InWara - ICO Database, ICO review, Security tokens and more

Is Ripple (XRP) a security, according to the Howey Test?

Is Ripple a security? According to the Howey test

It’s a simple question. Is XRP, the native cryptocurrency of the XRP ecosystem, a security? But the answer to it is anything but simple. In this article, we’ll provide a comprehensive answer to this question as well as addressing other legal hurdles Ripple is facing.

It’s important to note that there’s an ongoing class-action lawsuit filed by an investor Bradley Sostack against RIpple. Bradley alleges that that Ripple has raised hundreds of millions of dollars through the sale of its XRP tokens — an unregistered security — to retail investors from around the globe. 

While overseas, the UK Financial Conduct Authority (FCA) has ruled that it does not consider XRP as a security, according to a video published by the regulators.

So is XRP a security? And by default, has Ripple been conducting an unregistered Securities Offering all these years? Let’s dive into the details. 

A simple analysis of our Litigation and Compliance database shows that there have been at least 50 cases of token offerings being treated as an unregulated securities offering. Gain access to the complete list here. 

Litigation and Compliance databaseGet Started

What counts as a security? The Howey test

In the US, the Howey Test is the legal gold standard to check if a contract or agreement is an “investment contract” and thus should be regulated under US securities laws. So what’s the Howey Test?

The Hoey test: Is Ripple a Security?

For a contract or legal agreement to be considered as a security under the Howey test, it must involve 1) an Investment of money 2) With an expectation of profit from the investment 3) in a common enterprise and 4) through the efforts of the promoter or a third party. So does Ripple’s XRP fit into this category?

Is Ripple (XRP) a security? According to the Howey Test? 

The Howey test applied to XRP — 

1) An Investment of money: You’ll have to invest money in the XRP ecosystem to receive XRP tokens. 

2) With an expectation of profit from the investment: Is there an expectation of profit? It’s subjective as it depends on the user. There’s no expectation of profit from users who aim to use XRP for cross-border payments or as payment for utilities or goods. But since XRP is highly volatile just like every other cryptocurrency, it’s safe to assume there are plenty of users investing with an expectation of profit. 

3) In a common enterprise: Whether or not this criterion is satisfied depends on who’s issuing XRP tokens. 

That’s obvious you may think, isn’t Ripple issuing XRP? Well, apparently not. Ryan Zagone, the director for regulatory relations for Ripple was quoted saying — 

“XRP is open source and it was not created by our company, so that existed as an open source technology. We created a company that was interested in modernizing payments and then began using that open-source tech to do so … We didn’t create XRP … What we do have is we do own a significant amount of XRP, it was gifted to us by some of the open-source developers that created it. But there’s not a direct connection between Ripple the company and XRP.” (source)

4) Through the efforts of the promoter or a third party: Will investors profit from the efforts of Ripple and it’s management? Yes. But not entirely from their efforts. XRP is the native cryptocurrency of XRP ledger which is an open-source distributed ledger. It’s from the collective effort of the open source community which involves Ripple that the value of XRP increases. 

Ripple has continually made efforts to further the decentralization of its XRP ledger, as it explicitly states in a blog post — 

“Decentralization of XRP Ledger is a process that started right at its inception and has been ongoing since. We intentionally haven’t rushed the process and have been making continuous progress all along. To meet the growing demands of our customers, we need to diversify the validator ecosystem to further increase resiliency and robustness. We believe these efforts will lead to XRP becoming globally adopted as the digital asset for payments”

It’s clear that by these standards XRP isn’t a security as it doesn’t meet all the criteria of the Howey test. And hence, it shouldn’t be regulated under the US securities laws. But there is a caveat here that might make the SEC consider otherwise.

Is Ripple (XRP) a security? The caveat — Ripple owns a majority of XRP tokens

Ripple owns as much as 60% of the 100 billion XRP tokens created, according to some estimates. Even the top executives of Ripple, including its current and former CEO, owns billions of XRP tokens. Leading many in the crypto community to conclude that Ripple controls XRP. But according to Brad Garlinghouse, CEO of Ripple, this just isn’t true. He was quoted saying — 

“I don’t think that our ownership of XRP gives us control. Saudi Arabia owns a lot of oil-that doesn’t give them control of oil.” (source)
The primary reason, Garlinghouse believes so is because of Ripple’s consensus algorithm which is fundamentally different from PoS algorithms like that of Bitcoin. Ripple’s algorithm doesn’t grant holders of the token more power over the network than others. Its validators are chosen on the basis of merit. 

On several occasions, Garlinghouse has reiterated the phrase that even if Ripple Labs shut down XRP would still exist as a cryptocurrency. We agree it would exist on the XRP ledger. But without Ripple labs driving its adoption would it be worth anything? The success of XRP is heavily dependant on the success of Ripple Labs and it’s products xCurrent and xRapid.

Register for a free trial

The Most Trusted

Market Intelligence Platform

Get Started