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Cryptocurrency Startup Ripple’s Future Hinges on SEC Case

Cryptocurrency Startup Ripple’s Future Hinges on SEC Case
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Last year at the World Economic Forum in Davos, Switzerland, Ripple CEO Brad Garlinghouse was publicly considering an initial public offering for the San Francisco startup.

The company had just raised about $200 million in a round of project financing led by Tetragon Financial GroupAnd

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With a valuation of 10 billion dollars. The value of its token product, a cryptocurrency called XRP, has plummeted over the previous year. But Ripple was ready to rebuild the infrastructure for cross-border trade, Mr. Garlinghouse said, promising that its future is bright.

A year later, the IPO was cancelled. Instead, Ripple’s future hinges on a judge’s ruling in a civil lawsuit filed by the Securities and Exchange Commission in December.

Regardless of the outcome, the issue is expected to set a major precedent for how US regulators draft the rules and laws covering cryptocurrencies. It also highlights a broader truth about most digital currencies: Other than the two largest currencies, bitcoin and ether, most of the hundreds of others have struggled to find utilitarian value beyond guesswork.

At the heart of the SEC’s lawsuit is a debate about XRP, a bitcoin-like digital asset created by the founders of Ripple that would become the world’s third largest cryptocurrency. It is designed to be part of a network that will help banks reduce expenses on cross-border transfers. However, the related software has not gained any traction, the SEC claims, leaving XRP with no clear purpose, other than to transfer sales to Ripple.

Unlike bitcoin, which operates over an open network that is not controlled by any one party, XRP is an asset whose value and viability depends almost entirely on Ripple’s efforts, the SEC alleges in its complaint. That makes it a security that should have been registered as such by Ripple years ago, according to the Securities and Exchange Commission.

Ripple said that XRP is a currency that should not be subject to securities laws. If the company is forced to register XRP as collateral in the US, its potential value as a cross-border tool will diminish.

Said Andrew Ceresni, partner at Debevoise & Plimpton LLP, the law firm representing Ripple in the SEC case.

He said that XRP is being traded in a broad market against a range of other currencies, none of which are controlled by Ripple. Moreover, Ripple is not making any promises to sell XRP, and the sale is not an investment contract, he said.

“For us, this is the Securities and Exchange Commission trying to stretch Howey beyond the breaking point,” Siriseny said.

The agency sees it differently. Ripple has earned more than $700 million selling XRP to the public since its founding in 2012, according to the Securities and Exchange Commission, which said the company made only $23 million in software sales through 2019. It has never been adopted by banks. On a large scale, the few who used it were directly backed by Ripple, the SEC claims.

If the SEC wins its case, it could block Ripple from selling any securities, including XRP. This could be a severe blow to the company and assets that had a market capitalization of about $150 billion at their peak during the day.

This outcome will be the biggest failure ever for the crypto sector, which has been marked by several token projects that have failed to generate returns for investors. Hundreds of startups raised billions of dollars in 2017 and 2018 by selling ICOs; Almost all of these projects failed, and a number of companies were accused of fraud.

Even with investors returning to bitcoin and ether in recent months, some describe the crypto sector as an arena full of manipulation on unregulated exchanges and only momentum trading. Skeptics say even bitcoin has not fulfilled its initial promise to become a digital version of cash.

Investors holding XRP have watched the price drop since the SEC case became public. It traded around 51 cents on December 21, when Ripple publicly revealed that a lawsuit was imminent. Since then, it’s down 45%, and has recently been trading at around 28 cents. The market value of XRP in circulation has fallen to around $12 billion from a daily peak of $148.8 billion in January 2018, according to CoinMarketCap.

Meanwhile, at least six cryptocurrency exchanges — including Coinbase, one of the largest — have delisted XRP since the SEC lawsuit. A number of market makers and asset managers have decided to stop dealing with XRP trading. Tetragon, the company that led Ripple’s 2019 capital raising round, has filed a lawsuit against the company, asking for its investment back. Tetragon could not be reached for comment.

Outsiders said it would be hard for Ripple to beat the Securities and Exchange Commission.

The price of Bitcoin skyrocketed, which led to a momentum trading rush that pushed its value higher than it was before. The WSJ explains how bitcoin trading works, and why the volatile digital currency is reaching all-time highs. Illustration: Jacob Reynolds/The Wall Street Journal

Stephen Paley, a partner at law firm Anderson Keel, who has a background in securities and crypto laws, said the complaint shows a pattern of Ripple managing XRP like a security, selling it based on proprietary information.

He said the complaint appeared to be “close to the streak of securities fraud.” He said the recent SEC cases against Kik Interactive Inc. and Telegram Group Inc. You will create an opposite Ripple to Ripple. The two companies were sued by the Securities and Exchange Commission alleging the creation of unregistered securities. Kik lost. Telegram settled.

Phil Liu, chief legal officer at Arca, an asset management company focused on crypto and which does not own XRP, said the SEC’s case is compelling.

He said that Ripple does not appear to have stable revenue streams outside of selling XRP, adding that the products developed by the company are “absolutely insufficient to support the operation.”

“I think this thing will be a relic of history by the end of 2021,” he said, referring to XRP.

It is not clear whether the change in leadership at the Securities and Exchange Commission will change the course of the case. Gary Gensler, who was chosen by the Biden administration to lead the agency, has been familiar with the cryptocurrency sector since he was the chair of the Commodity Futures Trading Commission, and has taught courses focused on cryptocurrency at the Massachusetts Institute of Technology.

“We hope he’ll want to reach out to us on these issues,” Mr. Ceresny said.

write to Paul Vigna at paul.vigna@wsj.com

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