The Journal. - A Crypto Ruling Ripples Across the Industry

Episode Date: July 18, 2023

Last week, a federal judge ruled that crypto company Ripple Labs did not violate securities laws by selling its token to retail investors. The ruling is seen as a setback for the Securities and Exchange Commission's strategy to regulate cryptocurrencies and as a victory for the crypto community as a whole. WSJ’s Vicky Huang explains.  Further Listening: -SEC Chair Gary Gensler On His Crypto Crackdown  -A Crypto Exchange Crackdown  Further Reading:  -Ripple Ruling Deals a Blow to SEC’s Effort to Regulate Crypto  Learn more about your ad choices. Visit megaphone.fm/adchoices

What exactly is cryptocurrency? Is it money? Is it goods and services? Or is it an investment asset, like a stock? For the last several years, the Securities and Exchange Commission, the SEC, has argued that most cryptocurrencies are actually more like stocks, or in its parlance, securities. And if they're securities, the SEC says it should regulate them. Why is it important for the SEC to label crypto as a security?

The SEC is the regulator that oversees securities and regulates securities like stocks and bonds. So it has jurisdiction over securities. By labeling these cryptocurrencies as securities, it's establishing the authority over these companies that issues cryptocurrencies. That's our colleague Vicky Huang. The SEC has brought a number of cases against crypto companies and exchanges over the years. These lawsuits differ in several ways, but a lot of them center around this idea that some cryptocurrencies should be regulated by the government. should be regulated by the government.

One of the earliest examples of these lawsuits goes back to 2020 against a company called Ripple and its crypto token, XRP. The lawsuit revolved around whether XRP should be classified as a security and registered with the regulator before being issued to the public. The crypto world has sternly rejected this classification. This type of regulation is often seen as antithetical to the open, transparent goals of crypto. And last week, there was a major ruling in that 2020 case that could have big implications for the entire industry and for the SEC. Welcome to The Journal, our show about money, business, and power.

I'm Kate Leinbaugh. It's Tuesday, July 18th. Coming up on the show, a game-changing ruling for crypto. With Uber Reserve, you can book your Uber ride in advance. 90 days in advance. Perfect for all you forward thinkers and planning gurus. Reserve your Uber ride up to 90 days in advance. 90 days in advance. Perfect for all you forward thinkers and planning gurus. Reserve your Uber ride up to 90 days in advance. Uber Reserve. See Uber app for details. Ripple Labs was founded in 2012. Its main goal was to simplify how banks in different countries transfer money to each other. So Ripple is one of the earliest crypto startups. It's based in San Francisco,

and the main mission of the company is to build a Bitcoin-like payments platform, mainly aimed at helping banks move money faster and more cheaply. Here is Ripple CEO Brad Garlinghouse explaining his company's business in an interview with Yahoo in 2018. If the three of us decided we needed to get $10,000 or 10,000 pounds to London today, the fastest way for us to do that is to go buy a ticket, EWR or JFK, and fly it there. And that's just a fact. Obviously, that seems crazy in a world of the internet.

So the goal of Ripple is to, like many crypto companies, is to disrupt traditional financial services companies. So they built this protocol, and that's sort of the blockchain or crypto project that helps them move money and settle transactions faster than the traditional methods. To do this,

Ripple uses its own crypto token called XRP. And the way it works? Customer funds are converted into XRP and then XRP. And the way it works? Customer funds are converted into XRP, and then XRP is used to transfer those funds between banks across borders. So XRP is so-called the native token of Ripple. That means the token is issued by the company. And so it's a little different from like Bitcoin or Ethereum, which are mined currencies. Yes. Bitcoin and Ethereum are considered more decentralized cryptocurrencies

because it's mined by a lot of different miners versus this token is kind of issued by a centralized company. Ripple also made its XRP token available to buy and sell outside its main business. The company did this in two different ways. Ripple went directly to institutional investors, like hedge funds and venture capital funds, and offered them XRP as an investment that could make money. Ripple also offered XRP up for sale on major crypto exchanges like Coinbase and Binance, meaning any retail investor or regular person could buy or sell it on those exchanges.

Ripple raised a lot of money by selling XRP to institutional investors and then retail investors over the years. On the institutional side, it was a lot of venture capital investors, hedge funds. And on the retail side, it was just anyone trading on crypto exchange that lists the XRP token could buy it. The XRP token took off. At one point in 2017, it was the third most popular cryptocurrency, with the value increasing more than 30,000%.

But as XRP was rocketing up, it was also attracting the attention of the Securities and Exchange Commission. In 2020, the SEC sued Ripple, saying the company sold $1.4 billion of its token and that those sales should have been registered with the government. The SEC is preparing to sue that crypto startup for selling unlicensed securities. The asset in question here is called XRP. The SEC said that Ripple, the company, issued XRP tokens, sold them to investors, and told the investors that Ripple would work to enhance the token's value.

According to the SEC, that means XRP tokens functioned essentially like a stock and as such qualified as a security. Ripple's CEO rejected that framing. Here he is in an interview with CNBC. We have shareholders. We've raised capital from venture capitalists, from actually institutions and even banks like Standard Chartered is a shareholder. XRP is a separate thing altogether. It is a currency that trades in the marketplace. What did this lawsuit do to Ripple and Ripple's XRP crypto coin?

After the lawsuit, a lot of crypto exchanges and trading platforms delisted the tokens, which really depressed the price. Immediately, the price of the token was in freefall and it went from the third largest token out of all cryptocurrencies to more of a sort of unknown token to investors these days. What does being delisted mean exactly? It got booted off of big exchanges? Yes. For example, Coinbase, which is the largest crypto exchange in the United States, suspended trading in XRP in January 2021. And that just means that if you're a retail investor trading on Coinbase, you can no longer buy or sell Ripple anymore. The value of XRP tanked, and many in the crypto

world were spooked about the broader implications. The business model of a lot of these crypto companies involve tokens issued by the companies themselves. So if the SEC can regulate these tokens, these crypto companies would have to go in and register with the SEC. And that means providing detailed disclosures of risks and business models and their financial conditions. The Ripple lawsuit was the first time the SEC came down on a high-profile crypto company. And it wouldn't be the last. I think it was the start of a sweeping crackdown on the industry or the start of a shift from targeting smaller players

to more powerful players in the industry. So the SEC is charging two crypto firms with allegedly selling and offering unregistered security. So this is for Gemini, which is run, founded by the Winklevoss twins and Genesis. Coinbase is the latest crypto exchange in the SEC's crosshairs. The regulator is suing the crypto exchange, alleging that Coinbase was acting as an unregistered broker and exchange. The U.S. Securities and Exchange Commission filed more than a dozen charges

against the world's largest crypto exchange, Binance, and its CEO on Monday. A lot of the SEC's scrutiny has hinged on the same fundamental idea behind the Ripple lawsuit, that most crypto should be regulated as securities. Then last week, a federal judge made a ruling in the Ripple case. That's next. Summer is like a cocktail. It has to be mixed just right. Start with a handful of great friends.

Now, add your favorite music. And then, finally, add Bacardi rum. Shake it together. And there you have it. The perfect summer mix. Bacardi. Do what moves you. Live passionately. Drink responsibly. Copyright 2024. Bacardi. It's trade dress and the bad device are trademarks of Bacardi and Company Limited. Rum 40% alcohol by volume. At Air Miles, we help you collect more moments. So instead of scrolling through photos of friends on social media,

you can spend more time dinnering with them. How's that spicy enchilada? Very flavorful. Yodeling with them. Ooh, must be mating season. And hiking with them. Is that a squirrel? Bear!

Run! Collect more moments with more ways to earn. Air Mile. After three years, a federal judge in the Ripple case finally issued a ruling last week. And that ruling was kind of complicated. On one hand, the judge said Ripple's sale of the XRP token in some cases did qualify as a sale of securities. When the token was sold to institutional investors like hedge funds. That's because, the judge said, these big investors knew they were buying these tokens

from Ripple. And therefore, the investors were betting on Ripple as a company. And the judge's reasoning is that that means that these institutional investors could sort of rely on Ripple to boost the value of their bought XRP holdings. And that basically made the transactions a securities offering. So that seems like it's a victory for the SEC. Yes.

Ripple may face financial penalties over its sale of XRP to institutional investors. But that wasn't the end of the judge's ruling. When it came to selling the token to retail investors, everyday people buying XRP on a crypto exchange, the judge had a different opinion. She said in that case, XRP tokens were not securities. The judge ruled that the people who bought XRP on crypto exchanges, they didn't know who the seller was because trading is usually anonymous. So the judge kind of concluded that the investors

wouldn't be able to depend on Ripple's efforts to drive up the value of their XRP holdings. So as a result, those sales weren't securities offerings. That's complicated. Yes, like everything in crypto. So the judge is kind of giving institutional investors more protection than retail investors? More regulatory protection? That's a point that has been raised by some critics of the ruling, actually. if this ruling stands, it could potentially mean that sophisticated institutional investors

would get more protection over retail investors who wouldn't get the kind of risk disclosures or other financial disclosures before they buy this token. Ripple has taken the judge's decision on retail investors as a major victory. The SEC clearly lost as a matter of law, and the judge wrote, XRP is not a security. That's CEO Brad Garlinghouse again in an interview with Bloomberg.

Look, the market reacted in a very positive way. Certainly, Team Ripple is very happy with the decision. And what's happened to XRP, Ripple's cryptocurrency? The price of XRP shot up immediately after the ruling came out, and it continues to stabilize. Coinbase, Bitstamp, and some other exchanges have said that they are relisting XRP, which means that retail investors on these platforms are able to trade the token again. The SEC had a more mixed reaction. We are pleased from that decision, recognizing the importance of protecting investors on the institutional investors. That's SEC Chair Gary Gensler. And while disappointed on what they said about retail

investors, we're still looking at it and assessing that opinion. And this ruling seems to take a stand on this very fundamental issue between the SEC and the crypto industry, saying that this coin, XRP, when traded on an exchange, isn't a security. That seems like a victory for Ripple, but also for the industry overall. Yes, the crypto industry has really taken this ruling as a very positive sign because there has been a sweeping regulatory crackdown on the crypto industry over the past year. And since then, regulators have really signaled that they're ready to police industry with a heavier hand. And then last month, we had the SEC lawsuits against Binance and Coinbase. So I think it kind of gives a lot of companies hope that the industry can find more regulatory clarity and move forward.

Will it have implication for the SEC's lawsuits against Coinbase and Binance? It would probably make it more difficult for the regulator to demonstrate why the tokens listed on the Coinbase exchange are securities and why Coinbase is, as they alleged, an unregistered securities exchange. Vicky says Coinbase plans to cite the Ripple ruling in its own ongoing case. The SEC could still appeal the ruling, but hasn't said whether it will. What does this ruling mean for SEC Chair Gary Gensler and the SEC's enforcement strategy overall? If the Ripple case stands, it would probably make the SEC's job at regulating or taking enforcement actions against crypto companies a lot more difficult. But that still remains to be seen.

lot more difficult, but that still remains to be seen. This definitely just marks one of the first many rulings because there are a lot of ongoing crypto cases in court right now. So we'll have a lot more rulings to come. But if it doesn't get appealed, we'll probably set a precedent for a lot of future cases. That's all for today, Tuesday, July 18th. The Journal is a co-production of Gimlet and The Wall Street Journal. Additional reporting in today's episode by Dave Michaels. Thanks for listening. See you tomorrow.