This is the article I published on the technology edition of The Paper on July 25.
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The U.S. Securities and Exchange Commission (SEC) has been in a bit of a quandary lately.
On July 22, the SEC stated that Judge Analisa Torres of the U.S. District Court for the Southern District of New York made an error in her July 14 ruling in the case of Ripple (Note: Ripple, a provider of commercial blockchain solutions) v. SEC, and the SEC will appeal the ruling.
On July 14, the day of the ruling, the SEC responded: “We are ‘pleased’ that the court found that Ripple violated securities laws by offering and selling XRP (a cryptocurrency) as an investment contract in certain circumstances.”
The ruling mentioned twice by the SEC was a ruling made by the Southern District Court of New York in the SEC v. Ripple case on July 14. In the ruling, the judge distinguished between Ripple's sales to institutional investors and programmatic sales on the open market (programmatic sales, referring to Ripple Labs' sales to retail buyers on exchanges), and believed that the former was an investment contract in the traditional sense and met the four conditions of an investment contract, so it should be regarded as a securities issuance; the latter was sold in a programmatic manner through the open market, and the buyers in this case did not know the flow of funds, so such transactions should not be regarded as securities.
This seemingly "two-hundred-point punishment" ruling caused a stir in the US crypto industry, and was called a "historic" and "epoch-making" ruling by the crypto industry. Practitioners believe that this ruling overturned the SEC's determination that "cryptocurrencies are securities." Shortly after the ruling was announced, Coinbase couldn't wait to re-list Ripple's XRP.
It is worth mentioning that this ruling is not the final judgment of the case. It is only a ruling on some issues during the trial. Once the news was released, it caused a huge response. Why can a ruling that has not yet been concluded attract such widespread attention in the industry? What kind of impact will it have on the crypto market and related regulations in the future? We can further observe it from the origin of Ripple's lawsuit against the SEC, the focus of this ruling and its impact.
The origins of Ripple’s fight with the SEC
In December 2020, the SEC filed a lawsuit against Ripple Labs, its CEO Brad Garlinghouse and co-founder Chris Larsen. The SEC claimed that they conducted an illegal securities offering by selling the cryptocurrency XRP, illegally raising more than $1.3 billion. This marked the first time the SEC launched an attack on a mainstream cryptocurrency that was already in circulation.
The SEC's lawsuit has set off a huge wave in the crypto industry. Before this, the industry generally believed that as long as the project achieved decentralization, its tokens would no longer be securities. But the SEC's lawsuit tells people that once a token is issued through financing sales, it will always carry "original sin" and anyone who trades it is breaking the law. This is equivalent to declaring that the entire industry is illegal.
Why is Ripple a target?
First, Ripple's XRP had been in circulation for many years when it was sued, and had a large number of holders. If XRP is judged to be a security, then these holders will become participants in illegal securities transactions. This will bring tremendous pressure to the entire industry.
Second, Ripple obtained a large amount of funds by selling XRP directly to institutional investors. This kind of institutional financing sales is a typical securities issuance. This can easily become an entry point for the SEC's lawsuit.
Third, in terms of decentralization, Ripple cannot compare with Bitcoin and Ethereum, which gives the SEC an opportunity.
Ripple seems to be a strategic target deliberately chosen by the SEC. By attacking Ripple, it can send a warning to the entire crypto industry and force it to accept securities regulation. This lawsuit is also the focus of the game between the SEC and the entire crypto industry, and the result will determine the survival of the US crypto industry.
The key point of this ruling: the status of Ripple is undecided
The most important point of this ruling is that Judge Torres distinguished between two different methods of selling XRP and determined that the two methods are different in legal nature.
On the one hand, there are direct sales by institutions. The judge believes that such sales meet the four conditions of the Howey test (a standard for determining whether a specific transaction constitutes a securities issuance) for determining an investment contract: first, the buyer invests money; second, there is a common interest; third, there is a reasonable expectation of investment returns; and fourth, the returns depend on the efforts of others (Ripple). Institutions purchase XRP directly from Ripple with the purpose of expecting the value of XRP to rise and profit from it. Therefore, this is a typical investment contract behavior and belongs to securities issuance.
On the other hand, programmatic sales on the open market are completely different. The judge pointed out that open market buyers do not know who the seller is and have no expectation of profit with Ripple. Such programmatic sales do not meet the criteria for determining an investment contract and therefore do not constitute a securities offering.
The judge believes that the token itself does not have legal attributes, and the key lies in the form of transaction. Direct purchase by institutions with an investment contract relationship is securities issuance; free trading in the open market has nothing to do with securities.
Possible impact of this ruling
First, the impact on the legal attributes of cryptocurrency
Whether cryptocurrencies are securities has always been a question that has plagued the US crypto industry. Congressional legislation has been delayed, and the SEC has always had a firm grip on the right to speak. This ruling highlights the separation of powers and checks and balances in the US government. At a time when the legislative branch was silent and the executive branch was pressing forward, the judicial branch spoke out and effectively checked the executive branch.
This ruling will have an impact on the determination of the legal attributes of cryptocurrencies in the future: First, the court objectively denied the SEC's position that "tokens are securities". Although the ruling did not explicitly discuss the attributes of cryptocurrencies, the ruling that programmatic sales are not securities itself is a denial of the view that "tokens are securities". Second, the court believes that the trading method is more important for the identification of securities. The court emphasized that it is necessary to examine the trading and sales methods of crypto assets, rather than the attributes of the assets themselves. This means that the trading method is more important for the identification of securities. Third, judicial precedents are very important in the Anglo-American legal system, and this ruling will serve as a precedent to restrict subsequent SEC supervision. Unless the SEC successfully appeals to the circuit court, this ruling will limit the SEC's power to arbitrarily define crypto assets as securities.
Second, the impact on the token distribution method
Judge Torres ruled that cryptocurrency transactions on the open market do not constitute securities transactions. Unless it is overturned on appeal, it will have an impact on how the tokens are distributed.
First, it will reduce the compliance pressure for public distribution of tokens. In the past, the SEC considered a one-time public distribution as a securities issuance, which forced many projects to adopt private placement. Judge Torres' ruling provides a legal basis for public distribution. This may lead some more decentralized token projects to return to the public distribution method, such as directly distributing to users through airdrops.
Secondly, this will greatly reduce the compliance pressure on exchanges. In the past, exchanges faced greater legal risks in operation and were restricted in launching trading products. However, according to this ruling, public trading on exchanges should be considered free trading rather than securities trading.
Third, the impact on Bitcoin ETF (Exchange Traded Open Index Securities Investment Fund)
This ruling has made the legal basis for legal trading of digital assets more solid. It shows that trading crypto assets in the open market does not constitute illegal securities trading. This is conducive to the application of Bitcoin ETF, because ETF trading relies on the public Bitcoin spot market.
However, the ruling only explains the attributes of public trading, and does not involve the attributes of Bitcoin or other crypto assets themselves. This means that the SEC may still question the applicability of Bitcoin from other aspects.
Fourth, the impact on encryption legislation in Congress
Previously, the SEC determined that cryptocurrencies are securities and imposed regulation on the industry in the absence of rules. This ruling is equivalent to putting the brakes on the SEC's rapid growth. It also recognizes the current situation of the undetermined nature of cryptocurrencies from a judicial perspective, highlighting the lack of rules and the chaos caused by this lack. This will help boost the crypto legislation that Congress is actively promoting. After the Ripple ruling, many promoters of related bills spoke out through various media, hoping to use the public opinion momentum generated by this ruling to create a better public opinion environment for the passage of the bill.
The House Financial Services Committee and the Agriculture Committee are jointly launching the Crypto Market Structure Act, which aims to regulate the regulatory authority of the SEC and the Commodity and Futures Trading Commission (CFTC). The social media accounts of the two committees spoke out one after another after the Ripple ruling. On July 19, the House Agriculture Committee said on social media: "The Ripple ruling highlights the need for us to jointly legislate with the Financial Services Committee." The next day, the social media account of the House Financial Services Committee responded: "The Ripple ruling provides greater protection for large institutional investors than ordinary Americans. Our market structure legislation will provide all investors, customers, and market participants with the same long-term protection as traditional financial markets."
During this period, lawmakers in related fields have also spoken out. Bloomberg reported on July 18 that Glenn Thompson, chairman of the House Agriculture Committee, believes that the ruling in the Ripple case will strengthen legislators' support for crypto legislation and "hopes" that the ruling will push legislators from both camps together to develop a reliable solution to the industry's predicament. "Congress should step in and provide certainty and clarity."
In addition to the first time, on July 19, Rep. Ritchie Torres said, "After the Ripple case made a significant ruling, the SEC's continued attack on the crypto industry must be re-evaluated." On the same day, Rep. Warren Davidson said, "The Ripple case should make it clear that Congress needs to provide clarity that investors, innovators, regulators and even courts lack. I still hope that we can agree on a digital asset market structure bill that needs to do this quickly."
American politicians are masters at creating public opinion. This ruling has created a huge public opinion wave. Naturally, they will not miss the opportunity to use it to promote their own legislative initiatives and seize political capital.
The scope of this ruling and the prospect of an appeal
After being suppressed for a long time, the crypto industry finally breathed a sigh of relief with this ruling. However, from a judicial perspective, this is only a ruling during the trial of the local court. It has limitations in its scope of application, and it is certain that the SEC will appeal to a higher court later, so there is a risk that this ruling will be overturned.
In terms of scope of application, first, the direct effect of the ruling is limited to the jurisdiction of the Southern District Court of New York. In the US legal system, above the local courts are the circuit courts and the Supreme Court. Although the ruling of the local court can provide precedents for cases in other regions, it cannot directly affect the judgments in other regions, and its influence has geographical limitations. Secondly, the ruling is only a decision made during the trial of a case and is only part of the final judgment. Thirdly, this ruling only focuses on a specific digital asset, and its conclusion may not apply to other types of digital assets. Finally, this ruling only focuses on the legal attributes of some of Ripple's transactions, and does not provide direct rulings on other types of transactions such as secondary market transactions.
In terms of the prospect of appeal, the SEC will certainly appeal. However, given that judicial procedures in the United States are protracted, even if the SEC appeals and wins, the current ruling will be rejected at least a year later. During this period, the effectiveness of this ruling will continue.
How long will the SEC's subsequent appeal take? The general procedure is that first, the SEC needs to wait for the local court to finish hearing the entire case, which will take about 1 to 2 months. During this period, the SEC can apply to the court to expedite the final judgment and can quickly file an appeal motion. However, the opinions of the local court judges must also be considered. Secondly, it depends on whether the circuit court decides whether to accept the appeal. If the appeal is accepted, both parties need to submit complete appeal debate documents, which takes 3 to 6 months. Thirdly, it usually takes half a year or even longer from appealing to the circuit court to obtaining a final ruling. Therefore, just the step of appealing to the circuit court, the entire appeal process takes at least 1 year, usually this process takes one and a half to two years, and in many cases it may be longer. If the result of the circuit court still cannot satisfy both parties, it is possible to further appeal to the Supreme Court. In that case, it will take longer.
However, there is a saying that the SEC does not want to appeal to the Supreme Court because of previous Supreme Court rulings requiring the executive branch to act strictly in accordance with the authority of Congress to make laws. Ripple will definitely seize this point to prove that cryptocurrency does not yet have a clear definition and regulatory framework, and that the SEC has exceeded its statutory authority in crypto regulation, so the SEC's chances of winning are slim.
Regardless, the ruling of the Southern District Court of New York will affect the crypto industry for a long time to come. During this period, Congress will vigorously promote relevant crypto legislation before the election season, so after the Ripple ruling, the focus of US crypto regulation has returned to the game of legislation in Congress.
(Author Curiousjoe is a cross-border researcher of international politics and cryptocurrency.)
