Recently, the US Securities and Exchanges Commission’s [SEC] Chairman, in a conversation with representative Ted Budd, said that Ethereum [ETH] and similar cryptocurrencies were not subject to the securities law. This immediately gave rise to speculation on whether XRP was a security or not. This question can only be answered by addressing a larger concern, whether XRP was decentralized or not?
According to available records, XRP Ledger was formed by Jed McCaleb, Arthur Britto, and David Schwartz in 2011. In 2012, the trio approached Chris Larsen, who then joined the bandwagon. According to Hodor’s blog, the team then approached Ryan Fugger, who was responsible for the original concept behind Ripple with his credit network Rippleplay, and wanted to use their ledger on his credit network. According to the blog, Fugger and the XRP Ledger team founded a new company called Opencoin, which is now known as Ripple.
According to a BitMEX research piece, Ripple released 100 billion XRP in January 2013, out of which 80 billion was gifted to a company now called Ripple. According to the Githubrepository, this amount of XRP was given to Ripple “to develop the XRP ledger and its ecosystem.” Ripple claimed that they will use this 80 billion XRP to build an Internet of Value, ushering a world where money moves as fast and efficiently as information.
Decentralized or Centralized
As a company which claims to use its “native XRP” for its technology, Ripple was given 80 billion XRP out of 100 billion of the total XRP created during its inception. Along with the aforementioned amount, McCaleb was given 6 billion XRP and Larsen received 9.5 billion XRP. After McCaleb’s exit from Ripple, he signed a lock-up agreement along with Britto, who reportedly received 1 billion XRP. Larsen committed to putting 7 billion XRP of his share into a charitable foundation.
In 2015, Ripple Labs held 67,510,707,349.48 XRP, while 32,488,247,336.79 was held by others. After modifying the disclosure, the reserve balance was no longer available.
For a company which claims to be decentralized, Ripple holds an abnormal portion of XRP.
2) XRP in Escrow
Out of the available XRP, Ripple committed to placing 55 billion XRP in an escrow account in 2017. The company has 55 contracts of 1 billion XRP, which expire on the first day of every month. When a contract expires, the XRP is used by the company for providing “incentives to market makers who offer tighter spreads for payments and selling XRP to institutional investors,” an article by Ripple said.
This hold reflects that there is a certain amount of control that Ripple, as a company, has in the utilization of XRP, indicating that XRP is not completely decentralized.
3) Ripple nodes
Ripple claims to not control the validators running a node in order to approve a transaction and that anyone can become a validator. However, Ripple controls 20% of the nodes and in order to approve a transaction, a majority of 80% has to be achieved, which seems fairly possible.
Even though only 20% of nodes are controlled by Ripple, the validators need to download the software for a node to operate. According to a BitMEX research report, the node operates by downloading a list of five keys from the server v1.ripple.com. These five keys are assigned to Ripple.com and according to the software, four out of the five keys “are required to support a proposal in order for it to be accepted.” Since these keys are to be downloaded from the Ripple.com server, it can be argued that the company has total control over the ledger.
SECURITY or NOT?
Mike Dudas, CEO of the publication The Block, discussed how Ripple actually met every condition of Howey’s test.
1) It is an investment of money
According to Ripple’s website, users can purchase XRP on various crypto-asset exchanges with either fiat currency or crypto-assets. This means that there is an investment of fiat currency and crypto-assets, meeting the first condition of the Howey Test.
2) There is an expectation of profit from the investment
Ripple’s Chief Technology Officer [CTO], David Schwartz, who also goes by the handle name @JoelKatz, stated in a conversation with Bitcointalk.org,
“Anyone who holds XRP, particularly those who are contractually prohibited from dumping it, shares our interest in seeing the price appreciate over the long term.”
According to the document available on Ripple’s asset,
“@Ripple Labs plans to retain 25% of all $XRP issued to fund operations (and hopefully turn a profit)… as demand for $XRP grows, the value of $XRP should appreciate.”
The appreciation of the price of the token is what Howey test calls ‘an expectation of profits from the investment.’
3) The investment of money is in a common enterprise
The same document also states,
“If the @Ripple protocol becomes widely adopted, demand for $XRP may increase, leading to an increase in price. Unlike info protocols like HTTP or SMTP, investors can directly own a stake in Ripple.”
Schwartz had earlier said,
“I don’t think it’s likely $XRP would succeed w/o [@Ripple], though it’s possible. I do think it’s possible for us to succeed without XRP succeeding, as we do have other sources of revenue.”
“When pressed on what could cause $XRP to go to $0, @JoelKatz highlights 5 factors related to @Ripple Labs, implying the price of $XRP is strongly tied to Ripple Labs’ operations, development & strategy.”
4) Any profit comes from the efforts of a promoter or third party
Ripple Labs, in a section of XRP distribution, stated,
“[@Ripple] will engage in distribution strategies that we expect will result in a stable or strengthening $XRP exchange rate against other currencies.”
“As a corporation, [@Ripple] are legally obligated to maximize shareholder value. With our current business model, that means acting to increase the value and liquidity of $XRP”
It can thus be argued that XRP comes under the category of a Security. However, Howey’s test is an ancient test to term assets as Security, and cannot be completely applicable to digital assets.
The Token Taxonomy Act while proposing to regulate the crypto market to ensure customer protection, considers Howey’s test to classify an asset as a Security. Thus, the framework and regulations for crypto must be urgently upgraded, before deciding on the Security and non-Security aspect of cryptocurrencies.