale of commodities.”  Part of this authority is the power to enforce “general anti-fraud and anti-manipulation provisions.  See CFTC v. My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 4 (D. Mass. Sept. 26, 2018) (quoting 7 U.S.C. § 9(1)).  This includes laws against “any manipulative or deceptive device or contrivance” “in connection with any ... contract of sale of any commodity” in virtually all markets in which those sales would occur in the United States.  See My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 4-5 (citing 7 U.S.C. § 9(1) and 17 C.F.R. §180.1(a).  Therefore, whether the CFTC can prosecute fraud or criminal manipulation of the price of XRP hinges on whether it is a commodity.

Here is the critical definition under U.S. law:

• The term “commodity” means wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils (including lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, livestock, livestock products, and frozen concentrated orange juice, and all other goods and articles, except onions (as provided by section 13-1 of this title) and motion picture box office receipts (or any index, measure, value, or data related to such receipts), and all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in.

7 U.S.C. § 1a(9) (2010) (emphasis added).  This encompasses a great deal of articles of commerce such as raw materials and agricultural products, historically grouped into hard commodities (e.g., metals) and soft commodities (e.g., food).  But not onions—we’ll get to that later.

 

At Least One Federal Court Has Ruled that Virtual Currencies are Susceptible to Regulation as Commodities

In the My Big Coin case, the CFTC alleges that the defendants fraudulently enticed customers to buy a virtual currency (named “My Big Coin”) purportedly backed by gold, mimicked price fluctuations to give the appearance of an actively-traded virtual currency, and made off with $6 million of investors’ money. See CFTC v. My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 2 (D. Mass. Sept. 26, 2018).  The defendants argued that My Big Coin was not a commodity because there was no underlying futures contract which dealt in My Big Coin. My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 5.  In other words, they argued there was and is no futures market of My Big Coin, so it is not a commodity.

The Federal District Court Judge rejected the corporation’s argument, comparing the relationship of virtual currencies and My Big Coin to the relationship between “livestock” (a classic commodity) and a particular species.  See My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 6.  [To expand on this analogy, just because there is not yet a futures market in consumable horse flesh on the Chicago Mercantile Exchange, for instance, does not mean that horse flesh would not satisfy the definition of a commodity.  The category of livestock is a commodity, and various goods that may or may not be subject to futures contracts right now fall within that category.]  Stepping back into the opinion, the Judge recognized that futures contracts for virtual currencies such as Bitcoin exist, so the category to which it belongs (virtual currencies) is a commodity.  See CFTC v. My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 6-8 (D. Mass. Sept. 26, 2018).

There are limitations on the value of the My Big Coin ruling.  First, because the case raised this issue at such an early stage, the Judge was forced to assume My Big Coin was a virtual currency like Bitcoin for procedural reasons.  See CFTC v. My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 8 n.8 (D. Mass. Sept. 26, 2018).  The corporation will get a chance to prove that My Big Coin should not be lumped into a category of virtual currencies with Bitcoin.

Second, the Courts operate in a hierarchy and, if this decision gets appealed, there is no guarantee that higher authorities will agree. This decision is persuasive now because it is one of the rare decisions in this new area of law. If an issue like this arises in a different district court with different litigants, this decision is not binding.  Additionally, the decision could still be reviewed by a U.S. Court of Appeals (and possibly the U.S. Supreme Court thereafter) which would provide a more certain statement of what the law on commodities means relative to virtual currencies.

Third, and perhaps most problematically, the ruling did not dive into whether it serves the statutory regime to treat My Big Coin and virtual currencies more generally as commodities. For this Judge, it was enough that futures contracts for Bitcoin exist, Bitcoin is a virtually currency, virtual currency is therefore a commodity, My Big Coin is a virtual currency (for purposes of that ruling), so My Big Coin is, too, a commodity. This sort of heuristic reasoning would be more helpful if it had explained any earlier decisions addressing why Bitcoin is suited to be viewed as a commodity.

What Does Commodities Regulation Achieve?

Again, keep in mind that I’m interested in what tools potentially exist to mitigate risks to XRP consumers. The broader strokes offered in the My Big Coin ruling offer a useful lens with which to assess whether it would be helpful to regulate XRP as a commodity. More particularly, the Judge acknowledged that it was appropriate to construe the term “commodity” somewhat flexibly to effectuate the purpose of the regulatory structure over them.  See My Big Coin Pay, Inc., No. 1:18-cv-10077-RWZ, Dkt. Ind. 106, Memo. of Decision at 7 (quoting SEC v. Zandford, 535 U.S. 813, 819 (2002) (analyzing Section 10(b) of the Securities Exchange Act) (quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963))). 

The purpose of the regulatory scheme over commodities futures includes reducing risk associated with volatility, which in turn reduces retail prices for the underlying commodities.  See Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, 390 (1982).  “[A] futures contract provides for the buyer (the “long”) to purchase and the seller (the “short”) to sell a specified quantity of a specified commodity at a specified future date.” Jerry W. Markham, Manipulation of Commodity Futures Prices-the Unprosecutable Crime, 8 Yale J. on Reg. 281, 380 (1991).  If the price goes up, the buyer gets a bargain on its commodity purchase on the future date.  If the price goes down, the seller clears a surplus over market price.  Healthy futures markets operate to the immediate benefit of successful speculators and benefit the economy due to the reduced retail prices which result from price stability and predictability.  See Curran, 456 U.S. at 390.

The drafters of the regulatory scheme over commodity futures “intended to protect all futures traders from price manipulation and other fraudulent conduct violative of the statute” because fraudsters and price manipulators disrupt the benefits of a healthy commodities market.  See Curran, 456 U.S. at 390.  Let’s turn back to onions as an example.  There are various types of problematic market manipulation, and one of them is “the so-called ‘corner.’ Here the trader has control of all or virtually all of the available supplies of the commodity that underlie the futures contracts held by the trader. In such a case, the sellers or ‘shorts’ must pay prices dictated by the trader controlling the supply of the commodity.”  Markham, 8 Yale J. on Reg. at 283.  In mid-1950s Chicago, for instance, Vincent Kosuga and another trader cornered the market on onions, buying up nearly all available onions and onion futures.  They entered a short position, betting the price would fall.  Their near absolute ownership of the physical onions enabled them to ensure this occurred, thereby by flooding the market and generating profits on their short position. Not surprisingly, this was highly disruptive for the onion market.  See https://en.wikipedia.org/wiki/Vincent_Kosuga#CITEREFLambert2010 (citing Lambert, Emily (2010), The Futures: The Rise of the Speculator and the Origins of the World's Biggest Markets, New York: Basic Books; Greising, David; Morse, Laurie (1991), Brokers, Bagmen, and Moles: Fraud and Corruption in the Chicago Futures Markets, Hoboken: Wiley; Time Staff (July 2, 1956). "Commodities: Odorous Onions". Time. Retrieved January 2, 2011.); see also Markham,  8 Yale J. on Reg. at 318–19.  As a post-script, U.S. lawmakers banned onion futures, claiming that product to be uniquely susceptible to price fluctuations.  See Markham, 8 Yale J. on Reg. at 319.

By comparison, a sufficiently high XRP price relative to payment values, enough liquidity, and low volatility help best achieve XRP’s goal to facilitate low-value, low-cost payments and perhaps, eventually, high-value, low cost payments. See https://fudbingo.com/ripple-wants-to-suppress-the-price (“Logically speaking, if your XRP is not valuable enough to fund transactions on exchanges reliably because the liquidity is low, then xRapid use case for XRP falls apart and will be taken over by the asset with better settlement time and liquidity.”); https://ripple.com/files/xrp_cost_model_paper.pdf at 9-10 (as to volatility, use of the XRP rail in Ripple software imposed higher currency hedging costs “due to the potential higher volatility of XRP as a new asset” but lower overall costs due to the decreased costs associated with treasury operations and liquidity). As Ripple observed:

• We’ve shared our vision of an Internet of Value in which money moves like information moves today. Key to realizing that vision is lowering the cost of payments, especially in emerging markets. Financial institutions can use XRP, the native digital asset to the XRP Ledger, to exactly that end if XRP is highly liquid.
• To build XRP liquidity, we have been mindful over the years about how we distribute XRP. Our goal in distributing XRP is to incentivize actions that build trust, utility and liquidity. We engage in distribution strategies that we expect will result in a strengthening XRP exchange rate against other currencies.

https://ripple.com/insights/ripple-to-place-55-billion-xrp-in-escrow-to-ensure-certainty-into-total-xrp-supply/.

What is truly interesting then (and beyond the scope of my present thinking) is whether the commodity paradigm helps get us there. At least so far, Ripple has been successful without that regulatory scheme by successfully advancing XRP’s utility, increasing XRP’s value, and safeguarding the ledger’s growth (e.g., creating Xpring to jump start XRP ledger projects; hiring a lobbying team; initiating litigation against a founder who sought to sell 9 Billion XRP in a manner that was damaging to the market; replacing a chief executive’s whose interest in another 9 Billion XRP created a risk of conflict; etc.).  I guess I’m really just starting to ask questions rather than attempting to provide answers.