Even though it is the third largest cryptocurrency by market capitalization, Ripple’s XRP token has faced criticism from within and outside the crypto community. Observers have also construed the SEC’s silence on XRP’s status as a negative, meaning that classification as a security could crash its high valuation by saddling it with extra costs and disclosures for compliance.
Another one was filed this month. The class action suit was filed by Florida investors and seeks compensation for (putative) damages and classification of XRP as a security. It adds to the already burgeoning list of cases against the company. Since May 2018, four lawsuits have been filed against Ripple for violating securities laws.
The complaint cites the SEC’s guidance on investment contracts for cryptoassets released earlier this year and states that XRP is an unregistered security. It also charges Ripple with violating California’s securities laws, and false advertising and unfair competition laws.
The Case Against XRP
Bradley Sostack, a former US Navy veteran and candidate for Republican primaries last year in Florida’s 13th Congressional District, is the lead plaintiff of this case. According to the filing, Sostack bought 128,978.88 XRP (worth approximately $307,700 in Bitcoin and USDT) between Jan 1 and Jan 26 in 2018.
In the aftermath of Bitcoin’s phenomenal price run up the previous month, XRP hit an all-time high of $3.84 per pop on Jan 4 of that year. But it rapidly lost value and ended up shedding approximately 50 percent of its value by the end of January. A prolonged slump in cryptocurrency markets followed soon after and Sostack was forced to offload his XRP holdings for a loss of approximately $118,100.
In his filing, Sostack charges Ripple with “a scheme…to raise hundreds of millions of dollars through sales of XRP – an unregistered security – to retail investor in violation of the registration provisions of federal and state securities laws.” His counsel has marshalled evidence of XRP’s security status from several sources and charged well-known crypto firms and publications, such as online publication Coindesk and Techcrunch founder Michael Arrington’s XRP Capital, with aiding Ripple’s false promotions of XRP as token. Coindesk claims that it is editorially independent from Digital Currency Group (DCG), its parent holding company which also owns a stake in Ripple.
What is the Evidence that Ripple is a Security?
The filing provides an assortment of facts and quotes to bolster their claim that XRP is a security and an instrument for speculation. As a reminder, the SEC generally uses the Howey Test, formulated in 1933, to determine whether a token is a security or not. The test uses four prongs – investment of money, establishment of a common enterprise, expectation of profits by investors, use of a third party to promote the initiative – to determine whether a given token is a security.
The filing points to the fact that 100 billion XRP was pre-mined before being released into the markets. Out of that amount, Ripple founders awarded themselves 20 billion XRP while 80 billion tokens were retained by the company and disbursed programmatically in periodic intervals to manipulate its price, according to the filing. This is unlike Bitcoin and Ethereum’s ether, which are mined in real-time and released into the market.
Another point of contention with the plaintiffs is XRP’s utility in mainstream markets or businesses. Bitcoin has positioned itself as a store of value for investors (or digital gold) while Ethereum is a platform for smart contracts. Ripple claims that XRP can be used in conjunction with its products, such as xCurrent, as a market-making token to speed up transfers between borders. But proof of XRP adoption among banks and enterprises that use Ripple’s blockchain tech is sketchy at best.
“Ripple’s value proposition as a company depends on the promotion of XRP, yet XRP is entirely or essentially pre-functional and purchased by investors in anticipation of profit based on the efforts of Ripple,” the filing states.
The filing also lists proof, in the form of statements and blog entries made by its employees, that Ripple, the company, is responsible for promoting XRP. For example, David Schwartz, Ripple’s CTO, stated on a message board that Ripple is “legally obligated to maximize shareholder value.” “With our current business model, that means acting to increase the value and liquidity of XRP.” Once XRP’s price shot up during the rally in crypto markets towards the end of 2017, Ripple quickly cashed in on its holdings of tokens. “The money raised through XRP sales substantially exceeds the amount of money needed to establish a functional network or digital asset.”
The filing also claims that there is no correlation between the price of XRP and market price for any goods or services that can be acquired in exchange for XRP. The sum of various public assertions and statements by Ripple’s founders is one of misrepresentation. “Had the Lead Plaintiff known that truth about XRP, he would not have purchased XRP and/or paid as much for it,” the filing states.