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My running analysis of the SEC v. Ripple, Larsen et al


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1 hour ago, Pablo said:

 

This is an interesting claim to make. Kik can't sell Kin tokens without jumping through hoops. What would it mean if Ripple were similarly restricted and what do you think this means for Ripple's business plan, investor redemptions etc?

 

I will quickly say I was 100% right about XRP's price action vs. Kin's (as of right now anyway), was I not?

I'm out running errands--will respond to the rest later tonight. 

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This brings us to the latest development from the hearing yesterday regarding the SEC's request to access Brad/Chris's bank accounts as part of discovery. The question arises as to how the hearing aff

I've already commented in separate threads how I think the SEC case is playing out and what it means for XRP, Ripple and the broader crypto ecosystem.  Some people have asked me to consolidate th

You are correct that I wasn't confident of a good outcome. However it goes further than just the outcome of the case. It extends to the fact that a redemption clause was there in the first place for T

22 hours ago, Pablo said:

I'm hoping to advance the debate

I don't know what a pessimistic or realistic view looks like but I prefer to keep both feeth on the ground.

Just remember that most of us are invested in XRP and often we (or at least I) tend to see the developments as we like to see them. So, without having a legal background, your views help me to see also the other side of the medal, therefore your contributions are highly appreciated.

For me one of the key questions in the lawsuit and maybe THE key question is the use case. The SEC reasoning that Ripple i.e. the CEO's only goal was to make money and especially that the use case is basically non existing is a bit the foundation of their allegations which might turn out to be a wrong strategy if Ripple is able to explain their use case well.

Even the question whether or not the sales of tokens is to be seen as the sales of an investment contract, seems to be related to the existence of a real use case. Therefore, I prefer to keep the focus on the key issues rather than on short terms battles, even if these could become important if inconsistent behaviour or treatment by the SEC would come out during the discovery.

In conclusion, even if Ripple has won some battles, the war is far from over and will take months unless compromising information comes to the surface. On the other hand the SEC's lawsuit to me doesn't seem to be very solid considering they had years to prepare it.

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A big difference between XRPL and most other blockchains, especially Proof-of-Work and Proof-of-Stake, is that concentration of token wealth does not grant control of the network. A lot of FUD against Ripple and XRPL is rooted in the belief that concentration = centralization, which is only true with PoW (through concentration of money, access to cheap electricity, hardware) and PoS (through concentration of governance tokens). 

Then there is the question of whether Ripple really owns a large concentration of XRP.

That brings me to the potential strategy that I would use, if I were in Ripple's place and in the unlikely event that this goes to trial:

  • Expert witness can easily disprove how concentration of XRP has nothing to do with control of the network itself because it's not a governance token.
  • There have been no sales by Ripple for at least a couple of years now. Clearly there is line after which there simply weren't any new sales.
  • Ripple hasn't controlled the blockchain consensus for a couple of years now, with the cheque amendment being the oldest amendment introduced without Ripple's control over it. 
  • More importantly, the escrow today is controlled by the community. Ripple holds the wallets that get the monthly deposits, yes, but they don't own the escrow and if the rest of the validators want to, they can easily render it useless. 

That brings us to a few additional challenges in the lawsuit:

  • Assuming there is an XRP sale by Ripple that's considered an investment contract, when does it stop becoming an investment contract? Are all XRPs currently in circulation also considered securities ? I don't personally see this flying because this also taints Ethereum and others.
  • An allegation has been made that Ripple's Principals have intentionally drummed up support for XRP in order to personally gain from a higher XRP price. This can be argued both ways. The SEC will say "look at how much money they made" and Ripple + Brad/Chris will say "our sales haven't budged the market at all, and in fact XRP went down with good news so many times..".
  • When Brad, Chris, Ripple were "gifted" XRP, the value was close to a big zero. May be with Brad it was at best worth a few hundreds of thousands of dollars, which almost certainly can be proved as being at par with compensation for an executive at Brad's level. There was no such thing as a cryptocurrency market then. And once the market grew (in conjunction with BTC and ETH) Ripple simply couldn't distribute the tokens because other parts of the U.S. government wouldn't let them. For example, they couldn't just airdrop the tokens because they would be burdening retail investors with tax issues. I am sure they'll have plenty of internal memos and e-mails discussing this problem, which will support that Ripple has tried to do the right thing but simply wasn't allowed to.
  • For a long time, the development of the blockchain was concentrated with Ripple. Now, the source code has been technically open source so it's not their fault that the community was slow to adopt. Let's see what the court thinks about this.

I am sure there are other issues that the SEC and Ripple will have to resolve apart from the above. Here's my personal opinion - 

I agree with @Pablo that the only realistic positive outcome is a settlement that's face-saving for both the SEC and Ripple, but I don't think the outcome of this lawsuit handicaps the SEC in any way. Ripple has several unique factors going for it that simply don't exist for most other newer blockchains that are scared of SEC action. It's consensus mechanism (concentration != centralization), the fact that it raised VC money instead of relying on XRP sales, potential internal documents showcasing their discussions around this problem, cessation of sales for two years now, regular communication of state of XRP sales + volatility, etc. will instead allow the SEC to formulate a potential blessed path for newer companies to innovate. For example:

  • If you want to raise money through crypto, register with the SEC. Otherwise, raise through VC (and also register with the SEC). Sales outside of the U.S. might be a temporary loophole unless Biden's Administration fixes the offshore revenues issue.
  • Build on a consensus algorithm where concentration != network control. E.g. Avalanche, FBA, possibly some variants of PoS. On the plus side, carbon friendly !!
  • Make sure token distributions always happen through an escrow of sort - that way you avoid market dumping but also avoid concentration with the company/non-profit foundation. 
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22 hours ago, HenrySeldom said:

I will quickly say I was 100% right about XRP's price action vs. Kin's (as of right now anyway), was I not?

Yes - agreed. And I've given you credit for picking the Tetragon case. You haven't been right on the timings though. Discovery won't start until later in May. Settlement is therefore several months away unless you think a politically expedient settlement will be offered by the SEC. I think it will come down to each party testing the other side's case properly to assess the weaknesses and strengths and build leverage to take into the settlement negotiations. 

I'm pretty comfortable with the likely landing spot for this case. Win, lose or settle, I think the outcome for XRP and the XRPL itself does not change significantly and I presented the reasons why very early on. However what it means for Ripple and the broader crypto market is an important consideration as well.

As a lawyer advising projects on the future state of regulation, the Ripple case is only one small piece of the puzzle. What I've tried to argue is that the actions taken by Ripple and John Deaton and the attempts to embarrass and humiliate the SEC have domino effects beyond this case into other litigation, SEC's ongoing role in this space and the broader question of crypto regulations.

To take your parable further, cutting the Gordian Knot was a violent act whose calculus only emerged after further acts of violence were committed. If Gensler is indeed Gary the Great, what other bold steps must he take to make cutting the knot worthwhile?

Pursuing one strand coming from this knot is what quick settlement with Ripple means more broadly. It solves our immediate problem but leaves unanswered the larger problem of what to do with crypto. Does it force regulators to double-down and take a tougher stance on crypto or force them to retreat? We can already see some clues.

Picking another loose strand here, a Ripple victory or quick settlement doesn't solve Moneygram's class action (even if it appears pretty soft). What should other potential clients in the US do as they watch this unfold? Does settlement give a potential client the certainty they need prior to investment? I'd argue not. They either accept the regulatory uncertainty or they include better forms of redemptions and exit clauses and indemnites to mitigate the risk. Probably a combination of all the above.

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1 hour ago, Ripley said:

There have been no sales by Ripple for at least a couple of years now. Clearly there is line after which there simply weren't any new sales.

A couple of years? Are you sure? SBI only recently signed an option to buy XRP from Ripple at 15-30% discounts off spot price and other market makers will have similar arrangements. The SBI deal runs until November this year.

That was one welcome discovery coming out of this lawsuit for me as an investor. We've known about aggregate OTC sales and Jed's sales but it was a genuine eye-opener to see the terms of the SBI discounts and the daily volume caps. For me it puts to bed the conspiracy theory peddled by various Twitter personalities that there is some secret cabal of BTC maxis hell-bent on dumping XRP onto the market.

Sorry - I should have added @Ripley that I think there's lots of merit in your analysis, particularly with regard to a possible way forward for the parties and industry.

Edited by Pablo
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4 minutes ago, Pablo said:

A couple of years? Are you sure? SBI only recently signed an option to buy XRP from Ripple at 15-30% discounts off spot price and other market makers will have similar arrangements. The SBI deal runs until November this year.

That was one welcome discovery coming out of this lawsuit for me as an investor. We've known about aggregate OTC sales and Jed's sales but it was a genuine eye-opener to see the terms of the SBI discounts and the daily volume caps. For me it puts to bed the conspiracy theory peddled by various Twitter personalities that there is some secret cabal of BTC maxis hell-bent on dumping XRP onto the market.

Sorry, I was referring to the public markets. OTC sales came with those volume caps. Then there is the question of whether those sales were made in the US or outside.

I’d imagine if this was done outside the US with volume caps, the SEC might not have jurisdiction and they won’t be able to claim market manipulation either.

I’d be very surprised if they did anything remotely incriminating while the SEC investigation was going on. 

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1 hour ago, Ripley said:
  • There have been no sales by Ripple for at least a couple of years now. Clearly there is line after which there simply weren't any new sales.

Incorrect. Programmatic market sales were stopped, but OTC sales to interested parties have been ongoing.

 

25 minutes ago, Pablo said:

Pursuing one strand coming from this knot is what quick settlement with Ripple means more broadly. It solves our immediate problem but leaves unanswered the larger problem of what to do with crypto. Does it force regulators to double-down and take a tougher stance on crypto or force them to retreat? We can already see some clues.

Picking another loose strand here, a Ripple victory or quick settlement doesn't solve Moneygram's class action (even if it appears pretty soft). What should other potential clients in the US do as they watch this unfold? Does settlement give a potential client the certainty they need prior to investment? I'd argue not. They either accept the regulatory uncertainty or they include better forms of redemptions and exit clauses and indemnites to mitigate the risk. Probably a combination of all the above.

This sums it up nicely, but don't forget that a settlement is only a settlement if both parties agree to it. I'd argue that ripple would be foolish to agree to any settlement that doesn't provide the clarity they require to onboard Banks/FIs that fall under US jurisdiction. Ripple have said so many times that regulatory clarity is holding back the industry, so there's no way they should settle unless the terms allow them to unroll ODL and LoC to anyone and everyone that wants it, (under reasonable terms). They should have the freedom to incentivise market makers with XRP (as they have been doing), to reward payment providers like MGI with XRP (as they have been doing), to pay off developers like RippleX and Coil (as they have been doing) and potentially unroll other incentives like the ones proposed in the Patent to increase liquidity and push ODL to the top of the pile for large scale adoption within ripplenet (and beyond).

What the terms of such a settlement might be, I cannot say, but with the new SEC chair coming soon, hopefully someone will have some ideas that would work.

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Ripple are not going to settle unless the settlement includes clarity of XRP being deemed not a security and a currency. 

As of now, Ripple are winning quite comfortably on how XRP is perceived. Ripple are extremely well seasoned. If someone is to blow up it'll be something that would shake up the entire market and just like Jeremy Hogan eluded to, it much better being the first to feel wrath of something than much later on e.g. financial crisis and penalties. The first list of Bank holding their hands up had quite miniscule penalties compared to the rest.

Personally, the SEC are so far down the rabbit hole that agreeing to the above I think pigeon holes themselves for future cases. It basically forces them to agree what is not a security and what is a currency without having control of the messaging. I.e. they can't turn a blind eye to XRP and then tell the rest of the market a different story. It has turned into all or nothing now. If a settlement was to be reached it would've happened already.

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Just to be clear - really the SEC cannot declare XRP is not a security as part of the settlement, they can only declare that they have no reason to purse enforcement against XRP sales.  Is this correct?

Also - fwiw in the transcripts of the hearings so far, one significant difference Ripple's attorney's point out between XRP and Kin/Kik is that that in those other cases the fundraising/sales began before the tokens were created.  It seems like Ripple is going to really lean on the fact XRPL was up and running and then gifted to differentiate their case.

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15 hours ago, WrathofKahneman said:

Just to be clear - really the SEC cannot declare XRP is not a security as part of the settlement, they can only declare that they have no reason to purse enforcement against XRP sales.  Is this correct?

That's the big question. Really. This is a big reason why Ripple says this is an attack on all of crypto. Apart from the PR aspects of the statement, there is a foundational basis to be concerned about. Not that the token itself is a security. Not even that the token was sold as an investment contract by Ripple. But when does it stop being an investment contract ? 

As retail investors, we may feel that once a token hits a public exchange, that's the end of it. It feels logical. But that's not necessarily what the law says, as of today. The SEC's charter is to enforce the law. They themselves have their hands tied unless Congress passes legislation. 

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On 4/11/2021 at 9:41 PM, WrathofKahneman said:

Just to be clear - really the SEC cannot declare XRP is not a security as part of the settlement, they can only declare that they have no reason to purse enforcement against XRP sales.  Is this correct?

I think that's right - it's unlikely the SEC would agree to a statement that says "XRP is not a security" but by the same measure, it would be unlikely for them to state in the settlement that they won't pursue secondary markets because it has nothing to do with their case against Ripple. The parties would simply set out the terms on which Ripple can and cannot sell XRP in the US market and the extent to which Ripple can and cannot supply XRP to 3rd parties to sell in the US market.

Depending on how much leverage Ripple has, I expect they would want the SEC to make some type of declaration regarding XRP because it's important for market confidence and regulatory clarity. We haven't seen the SEC agree to this in other ICO lawsuits but it needs to be asked.

In the Kik matter, the SEC won the case but left the question open regarding the Kin token and the outcome was that secondary markets for Kin continued outside the US but Kin hasn't been listed on US exchanges nor has Kik sold any more itself (as far as I can tell). That's not really helpful to the industry.

 

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On 4/11/2021 at 4:48 PM, Ripley said:

A lot of FUD against Ripple and XRPL is rooted in the belief that concentration = centralization

I have seen this mentioned a lot, but is it relevant to the SEC case? My understanding is that it is precisely the concentration of XRP held by Ripple which lends weight to the common enterprise argument as part of the four prong Howey test.

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On 4/9/2021 at 11:36 PM, Pablo said:

I don't see how the SEC can afford to lose this case. If they do lose because they interpreted the act incorrectly, they are facing a tsunami of lawsuits as wronged investors and ICOs pursue the SEC for abusing their authority

This is what befuddled me when the SEC lawyer stated that this case was solely about the sales of XRP by ripple and they weren't targeting secondary market. Had they said this in the original lawsuit it may not have resulted in such a huge drop in XRP price. Do you think this was naivety on the SEC's part or they are simply keeping the door open to kill the secondary market as well?

If the former, it does strike me as odd that the SEC would leave themselves with such little room to manoeuvre. That is not to say that they do not have a good chance of winning - just that the consequences of losing seem dire. John Deaton's motion to intervene has demonstrated there is sufficient anger amongst holders to go after the SEC. To me this suggests a smaller chance of a settlement or even clarification made by the SEC, as any concession they now make opens the door to a 'tsunami' of lawsuits - as you say.

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22 minutes ago, xiaoipower said:

I have seen this mentioned a lot, but is it relevant to the SEC case? My understanding is that it is precisely the concentration of XRP held by Ripple which lends weight to the common enterprise argument as part of the four prong Howey test.

Ripple doesn't own the Escrow though. That's the point. They don't have a concentration of XRP. They own the wallets that get the deposit. It's the community - the rest of the validators - that is allowing that Escrow to exist. Ripple doesn't control the network and cannot stop that Escrow from being destroyed, if the rest of the validators desire so. 

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2 minutes ago, Ripley said:

Ripple doesn't own the Escrow though. That's the point. They don't have a concentration of XRP. They own the wallets that get the deposit. It's the community - the rest of the validators - that is allowing that Escrow to exist. Ripple doesn't control the network and cannot stop that Escrow from being destroyed, if the rest of the validators desire so. 

Yes that certainly throws a spanner in the works in terms of complexity. I assume your argument is therefore that once the ripple no longer had majority of validators of the UNL then the common enterprise by concentration argument goes away?

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