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In light of the SEC v. Ripple Labs verdict: How can token economic design avoid stock characteristics?
星球君的朋友们
Odaily资深作者
2023-09-22 07:37
This article is about 1524 words, reading the full article takes about 3 minutes
Crypto-asset issuers can avoid certain characteristics of stocks when designing token economies, making it very difficult for crypto-assets to be directly recognized as stocks.

Original author: William

Original source:Axia8 Ventures

The SEC filed a lawsuit against Ripple in 2020. Years later, a federal court ruling added a little fun to the bear market in the currency circle. Let’s first take a look at what this judgment says.

Securities Law Section 5 and Howey Test

Section 5 of the U.S. Securities Act of 1933 stipulates that any public sale of securities that is not registered with the SEC is illegal.

In order to prove whether Section 5 is violated, the SEC needs to prove to the court that Ripple (1) trades without registration, (2) sells securities directly or indirectly, and (3) has cross-state transactions.

Ripple defended: The XRP sold is not an investment contract (security category) and therefore does not require registration.

How does the United States define securities?

The Securities Act of 1933 adopted an enumerated approach to securities. Securities generally refer to any bills, stocks, treasury bills, security futures, security swaps, bonds, letters of credit, investment contracts... But it also leaves a hole for various new financial instruments through investment contracts, and the Howey Test is a standard commonly used to judge whether a transaction is an investment contract. If a certain transaction meets the Howey Tests determination of an investment contract, it is deemed a security and shall be subject to securities laws and subject to SEC supervision.

In SEC v. W.J. Howey Co., the Supreme Court held that under the Securities Act, an investment contract is “a contract, transaction or scheme whereby a person [( 1)] invests his money [( 2)] in a common enterprise and [( 3)] is led to expect profits solely from the efforts of the promoter or a third party.

In summary, the Howey Test lists 4 criteria for whether a transaction is an investment contract:

  • Have capital investment

  • Invest in a common cause/enterprise

  • expect to gain profits

  • The profits are derived from the efforts and operations of others

Judgment in this case

When analyzing whether a contract, transaction or plan is an investment contract, the principle of substance over form should be adopted, focusing on the economic substance and overall circumstances. As of the end of 2020, Ripple had sold XRP in three ways:

  1. Approximately $728.9 million in XRP sold to institutional investors;

  2. Approximately $757.6 million in XRP was programmatically sold through trading platforms (Ripple did not know who the buyers were, and buyers did not know who was selling them XRP);

  3. Other types of distribution, such as wages, payment for external services, etc., accounted for approximately $609 million in XRP sales.

The court held that based on the first point, the XRP that Ripple had sold to institutional investors complied with the Howey Test’s determination of investment contracts and was considered a security.

However, the strange thing about this judgment is that the court held that according to the second point, XRP programmatically sold to retail investors through crypto-asset trading platforms did not meet the determination of the Howey Test and should not be recognized as securities. The reasons are as follows:

  • Institutional investors would reasonably expect that Ripple would use investment funds to improve the XRP ecosystem and therefore increase the price of XRP, but retail investors on the exchange do not have such expectations;

  • For both parties, transactions on the trading platform are anonymous. Retail buyers do not know who sold the XRP they purchased or whether it was sold to Ripple. Therefore, it does not meet a common investment requirement in the Howey Test. Enterprise standards;

  • Retail buyers who purchase XRP on trading platforms do so more for speculative purposes and cannot be considered as investing in Ripple, nor can they expect to profit from Ripples efforts.

At the same time, the court also held that the other types of distribution referred to in the third point did not meet the Howey Tests determination of an investment contract because the distribution object did not invest funds.

analyze

Judging from the background and development of the Howey case, the identification of investment contracts is aimed at financial instruments issued in the primary market. These are mostly new innovative financial instruments brought about by technological development and usually do not have mature public trading venues. ; Therefore, as to whether XRP, which is publicly traded on an encryption trading platform, is an investment contract, the court has not had much opportunity to discuss this issue before.

Unlike stocks that trade in the secondary market, stocks are inherently securities. Stocks and investment contracts are juxtaposed. Stocks do not need to pass the Howey Test and are naturally securities.

So, can XRP that is publicly traded on an encryption trading platform be directly recognized as a stock? Usually stocks have the following characteristics:

  1. Have the right to receive dividends

  2. Have liquidity

  3. Can be pledged or pledged

  4. Holders have voting rights

  5. There is a possibility of appreciation

In reality, crypto-asset issuers can avoid certain characteristics of stocks when designing token economies, making it very difficult for crypto-assets to be directly recognized as stocks.

From this perspective, it seems to make sense for the court to separately discuss XRP traded in the primary market and secondary market in this judgment.

However, judging from the impact of the judgment, securities supervision can be circumvented by selling crypto-assets to unspecified retail investors through crypto-asset trading platforms without any information disclosure or marketing. This will undoubtedly turn the crypto market into a speculation and fraud. paradise, which is detrimental to the long-term development of the entire encryption market.

Therefore, the subsequent development of this case deserves close attention, and it is not ruled out that the Supreme Court will regard this as a new legal issue and intervene in this case.

SEC
XRP
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