All Eyes on Ripple as it Faces Lawsuit – is XRP a Security?

A class action lawsuit was filed on the 3rd of May against Ripple.

According to the court documents, plaintiff Ryan Coffey is suing Ripple Labs (“individually and on behalf of all others similarly situated”) and its CEO Brad Garlinghouse at the Superior Court of the State of California in San Francisco.

The complaint is the unregistered offer and sale of securities – Coffey claims that Ripple’s token, XRP, is a unregistered security which is being used to raise “hundreds of millions of dollars”.

What is Ripple?

Ripple is a company which offers a blockchain-based payment system for institutions. It has signed partnerships with hundreds of banks and is considered to be a possible successor of SWIFT. Like all blockchains, it needs a token to function. That token is called XRP.

The market capitalisation of XRP is currently $32 billion, making it the third most valuable cryptocurrency listed on coinmarketcap.com after Bitcoin and Ethereum. The token has always been secondary to Ripple’s real purpose, however the company’s success has led to XRP becoming very valuable.

What is a security?

Securities are basically ownership shares. There are different types of security, but the essence is that a company is split into tiny parts which can be purchased.

The lawsuit

Coffey states in the official documentation that at Ripple’s point of genesis 100 billion XRP tokens were created “out of thin air” (as opposed to being mined à la Bitcoin/Ethereum) and retained by Ripple and related persons. Since then the tokens have been sold in “what is essentially a never-ending initial coin offering”. To this end, Ripple has actively advertised XRP and portrayed it to be a good investment.

He argues that because people 1) paid money to obtain tokens, 2) “reasonably expected” to profit from this ownership (based on the promotional effort of the Ripple team), and 3) this profit was conditional on the management decisions of the Ripple team, XRP tokens “have all the traditional hallmarks of a security.”

Key to the argument is that the XRP tokens are not actually related to the products which give Ripple value.

The document states: “While publicly touting its xCurrent, xRapid, and xVia enterprise solutions (collectively, “Ripple Enterprise Solutions”), Ripple Labs’ primary source of income is, and has been, the sale of XRP. Defendants earned over $342.8 million through XRP sales in the last year alone—XRP which costs Defendants nothing since they created it out of thin air.”

It provides many examples of this. One is that on the 20th of March 2017, Ripple Labs posted on its social media page a news article about the successful adoption of its payment system. This cause the price of XRP to rise. A few days later, Ripple published this statement: “The price of #XRP continues to surge showing that people are looking for  #bitcoin alternatives.”

Thus, the argument is made that Ripple is actually selling a security, and as such should be registered with the Securities and Exchange Commission.

Lost $551

Now, Coffey is not an employee of the SEC, and his motive for suing is not to altruistically defend the integrity of American financial regulations. Rather, he purchased 650 XRP on the 6th of January 2018 and after trading it for another coin, sold his stake. His net loss was $551.

Coffey further accuses Ripple of “attempting to bribe” two cryptocurrency exchanges to list XRP. The exchanges referred to are Coinbase and Gemini, and Ripple’s dealings with them were not a secret. Rumours that the Coinbase deal was successful caused the price of XRP to spike, and then drop when the rumours were nixed. Coffey claims that Ripple was the source of the rumour.

This in itself is not unique to Ripple; according to an investigation carried out by Business Insider, cryptocurrency exchanges charge a listing fee to new cryptocurrencies of between $50,000 – 1 million. They are able to do this because listing on an exchange is vital for a coin’s success, as this is where most business happens.

Oliver Bussmann, president of Switzerland’s Crypto Valley Association and former chief information officer of Swiss investment bank UBS, told Business Insider: “If you prepare for an ICO, you have to prepare for a listing. It’s important to get access to liquidity. That means the bigger the exchange is, the more effort and also more cost to get listed.” Bussman has acted as an advisor to Ripple in the past.

Having said that, at the time Ripple attracted criticism for the move. Jesse Overall, an attorney at Clifford Chance, told Bloomberg: “Listing on an exchange is the integral part of the process of facilitating an unregistered, unlawful, illegal securities issuance to people who are not allowed to buy.”

Nonetheless, accusations of unregistered securities are not new to Ripple, and the accusation is not entirely without merit even if the motivation to sue is sour grapes.

Tom Channick Ripple, Ripple’s head of corporate communication, said to CoinDesk: “Like any civil proceeding, we’ll assess the merit or lack of merit to the allegations at the appropriate time. Whether or not XRP is a security is for the SEC to decide. We continue to believe XRP should not be classified as a security.”