The recent split decision by Judge Analisa Torres of the Southern District of New York (SDNY) in SEC v. Ripple Labs et al. has left the legal status of cryptocurrency tokens sold to the public uncertain. According to the Howey Test, a contract, transaction, or scheme involving (1) the investment of money (2) in a common enterprise with (3) a reasonable expectation of profits arising from the entrepreneurial or managerial efforts of others is a juridical critter known as an “investment contract” and is, per the federal Securities Act of 1933, to be regulated in exactly the same manner as a security.
The Court divided Ripple’s sales of tokens into three categories: (1) institutional sales to hedge funds, VCs, and the like; (2) programmatic sales to retail directly on digital asset exchanges; and (3) “as a form of payment for services,” such as in restricted token purchase agreements or option contracts, to employees and other service providers. On the first category, institutional sales, Ripple lost. On the second category of sales, programmatic sales, the Court found in Ripple’s favor, arguing that the third, “expectation of profits” prong of Howey was not met. On the third category, the Court opined that the necessary contractual consideration was absent and no “tangible or definable consideration” was paid to Ripple.
Preston Byrne, an occasional CoinDesk columnist, is a corporate partner in Brown Rudnick’s Digital Commerce group. He states, “The legal status of XRP, then, seems to possess a kind of quantized duality, Schrodinger’s Shitcoin, if you will. It’s a security when sold to an institutional investor in a primary sale, but not a security when sold behind the anonymity of a cryptocurrency exchange, or when sold in exchange for services to insiders.”
The only thing this ruling guarantees for cryptocurrency issuers is continued uncertainty in the cryptocurrency markets – uncertainty which Congress, and only Congress, can step in to correct. Startups should exercise extreme caution, as Stephen Palley puts it, “Don’t yolo into anything based on that decision.” My hope is that Congress will get its act together and pass laws to normalize cryptocurrency investment, allowing U.S. crypto business to proceed in a more laissez-faire manner.