XRP Fails Howey Test and Is Not a Security, Says Former CFTC Chairman Christopher Giancarlo

In an op-ed released on Wednesday, former Chairman of the US Commodity Futures Trading Commission (CFTC) Christopher Giancarlo and his colleague Conrad Bahlke argue that XRP is not a security.

Giancarlo, who is currently senior counsel at Willkie Farr & Gallagher, and Bahlke both work on behalf of Ripple, a client of Willkie Farr & Gallagher. Their statements, published on Wednesday by the International Financial Law Review (IFLR), discuss Ripple and the application of US securities laws to the world’s third-largest cryptocurrency, highlighting the case for XRP’s classification as a medium of exchange or a currency.

Giancarlo and Bahlke note that while senior officials at the US Securities and Exchange Commission (SEC) have made public statements that Bitcoin and Ethereum, the largest cryptocurrencies by market cap, are not securities, they’ve issued no such remarks about XRP.

They add,

“Much like bitcoin and ether, XRP is a digital currency supported by a distributed ledger that uses cryptography to store and transfer assets. However, XRP and the underlying XRP Ledger were designed in 2011 and 2012 specifically as a payment mechanism by software developers who later founded Ripple Labs (Ripple). Ripple today utilises XRP to address liquidity challenges faced by financial institutions, including high transaction fees, long processing times and the need for third-party monitoring interposed by traditional clearinghouses and settlement mechanisms.”

Unlike Bitcoin and Ethereum, however, XRP is not mined. According to Giancarlo and Bahlke, the lack of mining does not fundamentally change how XRP is utilized or how securities laws should be applied.

They write,

“In the absence of mining, XRP cannot be generated by third parties. Instead, a finite supply of XRP (100 billion units) was created at the time of inception, slightly more than 50% of which is currently held in escrow by Ripple and sold periodically. While these differences enable XRP to better serve its intended purpose as a liquidity tool and settlement mechanism, they do not fundamentally set XRP apart from its peers from a legal and regulatory perspective.”

Under the Howey framework, a transaction represents an “investment contract” if a person “invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter, sponsor or other third party.”

The authors state that XRP fails the Howey test in multiple ways.

“The mere fact that an individual holds XRP does not create any relationship, rights or privileges with respect to Ripple.

…

Ripple has not marketed XRP as an investment product, nor has it promised XRP holders any sort of profit or return on investment. To the contrary, Ripple has repeatedly emphasised the functionality of XRP as a liquidity tool and a settlement mechanism. The fact that certain parties may acquire XRP with the hope that it may appreciate in value cannot be dispositive as the same is equally true of the large number of bitcoin and ether speculators.

…

As discussed above, XRP fundamentally falls outside of the definition of an investment contract under the Howey test. Moreover, there is strong evidence that the specific use of XRP for ODL [Ripple’s liquidity product] constitutes a utility token and, in this capacity, should not be subject to regulation as a security.”

While former CFTC chairman Gary Gensler has said that Ripple “sure seems like a common enterprise” and suggests that over 1,000 cryptocurrencies could be operating outside of the law, the current CFTC chairman Heath Tarbert has made no definitive statement about XRP, calling its status “unclear”.

When asked in October of 2019 about XRP’s consideration as a security, SEC Chairman Jay Clayton said he was not at liberty to make any conclusive remarks.

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