In 2020, the SEC and Ripple engaged in a legal dispute concerning the classification of XRP, a digital currency that functions on the Ripple network. The SEC claims that XRP is a security and that Ripple illegally sold it.
At the same time, Ripple argues that XRP is a commodity and that the SEC did not provide clear guidance, while Ripple argues that XRP is a commodity and that the SEC didn't provide clear guidance.
There is a debate surrounding XRP and its decentralization level. The concern is whether it can be considered a security or not, and this depends on how much control Ripple has over the network and token.
Okay, dropping the formal language here (I want to see if the newsletter can retain the attention span of people slightly longer)
Back in 2020, Ripple, the company that made XRP, got into a legal bitchfight with the SEC. The SEC views XRP as a security - like stocks or bonds - and Ripple didn't play by the rules when selling it. The SEC did not get their piece of the cake.
Ripple: "Hold on, bro. Why you start this cap? XRP isn't a security, it's a commodity – more like oil or gold. And btw y'all at the SEC are throwing shade all over the place but you didn't give us a heads up and clear rules to follow in the first place."
The big question everyone's arguing over is whether XRP is decentralized enough or not.
The more control Ripple has over XRP and its network, the more it looks like a security. And that's a big deal because securities have to follow a lot of strict rules. So, that's what all the fuss is about.
The Mystery of XRP's Decentralization Level
One of the documents that could shed light on this issue is the Hinman documents, which are internal SEC communications related to a speech given by former SEC Director William Hinman in 2018.
In his speech, Hinman stated that cryptocurrencies could transition from securities to commodities once they become decentralized enough. He gave the example of Ethereum as a cryptocurrency to commodities once they become decentralized enough. Ripple has been trying to obtain these documents to support its defense and to compare XRP with Ethereum. The SEC does not consider Ethereum as a security.
The Hinman documents were recently made public in June, following a court order that denied the SEC's request to keep them sealed.
According to the documents, there have been internal discussions and opinions within the SEC regarding the status of cryptocurrencies and the criteria used to determine their decentralization. The documents also reveal inconsistencies and contradictions in the SEC's approach and reasoning.
The Human documents may be beneficial for Ripple's legal case and could have wider implications for the cryptocurrency industry and its regulation.
To summarize this paragraph
The "Hinman documents" refer to a set of internal communications from the Securities and Exchange Commission (SEC) regarding a speech given by former SEC Director William Hinman in 2018.
During his speech, Hinman put forward the idea that if a cryptocurrency attained a certain level of decentralization, it could shift from being classified as a security to a commodity. This statement suggested that the SEC did not view ETH as a security, which differs from their position on Ripple (XRP), which they accused of selling unregistered securities.
During the lawsuit, Ripple requested access to certain documents that were eventually unsealed by a judge on May 16, 2023, despite the SEC's attempts to keep them confidential. These documents suggest that the SEC was concerned about the potential for Hinman's statement to contradict its stance on Ethereum, which could limit its ability to change it in the future.
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SEC's Indecisive Stance on Digital Assets
In 2018, William Hinman, the director of the SEC Division of Corporation Finance, gave a speech at the Yahoo Finance All Markets Summit: Crypto
During a speech, it was stated that ETH did not fall under U.S. securities laws. This conclusion was drawn because the Ethereum network was deemed to be decentralized enough and those who bought ETH did not expect to rely on a central entity for profit. This speech was seen as a significant clarification of the SEC's stance on digital assets and their regulatory status.
However, Ripple has released internal emails from the SEC which reveal that some officials had doubts about the implications of Hinman's speech for the digital asset industry. One former director of Trading and Markets at the SEC, Brett Redfearn, wrote that the speech was vague and confusing regarding whether ETH was a security or not. He suggested that Hinman should either make a clear statement or avoid mentioning ETH altogether.
According to Laura Jarsulic, a lawyer at the SEC's Office of General Counsel, Hinman's speech recognized the existence of a category of tokens that didn't fit into the securities or commodities classification, creating a regulatory gap that must be addressed.
The correspondence found in these emails indicates that the SEC lacked a uniform and logical approach regarding digital assets during 2018. Additionally, it appears that Hinman's speech did not necessarily represent the official stance of the agency. These revelations also bring up inquiries regarding why the SEC has been singling out XRP and other Ethereum competitors while ignoring Ether. Ripple has put forth the argument that Hinman's speech provided XRP holders with a fair notice defense, as they could reasonably assume that XRP was not a security based on his comments about Ether. These emails could have an impact on the ongoing efforts of Congress to establish a clear and comprehensive regulatory framework for digital assets in the United States.
So, According to recently revealed SEC internal documents, there were reservations about Hinman's clear-cut statement on ETH due to the difficulty of changing their stance in the future.
So, why should you, as a crypto trader, care?
Well, it could explain why the SEC has been leaving ETH alone while going after other cryptocurrencies and tokens. Plus, these revelations could sway how U.S. lawmakers regulate cryptos in the future, potentially giving Ethereum a free pass.
The Howey test
The SEC has acknowledged that tokens operating on a decentralized network may not be classified as securities, creating a possible regulatory gap. This is because no "controlling group" can be identified according to the Howey test, while also recognizing the necessity of regulation to safeguard buyers.
Now you may wonder what the Howey test is about, I am not a legal expert but I will try to break it down and extremely oversimplify it. You know, I've been through that with Viacoin in 2018.
The Howey test is basically an old rule from a 1946 Supreme Court case that's used to determine what counts as an "investment contract" (a type of security). If something passes the Howey test, it's considered a security. The test has four parts:
- Is it an investment of money or assets?
- Is the investment in a common enterprise?
- Are there expectations of profits from the investment?
- Are the profits generated by a third party or promoter?
If the answer to all these questions is "yes," then it's a security.
A New Category for Decentralized Coins & Tokens?
Congress is trying to figure out how to handle Ethereum and other decentralized cryptocurrencies. The easiest thing they can do is treat Ethereum like Bitcoin, which is seen more like a commodity, Commodities are handled by a different group, the CFTC instead of the strict SEC.
Congress might come up with a whole new category for cryptocurrencies like Ethereum. This category would be for cryptocurrencies that are decentralized enough to dig being labeled as securities. This new "other category" would have some more rules and protection for investors than the typical commodities but it wouldn't be as intense as those for securities.
So, Ethereum and other similar cryptos could get their own unique label with a set of rules that's kind of a middle ground. Stricyer than commodities but more chill than securities.
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XRP's Rulebook vs. Ethereum's Innovation:
Who Will Come Out on Top?"
So, you're probably wondering about the deal with XRP and ETH in comparison and how all this legal drama might end up. Let's go over some possibilities!
XRP is a tight spot (that might be an understatement). The company behind XRP has a lot of control + a lot of XRP token holders are held by a few people, there aren't a lot of validators and its use cases are kind of limited.
So chances are slim to non that it could dodge being classified as a security.
Ethereum on the other hand, has been getting more decentralized over time. They've got smart contracts that let people build all sorts of apps and projects (or as I like to call it, vaporware). ETH doesn't depend on any central power (which might be a bit of a stretch, ask any Bitcoin maximalist).
Ethereum relies on a bunch of validators scattered around the globe and users who use ETH as "gas" for transaction fees.
Now, for the legal stuff. Honestly, it's not clear when the Ripple vs. SEC case will wrap up. The "Hinman documents" helps Ethereum's chances of avoiding the "security" label, but it doesn't directly help Ripple.
But, here's a curveball.
If Ripple wins their "fair notice" argument (which is basically them saying "Hey, SEC, you didn't warn us properly!"), that could throw a wrench into the SEC's plans.
This means other crypto companies the SEC goes after could use the same argument, saying the SEC didn't give them a heads-up.
In short, things are looking better for Ethereum than for XRP right now, but the legal outcome is still up in the air.
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