Brad Garlinghouse,
the chief executive of Ripple, was last year publicly contemplating at the World Economic Forum in Davos, Switzerland, an initial public offering for the San Francisco startup.
The company had just raised about $200 million in a round of venture funding led by
with a $10 billion valuation. The value of its signature product, a cryptocurrency called XRP, had fallen over the previous year. But Ripple was poised to rebuild the infrastructure for cross-border trades, Mr. Garlinghouse said, promising that its future was bright.
A year later, an IPO is off the table. Instead, Ripple’s future hinges on a judge’s ruling in a civil lawsuit filed in December by the Securities and Exchange Commission.
Regardless of the outcome, the case is expected to become a key precedent for how U.S. regulators craft rules and laws covering cryptocurrencies. It also highlights a broader truth about most digital currencies: Beyond the two largest, bitcoin and ether, most of the hundreds of others have struggled to find a utilitarian value beyond speculation.
At the heart of the SEC’s suit is a debate about XRP, a bitcoin-like digital asset created by Ripple’s founders that would grow to become the world’s third-largest cryptocurrency. It was designed to be part of a network that would help banks cut expenses in cross-border transfers. The related software, however, never gained traction, the SEC alleges, leaving XRP without a clear purpose, other than to funnel sales to Ripple.
Unlike bitcoin, which operates across an open network that isn’t controlled by any one party, XRP is an asset whose value and viability depends almost wholly on the efforts of Ripple, the SEC alleges in its complaint. That makes it a security, and it should have been registered as such by Ripple years ago, according to the SEC.
Ripple said XRP is a currency that shouldn’t be subject to securities laws. If the company is forced to register XRP as a security in the U.S., its potential value as a cross-border instrument would be diminished.
XRP doesn’t fit several of the criteria of what is called the “Howey Test,” which the SEC uses to determine whether an asset is a security, said
Andrew Ceresney,
a partner at Debevoise & Plimpton LLP, the law firm representing Ripple in the SEC case.
XRP trades in a wide market against a range of other currencies, none of which Ripple controls, he said. Moreover, Ripple makes no promises in the sale of XRP, and the sale isn’t an investment contract, he added.
“To us, this is the SEC trying to stretch Howey beyond its breaking point,” Mr. Ceresney said.
The agency sees it differently. Ripple has earned more than $700 million from selling XRP to the public since its founding in 2012, according to the SEC, which said the company had generated only $23 million in revenue from sales of software through 2019. Banks haven’t adopted it at any scale, and the few that have used it have been directly subsidized by Ripple, the SEC alleges.
If the SEC wins its case, it might bar Ripple from selling any securities, including XRP. That could be a crippling blow to the company and an asset whose market value was nearly $150 billion at its intraday peak.
Such an outcome would be the highest-profile failure ever for the cryptocurrency sector, which has been marked by numerous token projects that have failed to deliver returns for investors. Hundreds of startups raised billions of dollars in 2017 and 2018 by selling initial-coin-offering tokens; virtually all of those projects failed, and a number of companies were charged with fraud.
Even as investors have piled back into bitcoin and ether in recent months, some describe the cryptocurrency sector as an arena rife with manipulation on unregulated exchanges and solely a momentum trade. Even bitcoin, skeptics say, hasn’t delivered on its initial promise of becoming a digital version of cash.
Investors holding XRP have watched the price plummet since the SEC case became public. It was trading at about 51 cents on Dec. 21, when Ripple publicly revealed that the suit was imminent. Since then, it has fallen about 45%, most recently trading at around 28 cents. The market value of the XRP in circulation has dropped to about $12 billion from an intraday peak of $148.8 billion in January 2018, according to CoinMarketCap.
Meanwhile, at least a half-dozen cryptocurrency exchanges—including Coinbase, one of the biggest—have delisted XRP since the SEC’s suit was filed. A number of market makers and asset managers have decided to stop handling XRP trades. Tetragon, the firm that led Ripple’s 2019 capital-raising round, has sued the company, demanding its investment back. Tetragon couldn’t be reached for comment.
Prevailing against the SEC will be daunting for Ripple, outsiders said.
The complaint shows a pattern of Ripple managing XRP like a security, selling it based on proprietary information, said
Stephen Palley,
a partner at the law firm Anderson Kill, who has a background in securities laws and cryptocurrencies.
The complaint, he said, appears to “walk up close to the line of securities fraud.” Recent SEC cases against Kik Interactive Inc. and Telegram Group Inc. will create a headwind for Ripple, he said. Both companies were sued by the SEC for allegedly creating unregistered securities. Kik lost; Telegram settled.
Phil Liu,
the chief legal officer at Arca, a crypto-focused asset-management firm that doesn’t hold XRP, said that the SEC’s case is compelling.
Ripple appears to have no stable revenue streams outside of selling XRP, he said, adding that the products the company has developed “are wholly inadequate to support the operation.”
“I think that this thing will be a remnant of history by the end of 2021,” he said, referring to XRP.
It isn’t clear whether a change in leadership at the SEC will change the case’s trajectory. Gary Gensler, the Biden administration’s pick to lead the agency, is familiar with the cryptocurrency sector from his time as chairman of the Commodity Futures Trading Commission and has also taught cryptocurrency-focused courses at the Massachusetts Institute of Technology.
“We’re hopeful he will want to engage with us on these issues,” Mr. Ceresney said.
Write to Paul Vigna at paul.vigna@wsj.com
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