On Friday, the Blockchain Association filed an amicus brief in the SEC lawsuit against Ripple. Association lawyers joined other friends of court petitioners like John Deaton in arguing that “downstream buyers” of cryptocurrency coins and tokens are not necessarily investing in securities. or involved in an investment contract.
…even if an initial token issuance qualified as an investment contract… the SEC seems to believe that this token remains a “security” through other downstream transactions, regardless of the rights the buyer initial kept to itself…why the downstream user buys this token…or how this token is used.
AMICUS CURIAE BRIEF THE BLOCKCHAIN ASSOCIATION, theblockchainassociation.org, 10/28/22
Interestingly, therefore, these petitioners do not dispute the SEC’s claims that Ripple originally sold XRP (XRP-USD) as an unregistered security. Rather, they argue that there is a clear limit to the application of current securities regulations to digital assets and a limit to the use of the Howey test on coins and tokens because, by their nature, they do not easily adapt to the now outdated regulatory regime instituted in 1946.
The Blockchain Association explained the specific problem simply but somewhat unorthodox in the following excerpt from the brief:
… SEC Chairman Gary Gensler recently stated that the “vast majority” of tokens are – not werebut are – titles.
AMICUS CURIAE BRIEF [emphasis is original] (link above)
The brief conveyed a number of points establishing this contrast between “were” and “are”. And the article below weighs in on some of the ideas included and how the Court’s decision can support XRP and the broader crypto industry through regulatory clarity. A finding that XRP is not currently a security would likely have broad positive ramifications for the current process of crypto legislation, general institutional adoption, and pricing of similarly situated large-cap altcoins.
Tokens work beyond investment contracts
Many holders seek to profit from the appreciation of their coins and rely on the efforts of those issuing the coin to increase those profits. But there is now substantial, significant, and rapidly growing evidence that cryptocurrencies work well beyond just a means of speculation. Examples of some uses are compiled below and appear as cited in the Blockchain Association’s amicus brief.
- Some people use tokens as currency or as payment.
- Some tokens are used in a particular implementation in a blockchain-based infrastructure.
- Some tokens allow users to participate in community governance…
- Other tokens allow users to collectively own an asset like a domain name.
- Some tokens represent digital embodiments of art, music, video, or other media, and may convey intellectual property rights…
In fact and in practice, continuing to treat digital assets as securities each time they are transferred would impair their ability to operate in the manner noted above. Because of this, the Blockchain Association brief suggested the following:
The Association respectfully submits that even if the Court finds that the original issuance of XRP was a security, the Court should refrain from ruling that the secondary sales are investment contracts or that XRP itself is, today. a title.
AMICUS CURIAE BRIEF (link above)
Howey Testing issues
In the case of SEC vs. Howeythe Supreme Court stated that “an investment contract, for the purposes of the Securities Act, means a contract, transaction or scheme whereby a person invests his money in a joint enterprise and is made to expect benefits solely from the efforts of the promoter or a third party party.”
However, beyond the first glance, this Howey test becomes somewhat problematic when applied to cryptos:
1. With crypto projects, there is often no money investment to receive the initial tokens. For example, projects gain participants on their platform although giveaways of tokens for using the system or tokens are partially given out for free or to charity.
The language of the Supreme Court in Howey should be taken at face value: an investment contract requires a real investment of tangible consideration. Intangible assets cannot suffice, as such concepts could include literally anything.
AMICUS CURIAE BRIEF (link above)
2. As mentioned in the first section, many token holders do not expect profit and increasingly use or consume their coins or tokens. And the brief quotes and comments on United Housing Foundation v. Forman since 1975:
On the other hand, when a buyer is motivated by the desire to use or consume the property purchased…securities laws do not apply… [Forman]
Accordingly, even if the Court finds that some participants purchased XRP with the expectation of profit, the Association respectfully asks the Court to be careful not to find that, out of necessity, all buyers in the XRP market had a expectation of profit.
AMICUS CURIAE BRIEF (link above)
When we look at the Howey test, many previous arguments from crypto proponents had focused on the decentralized nature of crypto platforms and their development. These arguments rightly pointed to the often harder-to-identify “sponsor” or “third party” required in the test. And the arguments above add to these problems for the SEC’s position, notably by weakening the expectation of profits from the test arm relative to the downstream buyers of the assets.
Defense of Fair Notice
Due process includes fair notice that an act is criminal before the offence. And the SEC has made a compelling case that a “regular intelligence” crypto industry participant is aware that selling digital assets to raise capital involves federal security laws. The Commission underlined the long Howey test as well as enforcement actions and public statements such as providing necessary guidance and advice. It is important to note that a security exists if there is an investment of money, in a joint venture, where profits are expected, through the efforts of the promoter of the venture.
However, as detailed by the Blockchain Association, beyond the simple appearance Howey test, in application the SEC regulations are less clear. And some SEC commissioners agreed that the confusion persists. The link just below to the SEC statement regarding Coinschedule is a short must-read on this topic for those following the crypto regulatory process.
There is a clear lack of clarity for market participants regarding the application of securities laws to digital assets and their trading, as evidenced by the requests for clarity that each of us receives and the constant outreach by staff at the Commission for the lack of action and others the relief.
In terms of Coinschedule, sec.gov, 7/14/21
SEC commissioners have also weighed in on the “were” versus “are” debate, but not in a positive and fair way. The following quote about Ethereum (ETH-USD) is from Hinman’s now famous speech (note the fun title).
And aside from the fundraising that accompanied the creation of Ether, based on my understanding of the current state of Ether, the Ethereum network and its decentralized structure, the current bids and sales of Ether do not are not securities transactions.
Digital Asset Transactions: When Howey Meets Gary (plastic)sec.gov, 06/14/2018
Additionally, the Blockchain Association argues that the SEC cannot simply require platforms to simply register as securities. Indeed, the moniker “security” opens a Pandora’s box related to “buying, selling, brokering, trading, custody, trading and exchange” where existing regulations are not focused on how participants in the crypto industry actually use their coins and tokens. In the quote below, the Blockchain Association asserts that fair notice requires “sensitive regulations in the context of a software token.”
This Court should establish a marker: before the SEC takes legal action against participants in the blockchain industry for non-compliance with securities laws and regulations, these laws and regulations must be clear, understandable and makes sense in the context of a software token that has a fundamentally different technological nature than a traditional security.
AMICUS CURIAE BRIEF (link above)
Watershed moment for the XRP and Crypto sector
A Forbes article titled “Crypto Law Experts Suggest SEC Likely To Lose Key Case And Discredit Howey Test” demonstrates that lawyers outside the crypto industry tend to agree with the points raised in the amicus brief of the Blockchain Association. And if accepted by the Court, the above arguments provide a regulatory breakdown of the definition of securities for XRP, similarly located coins and tokens, and the digital asset markets that trade them.
One result could be that Ripple, which has directly declared its willingness to settle, pays a relatively large fine; but Ripple would require an agreement or ruling that XRP is not a security. This result would likely allow XRP to be relisted on digital asset exchanges like Coinbase (COIN). For this reason, a constructive resolution of the lawsuit may not be an information sale type event, as new demand channels could come online soon after the resolution.
So now a main question is timing. The supposedly final memoirs are expected by the end of the year. However, it appears the SEC may once again be adopting delaying tactics and has indicated a need for more time and more “pages” to respond to the friend of the offered hearing briefs. Note that this week, Coinbase also officially offered an amicus brief that it prepared and provided to the Court. Incidentally, the outcome of the case has a direct bearing on Coinbase’s business and their broader proposal for a new regulatory regime purpose-built for digital assets.
In any case, the battle of several years is coming to an end. Both parties filed and responded to briefs seeking summary judgment in their favour. Given the opinions of the media and Ripple representatives on the timing, the resolution of the lawsuit will likely come in the first quarter of next year. This makes the coming months a prime accumulation period for XRP from a fundamental standpoint. I am giving an initial buy rating on XRP based on litigation benefit.
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