XRP is not a stock, says the former CFTC president

When Chris Giancarlo was the president of the Commodity Futures Trading Commission, he became something of a rock star in some corners of the cryptocurrency community, helping to establish criteria that ultimately led to declaring bitcoin and ethereum commodities, more like coffee or sugar than stocks in a ‘company. The United States Securities and Exchange Commission largely followed suit, eventually stating that bitcoin and ether, the cryptocurrency that powers the Ethereum blockchain, were not stocks.

Now President Emeritus Giancarlo, who has been deemed “Crypto Dad” following a passionate congressional speech where he credited bitcoin for finally getting his children interested in finance, is back at it, having co-written a detailed topic. published this morning in Revision of international financial law for why XRP, the cryptocurrency formally known as “ripples”, wasn’t even a security. The only problem is that it is no longer a regulator. In fact, his employer is on the payroll of Ripple, the largest single owner of XRP, whose co-founders actually created the cryptocurrency.

The bombshell document, titled “Cryptocurrencies and US Securities Laws: Beyond Bitcoin and Ether,” co-authored by commodity attorney Conrad Bahlke of New York law firm Willkie Farr & Gallagher LLP, methodically reviews the Howey test criteria, established by the SEC in 1946 to determine if something is a security, and point by point it claims that XRP not qualify. Rather, the document argues, as its name indicates, cryptocurrency is a currency of perhaps more interest to the Federal Reserve and central banks than to the securities regulators.

The stakes here for the cryptocurrency world cannot be overstated. XRP is now the fourth largest cryptocurrency by market capitalization, with $ 5.9 billion in assets in circulation according to cryptocurrency data site Messari. While Ripple was valued at $ 10 billion according to its most recent funding round, the company continues to finance itself in part by selling its deep war chest of 55.6 billion XRP, coincidentally valued at the same amount as the company itself.

Not only could any SEC decision to classify, or not classify, XRP as a security title could impact the countless individual owners of the cryptocurrency, but also other customers who use Ripple services who don’t rely on cryptocurrency, including American. Express, Santander, and SBI Holdings could be impacted positively or negatively depending on the decision. After all, if XRP were canceled, it would be a huge cost to their software provider. If Giancarlo is right, Ripple could end up being one of the most valuable startups in fintech.

“Ultimately, with proper application of the Howey test and the SEC’s currently expanding analysis, XRP should not be regulated as a security, but instead considered a currency or medium of exchange,” argue Giancarlo and Bahlke in the paper. “The increased adoption of XRP as a medium of exchange and form of payment in recent years, both by consumers and in business-to-business environments, further underscores XRP’s usefulness as a bona fide legal substitute.”

Giancarlo was named CFTC commissioner by then President Barack Obama in 2013. In 2015, he helped drive the thinking behind the CFTC’s decision that bitcoin and other cryptocurrencies were commodities, paving the way for SEC comments that none of the neither bitcoin nor Ethereum are stocks. Then, at the height of the 2017 cryptocurrency bubble, President Trump appointed him president of the CFTC, where he oversaw the creation of a number of bitcoin futures projects, including at the CME Group and the short-lived effort at Cboe.

While many blame the creation of bitcoin futures for bursting the 2017 price bubble, which nearly hit $ 20,000 before halving today, others saw the jobs as a fundamental process of maturity, helping pave the way for deals. more sophisticated crypto-enabled financial institutions. Giancarlo’s last day in office at CFTC was in 2019, after which he promptly got involved in helping envision the future of assets issued on blockchain. In November, he joined the American Financial Exchange as an advisor, using Ethereum to create a Libor alternative. The following January he co-founded the Digital Dollar Project leading the push to use blockchain at the Federal Reserve and now appears to be hoping to influence XRP’s classification as he has done for bitcoin and ethereum, but on the other side of regulation.

Importantly, however, a footnote in the report reveals that not only is the company of Giancarlo and Bahlke, Willkie Farr and Gallagher LLP consultant to Ripple Labs, but “was based on some factual information provided by Ripple. in preparing this article “. While it’s impossible to analyze what information comes from the co-authors and what comes from Ripple, the resulting legal argument is fascinating, even if it leaves room for doubt.

The Howey test that Giancarlo uses to support his arguments is a three-pronged definition used by the SEC, none of which, according to him, apply to XRP. The first point is that an investment contract must be implied or explicitly stated between the issuer of the asset, in this case XRP and the owner, where the money swaps hands. “The mere fact that an individual holds XRP creates no relationship, right or privilege with respect to Ripple, just as the possession of Ether would create a contract with the Ethereum Foundation, the organization that oversees the architecture of Ethereum,” he writes.

This however overlooks the fact that OpenCoin, credited to Ripple’s site in 2013 for creating XRP (later described as “ripples”), was run by many of the same people who founded Ripple. The original creators of XRP then donated the vast majority of assets at Ripple, which they also ran, creating a sense of distance, however tacit it may be. The actual data on the creation of XRP was also confused by a glitch in the code which means that, unlike bitcoin and ethereum, crucial genesis data is no longer attached to the rest of the ledger. The rebranding of “ripples” as XRP has further extended the sense of distance between XRP and Ripple, followed by an aggressive campaign to get the media to stop describing cryptocurrency as “Ripple’s XRP”.

With so much distance between the company that actually created XRP and the company that now owns more than half of it, it would be forgiven for wondering, if there was an implied contract between OpenCoin and the owners of XRP, make the donation from a group of people in one company to a very similar group of people in another company separate this responsibility? Despite Ripple’s sense of distance between itself and the cryptocurrency created by its co-founders, numerous active lawsuits have been filed for alleged security breaches. In all fairness, however, Giancarlo seems to recognize that this pole may not be Ripple’s strongest defense and concludes the section, covering himself up: “Even if XRP does satisfy one or two of the” poles “of Howey’s test, it doesn’t satisfy everyone and three factors such that XRP is an investment contract subject to regulation as a security. “

The second point of the Howey test states that there can be no “joint venture” between shareholders or a shareholder and the company. While refuting both reports, Giancarlo curiously goes on to write that “given the juxtaposition between the intended use of XRP as a liquidity tool, its more general use to transfer value and its potential as a speculative asset, XRP holders who use coins for different purposes have divergent interests to XRP. “

Ironically, there has always been a widespread belief that owning a cryptocurrency would pool interests around a single goal: to co-create the infrastructure that allows cryptocurrency to exist and ensure it was vibrant and diverse. Meanwhile, XRP, despite its aggressive social media supporters, is one of the least diverse ecosystems, with the vast majority of serious developments taking place within Ripple. If the owners of XRP aren’t expecting an increase in value from Ripple’s work, they certainly aren’t as involved in helping build that future as the owners of bitcoin and ethereum are.

In a related issue, the third prong of the Howey test states that “no reasonable expectation of profit should be derived from Ripple’s efforts,” according to the paper. In support of this position, Giancarlo writes: “While Ripple retains a sizeable share of the XRP supply and certainly has a pecuniary interest in the value of its holdings, it is not enough to suggest that a mutual interest in the value of an asset gives rise to an expectation. of profits as contemplated by Howey. “Again, this strains gullibility.

According to their site, Ripple currently has access to 6.4% of all XRPs ever created. But that doesn’t count 49.2% of the total XRP Ripple owns, but is locked into a series of escrow accounts that periodically only become available to Ripple and Ripple. Adding these two percentages together leaves a free float of only about 44% of XRP that has been distributed for public ownership. For comparison, Facebook went public the same year XRP was created and has a 99% free float, according to data from FactSet, which means nearly all of its stock is in the hands of traders. even more traditional stocks, this distribution shows that Ripple may not be as distributed as it claims.

While perhaps unsurprising that Giancarlo sided with his own client, there are also many other reasons to believe his argument can actually hold up. In February 2018, the notoriously compliant exchange Coinbase added support for XRP, which it would hardly do if it were concerned it might accidentally sell an unlicensed stock. Perhaps most significantly, though, Ripple also got a hard-to-get BitLicense from the New York Department of Financial Services, giving it the blessing of a respected regulator. However, while the license was granted after then Superintendent Benjamin Lawsky stepped down from the regulator, it is perhaps no coincidence that a year later he joined Ripple on its board of directors and is now active in the space of cryptocurrencies. Perhaps a similar fate is in store for Giancarlo.

Editor’s note: This article has been updated to clarify that Ripple Labs is a client of Giancarlo’s law firm.