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Ripple sued by the SEC

The SEC announced it has filed charges against Ripple Labs and two of it’s executives for allegedly raising $1.3 billion through an unregistered and ongoing digital asset securities offering. In 2013 Ripple Labs launched a cross border payments network and minted 100 billion XRP token to be used as the native token of the Ripple network . It is the sale and use of the proceeds of the XRP token that is at the center of the charges.

Unlike most crypto projects that aim to distribute a large percentage of tokens to wide a range of holders, the 100 billion XRP tokens were distributed entirely to the founders and Ripple Lab’s. 20 billion were split among the founders with the remaining 80 billion allocated to Ripple Lab’s to be held in a reserve fund. The XRP tokens in the reserve fund are meant to be given away or sold to promote the currency and develop the network software.

The SEC alleges that XRP is a security and that Ripple Labs has been selling XRP since 2013 without registering it as such. If the SEC concludes that XRP should have be classified as a security for any of the past sales Ripple Labs and the two named individuals face significant fines. If the SEC deems XRP to remain classified as a security XRP could find itself de-listed from most exchanges and subject to securities compliance regulations.

For most projects being labelled as a security is a wet blanket on growth and adoption. The restrictions and costs associated with SEC compliance along with the limited number of exchanges willing to host a security will most often cripple a project before it can reach the critical mass required to manage the regulatory overhead.

The SEC uses the Howey Test to determine if a token is a security. The Howey Test refers to a case that reached the US Supreme Court in 1946. According to the Howey test a token that meets the following three criteria is considered a security:

  1. An investment of money.
  2. In a common enterprise.
  3. With an expectation of profits predominantly from the efforts of others

This action by the SEC is not surprising given that part of the proceeds from XRP sales by Ripple Labs has been used to fund development of the platform. Using a token offering to raise funds for development and then use the token as the native currency or utility token is a common approach used by many projects. Last year the company Block.one was fined $24 million by the SEC for failing to register the ICO for EOS which eventually raised $4 billion. There are enough differences between the EOS ICO and the XRP sales by Ripple Labs that one should not consider the EOS settlement as a template for the outcome of the Ripple charges.

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