Yes, Ripple's XRP Is a Security. Deal With It.

Number of the Week: 68,600 (explanation below)

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Yes, Ripple’s XRP Is a Security. Deal With It.

The Securities and Exchange Commission (SEC) lobbed a grenade into the cryptocurrency bunker this week, charging Ripple Labs with illegally issuing nearly $1.4 billion in unregistered securities. The asset in question is XRP, which Ripple maintains is not a security but a currency, and thus no SEC registration was required. Ripple pledges to fight the case in court, and at a minimum the complaint demonstrates the murky regulatory environment for digital currency.

For decades, the SEC has used a four-part test (known as the “Howey test,” after a 1946 Supreme Court decision) to determine whether a transaction qualifies as an “investment contract.” By my reading, XRP purchases meet all four criteria. The first, whether it’s an investment of money, is obvious. The second, investment of money in a common enterprise, is possibly open to debate, but the assumption that XRP is a common enterprise is hardly unreasonable, and the SEC can point to important precedents of digital assets being treated as a common enterprise. The third, whether investors expect a profit, is also fairly obvious, and the SEC cites numerous examples of Ripple executives declaring that the primary reason people buy XRP is to speculate. The final, whether profit comes from a third party or promoter, also seems reasonable—certainly the profit doesn’t come from any work on the investor’s part.

Ripple CEO Brad Garlinghouse vows that the company will fight the SEC in court, but he will need better arguments than he makes on the company’s blog. (Ripple did not respond to an interview request.) Garlinghouse has always been more expressive than effective; the criticisms in his famous Peanut Butter manifesto were valid, but barely changed the way Yahoo does business. With Ripple, he argues that the SEC action constitutes “an assault on crypto at large,” while simultaneously criticizing the agency for giving a “good housekeeping seal of approval” to Bitcoin and Ethereum—those assertions can’t both be true. He continually argues that XRP can’t be a security because it doesn’t resemble a stock certificate—a non sequitur, because obviously other assets can be securities besides stocks (the assets in the Howey case, for example, were tracts of land in an orange grove).

Garlinghouse and other SEC critics correctly point out that the agency, after all these years of cryptocurrency trading, ought to have clear and simple guidelines for which digital assets need to be registered and which don’t. The most comprehensive framework the agency offers is both long and complicated. It seems like the SEC went after XRP and not other cryptocurrencies for two reasons. Unlike, say, Bitcoin, with its decentralized network including thousands of “miners,” everything about XRP is controlled by Garlinghouse and Ripple cofounder Christian Larsen. The second reason is that Garlinghouse and Larsen repeatedly used their control to manipulate the trading—and therefore the value—of XRP, obviously at the expense of some investors, who were never informed of these moves.

It’s a safe bet that Biden’s SEC will continue to pursue the case against Ripple, though hard to imagine a jury will sit any time soon. In the meantime, it will be intriguing to see if any of the exchanges where XRP continues to trade will feel compelled to remove it.

DadaCoin

At times there is a thin line between cryptocurrency and conceptual art. This week the Ethereum-based social network Cent launched a feature that allows people to “buy” tweets using digital currency. One digital artist wrote a blog post saying he’s made $300 selling his tweets. The project immediately brought to mind the celebrated artist Michelle Vaughn’s transformation of Tweets into art-for-sale; she’s done many versions of this but 100 Tweets is very much in the spirit.

Five Bitcoin Predictions for 2021

You may have missed the piece I wrote this week for CNBC.com (to great responses), and while regular FIN readers may find the themes familiar, here it is:

This year has been a wild ride for anyone invested in, or even just watching, the bitcoin market. The world’s most valuable virtual currency in December traded at more than $23,000.

When the U.S. first began grappling with Covid-19 in early March, Bitcoin was below $4,000. For owners or sellers, it’s a gut-twisting source of gains and losses. For those (like me) on the sidelines, it’s an entertaining market show, with tinges of jealousy and dizziness.

Despite that tremendous bitcoin price fluctuation — in a generally upward direction — 2020 was also a year of relative maturity for a currency that, after all, has only been trading for a decade. From my perch as editor of FIN, here are what I see as the crucial bitcoin trends in 2021:

1. More mainstream acceptance

Bitcoin’s use in everyday life has always had a chicken-egg problem: Very few use or accept it because … for one thing, very few use or accept it.

But 2020 saw a striking evolution in bitcoin adaptation. Prominent fintech companies, from Square’s investment of $50 million in bitcoin to PayPal allowing its users to buy and sell bitcoin, gave it a stamp of approval.

In 2021, we’ll likely see an extension of this mainstream embrace. Look for at least one major U.S. or European bank to announce some kind of system where they either enable bitcoin purchases or agree to hold digital assets for their clients.

2. Competition from Big Tech

Whatever bitcoin may or not have accomplished in its decade of existence, it has forced a lot of big, global entities to think about offering an international digital currency.

Every company involved in the payment space understands not only that there is a market for digital payments still up for grabs, but that payments involving different currency markets have the most potential. That’s because currently such transactions can take days to resolve, and often involve hefty fees.

Bitcoin has demonstrated, if embryonically, that a global digital currency can dramatically streamline that process. This year, both Facebook and Google — companies with a massive global reach that bitcoin can only dream of — moved forward with big digital currency plans.

Tech offerings like Facebook-backed Diem aren’t exactly the same as bitcoin, but if they start to catch on in 2021, they may eat a little into bitcoin’s growth.

3. Competition from central banks

This year, the Bank for International Settlements issued a report and survey indicating that 80% of the world’s central banks are working on some form of digital currency.

China has taken the digital currency experimentation much further than any other nation. Recently, in the eastern Chinese city Suzhou, just west of Shanghai, a lottery was held in which 100,000 residents each received 200 renminbi (about $30) via a digital wallet. They were encouraged to link their digital cash to their bank accounts, and if they didn’t spend their digital cash within a few weeks, it disappeared — both great techniques to advance the experiment.

As China moves toward nationwide adaptation of the digital yuan, it is likely to undercut demand for bitcoin and other independent cryptocurrencies. Next year may see similar experiments in other countries.

4. A new regulatory playing field

President-elect Joe Biden’s administration will have higher priorities in its first 90 days than regulating cryptocurrency, and of course Congress’ mood and expertise on the subject is hard to read.

The natural assumption is that a Democratic administration will regulate more stringently than a Republican administration, yet some have asserted that Biden will be “good for cryptocurrency.”

Maybe, but bitcoin enthusiasts tend to overlook issues like anonymity and its potential use for fraud; for regulators, those are very serious concerns.

Biden’s team might well come up with a more comprehensive and rational way of regulating cryptocurrency, but I would not bet on any favoritism toward bitcoin in particular.

5. Continued volatility

Because the value of bitcoin is not directly tied to any obvious real-world phenomenon (such as fiscal or monetary policy), it can appreciate or depreciate in ways that are hard to predict or even explain.

As an investment, this makes it hard to recommend for anyone hoping to avoid big losses. Some say bitcoin could reach as high as $50,000 next year, and although that seems extreme, it is not out of the question if investors move money from other assets into bitcoin.

Of course, it is just as possible that the price will head in the opposite direction in 2021. The one thing that seems certain is that the wild ride of 2020 will be repeated — so buckle up.

FINvestments

🦈Number of the Week: In the first 9 months of 2020, 68,600 ATMs in China were shut down. The machines are increasingly needless as more and more Chinese consumers and businesses use digital money. Not so long ago, financial technology displaced human workers; now it also displaces older technology.

🦈Over the last three years, a neobank has launched somewhere in the world every five days.