SEC Caught in Ripple... But Messages Still Remain

Ripple Surging Sharply This Month... Still Remembered by Investors as 'Rittosok'
SEC Deemed It a Sub-Test... Logic Is Weak
But the Remaining Message: "Why Does Cryptocurrency Value Come from Exchanges?"

[Image source=Yonhap News]

[Asia Economy Reporter Gong Byung-sun] There is probably no cryptocurrency that has swayed investors' hearts as much as Ripple. In early December 2017, Ripple was priced in the 200 won range, but it gained popularity mainly in South Korea and rose to 4,080 won. However, its fall was also steep. When former Minister of Justice Park Sang-ki hinted at cryptocurrency regulations in 2018, Ripple dropped by 37.26%, falling to the 1,000 won range. It continued to decline steadily, maintaining the 300 won range during 2018?2019. So much so that the term ‘Rittosok’ (meaning ‘being deceived by Ripple again’) was coined.

Recently, Ripple has been making a comeback. According to the domestic cryptocurrency exchange Upbit, Ripple, which was in the 400 won range earlier this month, surged to 2,060 won as of 2:49 PM on the 17th. This is because the possibility of Ripple winning the lawsuit filed by the U.S. Securities and Exchange Commission (SEC), which was the biggest cause of last year's decline, is increasing. How did Ripple, which deceived everyone by dropping 41.15% in a single day, revive? And can Ripple overcome the questions posed by the SEC and continue its rebound?

Ripple Meets the Howey Test... Is SEC Targeting Most Altcoins?

On December 22 last year (local time), the SEC filed a lawsuit against Ripple’s issuer, Ripple Labs. The SEC claimed that Ripple is a security but did not go through the formal registration process.

To understand why the SEC considers Ripple a security, one must first look at the Howey Test. The Howey Test is an evaluation procedure used to determine whether a transaction qualifies as a security; if it meets four criteria, it is considered an investment, i.e., a security.

The criteria are as follows: ▲Was money invested? ▲Was there an expectation of profits from the investment? ▲Is the invested money part of a common enterprise? ▲Are the profits derived from the efforts of others rather than the investor’s own efforts?

The SEC’s judgment is that Ripple meets these four criteria. Ripple is currently traded on exchanges. We pay cash to buy Ripple and expect to earn profits. Also, the fact that Ripple is issued centrally is considered by the SEC as meeting the Howey Test.

In fact, Ripple was created for remittance purposes and has a centralized system. Domestic investors most frequently use Ripple as a fee when sending money through the overseas exchange Binance because the fees are low and the speed is fastest. Therefore, Ripple was not created through mining but is entirely issued and managed by Ripple Labs. In other words, Ripple Labs centrally manages Ripple issuance, and the SEC interprets this as embedding investment value in Ripple.

Additionally, the SEC filed charges because Ripple suggested long-term investment while receiving money from investors. According to the SEC’s complaint, Brad Garlinghouse, CEO of Ripple Labs, promoted holding Ripple for long-term investment. The SEC also believes Ripple Labs raised at least $1.38 billion (about 1.54 trillion won) by selling Ripple.

Although not stated in the complaint, the SEC has another intention. If they catch Ripple, they can open the door to regulate other altcoins. Professor Lee Byung-wook of Seoul School of Integrated Sciences and Technologies explained, “Most altcoins have a structure similar to Ripple, where issuance and management are centralized. The SEC aims for a twofold effect by regulating not only Ripple but also other altcoins.”

Ripple Labs: “Ripple Is Used for Payments, Not Investment”

However, the lawsuit is moving in favor of Ripple. The SEC’s logic is being directly refuted or failing to unfold its own reasoning.

First, while it is true that Ripple is traded on cryptocurrency exchanges, Ripple has a bigger function: payment, as mentioned earlier. Ripple was created not to gain investment profits but for payments. Ripple Labs claims that people purchase Ripple with the intention of using it as a payment method, not as an investment. This directly refutes the second criterion of the Howey Test, which asks whether there was an expectation of profits from investment. Professor Lee explained, “Ripple’s value is generated not internally through payments but externally on exchanges, so it is far from being a security with intrinsic value.”

Above all, past SEC rulings are tying their own hands. In 2019, the SEC ruled that Bitcoin is not a security because it is decentralized. In fact, there is no official entity that issues or manages Bitcoin. Furthermore, the SEC also judged Ethereum, developed by Vitalik Buterin and managed by the Ethereum Foundation, as not a security. Although Ethereum initially went through an Initial Coin Offering (ICO), it later adopted a decentralized structure, and the foundation does not make efforts to assign intrinsic value to Ethereum.

Ripple is focusing on these precedents set by Bitcoin and Ethereum. On the 7th, the U.S. District Court for the Southern District of New York ruled that the SEC must provide documents related to the Bitcoin and Ethereum determinations requested by Ripple Labs. From the beginning of the lawsuit, Ripple Labs has urged the SEC to clarify the differences between Bitcoin, Ethereum, and Ripple. Recently, Ripple Labs went further, claiming that the SEC threatened Ripple’s overseas partners to sever business relationships, thus steering the lawsuit in their favor.

The Message Behind SEC’s Questions... Why Is Cryptocurrency Value Created on Exchanges?

[Image source=Yonhap News]

Although the SEC’s logic is confusing, it certainly gives us a message: why cryptocurrencies must be traded on exchanges like stocks, and why the value of cryptocurrencies is created through exchanges.

Not only Ripple but most cryptocurrencies are traded through exchanges. Prices are also determined on exchanges. Naturally, if demand for a cryptocurrency is high and supply is low, the price rises; the opposite causes the price to fall.

However, in this process, cryptocurrency issuers gain the value created on exchanges without any restrictions. As Ripple Labs mentioned earlier, cryptocurrencies were not created to generate investment profits. Not only Ripple Labs but most issuers list their coins on exchanges and gain investment profits from that. In fact, Vitalik Buterin, who developed Ethereum and holds at least 330,000 Ethereum, has assets approaching $500 million.

Experts point out that the benefits issuers take are close to unearned income. Professor Lee explained, “When blocks are mined, cryptocurrencies are given as incentives, but the value is not guaranteed by the issuer but sourced from external exchanges. Issuers do not bear responsibility for the value, such as paying cash incentives directly, yet the profits from issuing cryptocurrencies are substantial.” In reality, even if the cryptocurrencies mined by miners through time and cost are traded at suddenly plummeting prices on exchanges, issuers bear no responsibility.

Questions are also raised about whether blockchain and cryptocurrencies must coexist. Professor Hong Ki-hoon of Hongik University’s Business Administration Department said, “Blockchain and cryptocurrencies do not need to coexist,” citing the Australian Securities Exchange as a representative example, which attempts to enhance security through a private blockchain-based system without issuing cryptocurrencies separately.