Understanding litigation with Ripple, XRP, and SEC[Basic Knowledge]| CoinDesk JAPAN | Coin Desk Japan

Ripple and XRP (XRP) are making headlines again. It follows a new development in the three-year-long legal dispute between Ripple and the U.S. Securities and Exchange Commission (SEC) over whether XRP is a security.

The U.S. District Court for the Southern District of New York, who presided over the case, complicatedly ruled that XRP is a security when Ripple sells it to institutional investors, but not when it sells to general investors through cryptocurrency exchanges.

Ripple’s chief legal officer, Stuart Alderoty, called the ruling a “big win” on Twitter. Others described the verdict as an important but partial victory.

A huge win today – as a matter of law – XRP is not a security. Also a matter of law – sales on exchanges are not securities. Sales by executives are not securities.

— Stuart Alderoty (@s_alderoty) July 13, 2023

“Today is a big win. By law, XRP is not a security. Furthermore, by law, a sale on an exchange is not a security. A sale by an officer is not a security. Any other distribution of XRP — distributions to developers, charities, or employees — is not a security.”

In order to understand the implications of this ruling, and what led up to this ruling, it is necessary to take a moment to look back at Ripple, XRP, and the years leading up to this ruling.

Ripple history

The technical concept behind Ripple is said to predate Bitcoin by four to five years. Canadian computer programmer Ryan Fugger developed “RipplePay” in 2004-2005 as a way to provide members of online communities with secure payment options through a global network.

But it would take another six years to build a blockchain-based payment system called XRP and the fintech company that built it, now known as Ripple.

The XRP Ledger is an open source public blockchain created in 2011 by developers Arthur Britto, Jed McCaleb and David Schwartz to solve the inefficiencies of traditional bank cross-border remittances and payments.

The trio were later joined by Chris Larsen as CEO to form what is now known as Ripple. The XRP Ledger serves as the foundation that powers XRP, a decentralized crypto asset.

Apart from the cryptocurrency XRP, Ripple’s transaction protocol known as RTXP officially launched in 2012. Shortly thereafter, in 2013, the company (originally called OpenCoin) was rebranded to Ripple Labs. The company changed its name to Ripple again in 2015.

Ripple and XRP are intrinsically related, but they are separate entities, at least on paper. Ripple, a centralized fintech company that develops global payment products, has developed the XRP payment system, which the company describes as decentralized. XRP is an independent digital asset used for online payments, currency swaps, etc. As of July 2023, it has a market capitalization of approximately 37 billion dollars (approximately 5.18 trillion yen, converted to 140 yen to the dollar), making it the fourth largest crypto asset.

But Ripple uses XRP and the XRP public blockchain to power its product.

What is Ripple?

Unlike the public nature of the Bitcoin and Ethereum blockchains, which seek to disrupt legacy finance, Ripple is focused on improving the existing fragmented traditional banking system.

Ripple does this by unifying a network of independent banks and payment providers on a standardized protocol to make and communicate low-cost, instant payments globally.

Co-founded by McCaleb and Chris Larsen, who later went on to become chief technology officers of a competing project with similar goals, Stellar, Ripple initially announced three main products for bank-to-bank transfers.

xRapid, a liquidity product; xVia, a payment application programming interface; and xCurrent, a real-time payment system. In 2019, xCurrent and xVia merged and rebranded to RippleNet. xRapid has been renamed “on-demand liquidity” (ODL) and is used to expedite the transfer and exchange of fiat currencies between countries.

How ripple works

There are two main elements that make up a ripple.

• Ripple: Overall, it offers a real-time gross settlement system (RTGS), currency exchange, and remittance network. Backed by a blockchain payment protocol, the platform uses RippleNet to facilitate instant transactions between financial institutions.
• RippleNet: A proprietary network of payment facilitators and global banks. Through Ripple’s decentralized platform, it helps streamline communications and allows participants to send and receive payments seamlessly.

Like the standardized HTTPS used as a common protocol for transmitting information over the Internet, RippleNet also provides a framework and set of rules called Ripple Transaction Protocol (RTXP) that all network participants must follow, thereby alleviating transaction bottlenecks.

Applications can connect to the XRP Ledger through HTTP or WebSocket APIs. You can also use libraries in various programming languages, such as Java, JavaScript, and Python.

While anyone can connect to the ledger, there are a limited number of trusted validators who can approve transactions, mostly large banks and financial institutions. By March 2022, it will be able to process up to 1,500 transactions per second with a fee of $0.0007.

This is faster than Ethereum, which completes about 10 transactions per second, and Bitcoin, which can process 4-5 transactions per second. One of the reasons XRP is so fast is because it uses a network of smaller operators to reduce the latency associated with greater decentralization.

gateway

Gateways provide entry points for outside people and organizations that want to join the Ripple network. A gateway acts as a trusted intermediary (usually a bank) to help two parties complete a transaction. The gateway uses the Ripple network to provide a channel to send money in fiat currency and cryptocurrencies.

How XRP works

XRP is the native cryptocurrency of the XRP Ledger, a public blockchain that uses what is called a “federated consensus” algorithm to secure and approve transactions. It differs from the Proof of Work (PoW) mechanism used by Bitcoin and Ethereum’s Proof of Stake (PoS). The key difference is that, unlike larger public blockchains, Ripple network participants know and trust each other, largely based on reputation.

As of July 2023, there are more than 150 validators on the network, and more than 35 are registered in the Default Unique Node List (dUNL), a list of nodes trusted by network participants.

Three organizations, Ripple, the XRP Ledger Foundation, and Coil (an organization funded by Ripple), publish lists of validators they recommend based on factors such as past performance, verified identities, and secure IT policies. As more validators join the network, participants will have more flexibility in choosing which validators to add to their UNL, but there will be some risk as not all validators will have the same level of reliability or performance.

In contrast to traditional international payment methods, which can take 1-4 business days, XRP can be used as a bridge currency to provide on-demand liquidity or settle cross-border transactions in less than 5 seconds and at a fraction of the cost of traditional remittances.

A small amount of XRP (0.00001 XRP worth of XRP units, about 10 drops) is discarded to cover the cost of transaction fees. XRP remittance costs fluctuate based on network activity, but all related transactions are executed and settled on the XRP Ledger.

Unlike other cryptocurrencies, XRP cannot be mined and no new tokens are created. That’s because the founders issued the entire supply of 100 billion XRP at the ledger launch in 2012. To expand the business, the founders distributed 80 billion tokens to Ripple and kept the rest to themselves.

Whenever Ripple decides to sell coins from its pre-mined supply, additional XRP can be circulated in the secondary market. In 2017, for example, the company moved 55 billion of its 80 billion XRP tokens into an escrow account, from which it could sell up to 1 billion tokens each month. This was to improve the transparency and predictability of XRP sales.

XRP tokens held in escrow are considered “undistributed” and the rest becomes the circulating supply. Unsold tokens will be returned to escrow and redistributed at a later date.

As of March 2022, 46.1 billion XRP was held in escrow accounts. Data on the total number of XRP held and distributed by Ripple can be found on its official website.

Buying and selling XRP

From the SEC filing until the July 2023 ruling, U.S. exchanges either delisted XRP or temporarily suspended trading. Soon after the ruling, Coinbase, Kraken and others announced plans to list or relist XRP for trading, but some restrictions still remain. For example, as of this writing, New York residents cannot buy XRP on Coinbase.

Residents outside the US can still trade XRP on exchanges such as Binance, eToro and Kraken and remain unaffected.

Pros and Cons of XRP

Although it uses the open nature of the blockchain to decentralize bookkeeping and maintain transaction transparency, XRP is more centralized than Bitcoin or Ethereum in that no public institution or individual other than Ripple can decide to issue a new coin.

This is largely because XRP is ostensibly a tool for transferring value across borders through Ripple products rather than a speculative investment vehicle. However, the SEC believes that XRP undoubtedly functions as an investment product, and in 2020 it sued Ripple for illegally raising $1.38 billion from investors in what the SEC considers to be an “unregistered securities offering.” I will discuss this lawsuit in more detail later.

The advantages of Ripple and XRP are as follows.

• Fast, efficient, and transparent payments with added liquidity tools to streamline the payment process.
• XRP settlement speed is faster than Bitcoin and Ethereum.
• Ever-increasing scalability: The XRP network can handle up to 1,500 transactions per second.
• Ripple’s cross-border currency payment system has attracted more than 100 financial institutions, including banks, to its network.

Disadvantages are as follows.

• RippleNet is not fully decentralized compared to other public blockchains.
• As the product is for large financial institutions, it is of little practical importance to individual users. Still, the enthusiastic fans known as the “XRP Army” continue to promote the coin on Twitter.
• Since most of XRP is owned by Ripple, the price of the token can be easily manipulated or negatively impacted by market saturation with large-scale sales.

Ripple vs SEC

The battle between Ripple and the SEC has been watched closely by the cryptocurrency and financial industries and is seen as a precursor to other regulations and ongoing litigation with the SEC.

As mentioned earlier, the SEC sued Ripple in 2020, alleging that XRP was an unregistered security that Ripple sold in violation of US law.

The ruling found that the $728.9 million worth of XRP sales were direct sales to institutional investors and met the requirements of the Howey test assuming that investors would benefit from Ripple’s performance. And according to the ruling, Ripple used the proceeds to “promote and increase the value of XRP by developing uses for it and protecting the XRP trading market.”

However, the second half of the judgment favored Ripple. The court ruled that the “programmatic sale” of XRP by exchanges and algorithms did not envisage similar profit expectations because there was no conclusive evidence that retail investors expected to profit from the efforts of others.

The ruling was called “groundbreaking” in a post-judgment report by investment firm Bernstein, which said it would change “the regulatory cloud over the cryptocurrency industry.” JPMorgan Chase likewise hailed the ruling as a “groundbreaking victory”, but noted that the industry’s battle against regulation was not over.

The SEC has the ability to appeal the ruling and is likely to pursue similar lawsuits in the future.

｜Translation and editing: Akiko Yamaguchi, Takayuki Masuda
｜Image: Shutterstock
｜Original: Understanding Ripple, XRP and the SEC Suit