Latest Ripple Update
The Ripple situation is getting messy.
Quick update. As you may recall, the SEC gifted Ripple and two of its executives a Christmas present by serving them a complaint on December 22, 2020. Ripple responded earlier this year, the SEC then amended their original complaint in February, to which Ripple has just responded on March 4, 2021. Separately, the two executives are trying to get out of the case on an individual basis. A settlement does not seem anywhere in sight, nor should it be. Let’s run this all the way, let a jury decide and use it as an opportunity to clarify the reach of the securities laws.
Make no mistake, this is shaping up to be the crypto case of the decade. It will indeed make waves in the crypto space no matter which way the case goes.
Meanwhile, the ex-chair of the SEC thinks that the SEC is dead wrong in the Ripple case.
Of course she does, she is one of the attorneys representing Ripple.
The ex-Chairman of the CFTC also believes that XRP is not a security.
Of course he does, he is senior counsel to a law firm that does work for Ripple.
So, in one corner you have a major crypto actor and some high-powered attorneys. In the other corner, you have the SEC, which we believe is absolutely correct on the merits in this case. Our sister publication, the Full Court Press, is the better venue to cover the technicalities in this case, so be on the lookout for that analysis. In the interim, though, let us say this:
XRP has an identity problem.
Central to this case is what XRP actually is. Aswath Damodaran, Professor of Finance at Stern Business School at New York University, neatly categorizes trades into assets, commodities, currencies, or collectibles. Which one is XRP?
Well, XRP wants to be all things to all people. First, it wants to be a currency. The following three quotes are statements from Ripple in its answer to the SEC’s amended complaint:
XRP functions as a medium of exchange— a virtual currency used today in international and domestic transactions — moving value between jurisdictions and facilitating transactions.
But it also wants to be an asset:
XRP is a fast, efficient and scalable digital asset, making it ideal for payment processing … XRP is and long has been a digital asset with a fully functional ecosystem and utility as a bridge currency and other types of currency uses.
Finally, it also wants to be a commodity:
Ripple holds a large percentage of XRP, but that alone does not and cannot render it an investment contract. Many entities own large amounts of commodities and participate heavily in the commodities markets — Exxon holds large quantities of oil, De Beers owns large quantities of diamonds, Bitmain and other Chinese miners own a large percentage of outstanding bitcoin. Such large commodity owners inevitably have interests aligned with some purchasers of the underlying asset. But there is no credible argument that substantial holdings convert those commodities or currencies into securities, nor has any case so held.
Just 6 pages into their 100-page answer to the amended complaint, Ripple argues that XRP is a jack of all trades. You know how that saying ends, right?
Who are you, XRP? We feel like we don’t know you. You cannot be everything. Pick one and stick with it.
This is where this trial should start, with clear definitions. A framework that everyone can agree on. Then the law can be properly applied to the facts. Absent that, there can be no hope of reaching the right outcome in this case, at least not for the right reasons.
You know what is funny? XRP’s best characterization is arguably the only category it didn’t mention: collectibles.
To say that XRP is a functioning currency today would be a major stretch. It could become one at some point, in the future, but we are not paying for our milk in XRP just yet. You might say, so what, I can’t really buy milk with bitcoin either, what is the difference? The difference is that the SEC thinks that Bitcoin is decentralized and XRP is not, and that is material to the determination of whether or not something is a security. We look at it a bit differently, but that’s a whole different topic altogether.
XRP is not a financial asset either because it does not generate any cash flows and it cannot be valued. Therefore, it is a pseudo-asset.
It is also not a commodity, not in the classical sense. It can be a commodity from a CFTC perspective because currencies can be commodities in that universe. That said, it is not an input in a production process and it is not a commodity under Damodaran’s framework, either.
Where does that leave us? It’s essentially a digital collectible. Brett Scott has it right:
Here is another funny thing. This case somehow feels like the Daily Fantasy Sports ("DFS") case in New York. There, the state of New York was right on the merits and DFS brought in high-priced lawyers. The similarities are hard to miss:
Jack of All Trades
DFS, just like XRP, turned itself into a chameleon and became whatever it needed to become at any given point in time. Marc Edelman and others wrote a paper on it. They said:
First, DraftKings and FanDuel were able to categorize themselves differently to different audiences at different times in a manner that evaded categorization as an illegal gambling activity, only to then dominate the sports betting market after the Supreme Court’s decision in Murphy v. National Collegiate Athletic Association. This type of strategic categorization, which we call “fluid categorization,” raises important questions for regulators and others concerned with regulatory arbitrage. It also provides lessons for other businesses.
They warned that this type of regulatory arbitrage has broader implications than just sports gambling:
While this article has broad implications for the sports gambling marketplace, it also contributes to meaningful discourse for the broader business community, as its findings are relevant to industries, beyond DFS, that offer gray market products and seek to fight categorical labels until there is a reclassification-event.
People like being multiple things, they can be a parent, athlete and artist, for example. Or an entrepreneur, musician and grandparent. We the people wear multiple hats most of the time.
However, when a financial arrangement where money changes hands tries to become multiple things, it becomes harder for the law to work the way it is intended. If something can be an investment opportunity when the money is coming in, but not a security when the money is going out (cost of regulation), that is simply not right. The playbook that crypto is relying on is quite similar to the one that the DFS industry relied on.
The Truth Will Set You Free. But First It Will Piss You Off.
DFS described itself in many different ways. It was like poker at times. Other times, it was an investment (p.54 of this .pdf). It was also entertainment, not gambling. Yet at other times, it was like a golf tournament or spelling bee. Ultimately, the DFS industry argued that it is a game of skill that brings us closer to the sports we love.
What was never mentioned (other than by us), was what DFS really is. DFS is a claim on sports performance, not a game.
As mentioned above, XRP is claiming that it is a currency, or an asset, or a commodity. As of today, none of these things are true. What it really is today is a digital collectible, but you will find very few people saying that. The truth, when inconvenient for most, tends to stay in the dark.
I Have a Big Brother
DFS was keen on hiding behind its big brother, traditional season-long fantasy sports, when needed. Traditional Fantasy Sports was roughly 60 million strong in America. Strength in numbers, right? It was also widely seen as a rather harmless social activity. Reputation matters. It was rational for DFS to make references to an activity that generally had positive connotations.
Crypto also has a big brother. It’s called gold. An obsession for mankind for thousands of years, gold has some limited use as a raw material to the production process and was a legitimate part of the monetary system at some point, but today, it is an asset proxy that doesn’t produce anything. Don’t get us wrong, gold is an asset that belongs to a personal balance sheet as long as somebody is willing to pay for it. With so much history, it is unlikely that people all of a sudden will wake up and conclude that they are not willing to pay for gold. That said, gold is not a financial asset and it does not generate any cash flows. If you have ten minutes to spare, we recommend that you watch the Oracle of Omaha weighing in on this topic (he is quite the entertainer), and then finish with this video as a dessert.
Traditional fantasy sports has never been a game, but it is hard to see that. Similarly, gold has never been a (financial) asset in the first place, but it had such a stellar reputation, there really weren't any incentives to challenge that. Thus, traditional fantasy sports gave way to DFS and Bitcoin has become the digital gold.
Even the Most Obvious Truth Can Be Denied If Inconvenient
Were the DFS participants risking something of value when they “played” DFS? One can perhaps argue whether or not DFS is gambling. All kinds of things come into play here in terms of how we define gambling, how we measure it etc. (Check out this visual). What should not be arguable is whether DFS participants risk something of value. That part should be a slam dunk. Can anybody really say, with a straight face, that putting cash into a DFS platform can ever be not risking something of value?
If you are rolling your eyes and saying “Come on now, nobody would say that,” then maybe you need to open your eyes. The argument was made by DraftKings in a court brief in late 2015, where one of the arguments read: “Participants Paying An Entry Fees To DraftKings Are Not Staking Or Risking Anything Of Value.” That’s truly extraordinary alchemy. If nothing is being risked, then anybody should just go ahead and put their entire life savings into DFS. Nothing ventured, something gained, right? Eventually, people will win something and if one can win something without risking anything, they should just repeat the process forever.
Now … If you get on your favorite crypto exchange, whatever that is, and forking out cash to buy XRP, can it really be that there is “no investment of money?” Recall that the whole debate is whether XRP is an investment contract. Also, the point is not whether or not the product is a true investment but whether one buys into it thinking it is an investment and lays out some money as part of the process.
If you are rolling your eyes, and saying “Come on now, nobody would say that,” well, maybe you need to open your eyes, again. The argument was made by none other than the ex-CFTC chairman. Why? Because all the crypto side needs is to prevail on one of the arguments, so there is a huge incentive to argue all kinds of things, however nonsensical, hoping that one of them might just stick.
Is It Ever Too Late To Do The Right Thing?
DFS, just like Ripple, argued that it is too late to take action. That argument was made by David Boies, who pointed out that DFS was a thing in New York for eight years, FanDuel was operating in New York for six and half years and DraftKings for four.
Ripple made the exact same argument:
The SEC filed this Complaint 8 years after XRP was created, 5 years after the DOJ and FinCEN characterized XRP as a virtual currency, and after more than 2 ½ years of investigation during which the SEC allowed Defendants to continue to distribute XRP, allowed the XRP open market to grow, and allowed millions of market participants to rely on the free and efficient functioning of that market.
Do you see a theme here? Man, even the delay is the same. Eight years for DFS. Eight years for XRP.
To see how absurd this line of reasoning is, just consider that you go 100 miles an hour on a freeway where the speed limit is 60 miles an hour. Nothing happens for 30 mins and you enjoy the ride. It’s thrilling. Then, a cop pulls you over, and you say “Officer, I have been doing this for 30 minutes and nobody stopped me, you can’t do it now. It’s too late.”
Would that work? Of course not. Neither should it work for Ripple. The SEC may have been a bit slow to bring this case, but like any other government agency, they are probably understaffed. They might be late, but better late than sorry. The government rarely works as fast as the private sector, but that is not an excuse to let bad actors that sidestep the law escape the consequences of their actions.
The New York DFS case was settled. Call it karma, or whatever, but Eric Schneiderman’s career was turned upside down. He was a rising star not too long ago. The state of New York is now being forced to defend the exact opposite position they had taken previously.
Don’t settle, SEC. Don’t make the mistake that Attorney Eric Schneiderman made in the daily fantasy sports case. If you do, one of the last barricades might fall, we end up with a zillion more coins and it will be the American public that ends up being fleeced.