Former CFTC Chairman Gary Gensler dialed up the conversation on cryptocurrencies this week at the MIT Business of Blockchain conference by wading into contentious topics related to cryptocurrency regulation. His talk spanned a broad range of topics but the most controversial aspect of his speech related to the status of Ethereum’s ether and Ripple’s XRP as securities.
“There’s a very strong case, particularly for Ripple,” he said. Ether and Ripple are the second- and third-most valuable cryptocurrencies by market capitalization. Classifying them as securities could make it more difficult for initial coin offering (ICO) tokens to get off the ground because it would subject them to additional disclosure requirements. ICOs exploded into prominence last year but they have largely functioned outside the law.
Gensler used the Howey test to make his case for tokens as securities. The test, which is used by the SEC to classify securities, defines an offering as an investment contract “if a person invests his money in a common enterprise and is led to expect profits from the efforts of the promoter of a third party.” Gensler parsed this definition: Ethereum’s ICO offering had a 50% premium baked into it translating into a reasonable expectation of profit for investors. Similarly, Ripple’s association with market makers and the majority stake ownership of its founders is an incentive for them to pump up its price and profit from gains. The Ethereum foundation and Ripple Labs are third parties responsible for promoting their respective cryptocurrencies.
The Blowback Against Gensler
The reaction to Gensler’s broadsides against Ethereum and Ripple has been swift. Rippled issued a statement to Bloomberg in which it claimed that XRP will outlast Ripple. “XRP does not give its owners an interest or stake in Ripple and they are not paid dividends,” the company stated. “Ripple has always promoted XRP as a useful digital asset for enterprise payments because it’s faster, more scalable and more inexpensive than other digital assets.” In his speech, Gensler alluded to the fact that Ripple’s promoters withdraw money from their escrow accounts after trading XRP’s tokens.
Peter Van Valkenburgh, research director at Coincenter, a nonprofit for cryptocurrency advocacy, published a post refuting Gensler’s statements against ether as a security token. According to him, the pre-sale agreement between the Foundation and its investors may have qualified as an investment contract and ether may have been the underlying security. But he claims that it has, since, evolved. Ether’s value now ““flows from the efforts of thousands of unaffiliated developers, miners, and users.” As a result, the ethereum foundation is no longer responsible for promoting ether to increase its value for users and developers.
In a strange argument that stretches comparisons and veers into murky semantic territory, he also compared ether (which is generally referred to as the “gas” which powers ethereum’s network) to Apple’s iPhones and claimed that ether and iPhones are similar and cannot be considered securities.
Implications of Gensler’s Statements
There are no immediate implications to Gensler’s talks. The prices for ether and Ripple, which collapsed earlier under the threat of increased regulations, have mostly remained within their given range. But they ricocheted off the walls of cryptocurrency ecosystem increasingly being targeted by regulators. For example, SEC Chairman Jay Clayton has become increasingly vocal about his view that ICO tokens are securities.
For his part, Gensler said that 2018 is a time to bring compliance to the 1000 or so tokens. He said Ripple’s classification as a security might end up being decided in the courts and will have a net positive impact on the cryptocurrency ecosystem. This is because it will weed out bad actors, who comprise an overwhelming majority, from the ICO ecosystem.
The impetus for bringing regulation to cryptocurrency markets is economics, according to Gensler. “If someone is raising a quarter of a billion dollars and the market is the size that it is, the laws should adapt to bring it (ICO offerings) inside the public policy framework and, even if there is a chill immediately, reap the benefits later,” he said, adding that most evolving technologies, such as the Internet and Railroads, went through the same process. “Core public policy goals are still worthy but they need to be adapted,” he said.