XRP is not a security, asserts Ripple as it faces third lawsuit

Kieran Smith , 14 Jul 2018 - LawsuitRippleXrp

XRP and Ripple diverge as Ripple is sued again regarding allegations of illegal security trading

In the latest lawsuit against the firm, a private investor alleges that Ripple have conflated the XRP token with the Ripple transaction technology, making them guilty of both price manipulation and illegally trading securities. Filed in the state of California, the plaintiff David Oconer claims that XRP has “all the traditional hallmarks of a security”, without being registered as such.

This is the third lawsuit to find fault with Ripple’s centralized distribution model, which has seen the firm essentially create billions of XRP tokens out of nothing, to be sold to the public on what the plaintiff claims is the false premise that their value is related to the efforts of Ripple Labs, the software company.

This funding model has catapulted the senior staff of Ripple to prosperity, and made the firm one of the most valuable startups in history. Ripple have not yet issued comment on the lawsuit, but said in May that it continues “to believe XRP should not be classified as a security.”

A dual identity

As news of the lawsuit spreads, Ripple appear to have embarked on a rebranding exercise to clarify the difference between ‘XRP’ the Digital Asset, and ‘Ripple’, the software company.

Ripple Tweet2

Confusion over the two terms is unlikely to help their case in the courts, but only recently has a clear line been drawn between the two brands. Although XRP is the native asset of the Ripple ledger, the ‘Ripple Connect’ variant of the software can function without it, which has made it popular with banks.

Earlier this year, Ripple's chief market strategist expounded the difference between the two terms, telling The Street: “XRP is a digital asset that trades on its own that’s owned by lots of people in lots of places. We happen to own a lot of XRP – we own a lot of cash, chairs and computers – but the company is called Ripple and we sell software.”

Is XRP a security?

In the traditional investment world, investors suing for price drops is not unheard of, and given that XRP has suffered 70 percent losses since early January, such a “stock-drop lawsuit“ would not be surprising. This is the position that Ripple will be defending, and a spokeswoman has claimed that the action is just “another example of an extortionist bringing forth an opportunistic suit that lacks merit.”

However, before entertaining this notion, the court will need to explore the possibility that XRP is actually a security. Although holding XRP does not denote ownership in Ripple Labs like a stock would, or afford dividends or voting rights, its pre-mined model arguably fits the definition of Security more snugly than Bitcoin or Ethereum.

To determine this,  the XRP token will be measured against the “Howey Test”, which classifies assets as securities if they meet the following criteria:

  1. It is an Investment of money

  2. There is an expectation of profits from the investment

  3. The money invested is in a common enterprise

  4. Any profit comes from the efforts of a promoter of a third party

Although it might seem black and white, the test is famously flexible, and much depends on the manner in which it is applied.

The implications of classification

If the XRP token is found to be an unregistered security, then this could spell serious trouble for Ripple, who are likely to face fines and even prison sentences, as well as having to compensate investors in line with the Mandatory Victims Restitution Fund Act. While the current state of indecision might be unhelpful for Ripple, a definite verdict could be prescient for the crypto-space as a whole, paving the way for the classification of other cryptocurrencies and setting a clear foundation for regulation.

Just last month, the crypto community breathed a collective sigh of relief as the SEC director of corporate finance proclaimed that Ethereum was not a security. But notably, this decision rested on the extent to which the cryptocurrency is decentralized.