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31 July 2021

It is time for the US to create a ‘Ripple test’ for crypto

It is time for the US to create a ‘Ripple test’ for crypto


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22, 2020 falsely claiming that the SEC was abandoning the Howey test in favor of an approach that reportedly required “new companies to operate for eight years to find out if what they’re doing violates securities law.” However, more thoughtful commentators have joined the call for a Ripple test to prevent businesses from operating for years without knowing whether they might be called into court for having run afoul of U.S.

On May 18, Roslyn Layton, a senior contributor and well-respected technology policy writer for Forbes, publicly called for a Ripple test to “stop the SEC’s overreach on cryptocurrency.” Part of the overreach she identified was the SEC’s claim that it could initiate an action reaching back to sales that started more than seven years ago, potentially leading to a fine of billions of dollars.

Not surprisingly, Wyoming, the most crypto-friendly state in the nation, enacted the “Wyoming Utility Token Act” back in 2017 — and passed two related house bills in 2019 — which allows issuers to proceed with tokens created for a consumptive purpose.

In order to satisfy the requirements of this act, the predominant purpose of the token must be consumptive; the token cannot be marketed as a financial investment; and there either must be a reasonable belief that the token is sold to the initial buyer for consumption, the consumptive purpose must be available at or near to the time of the original sale, or the original buyer must be precluded from reselling the token until the consumptive use is possible.

Similarly, Montana has chosen to specifically exempt utility tokens (i.e., those with a consumptive purpose) from its securities laws.

Colorado, through its Digital Token Act, has also chosen to exempt the issuance of tokens with a primarily consumptive purpose from the state’s securities laws.

While it would probably take an act of Congress to encourage (or force) the SEC to move in this direction, a Ripple test adopting the utility token (or consumptive purpose) approach could have precluded the application of securities laws to Ripple’s XRP tokens.

An alternative Ripple test could limit the scope of the SEC’s authority under the securities laws so that an interest determined by the Financial Crimes Enforcement Network (FinCEN) to be a currency is not a security.

There is certainly a logic to that position, as the settlement with FinCEN allowed Ripple to continue its operations and sales, which presumably should not have happened if the sales were illegal under federal law.

That decision could have been forestalled if the courts decided to remove digital currencies from the ambit of securities laws, or if the SEC reached that same conclusion.

A significantly more limited response, which could also be called a Ripple test, might involve something as simple as limiting how late the SEC can act after the commission becomes aware of the distribution of an interest it regards as a security.

First, a test that is focused on whether a particular crypto token has utility (or consumptive value) in order to determine whether or not the asset in question is a security may leave members of the public with inadequate remedies in the event that there is fraud.

A problem with saying that utility tokens are exempt is that it might be too easy for issuers to evade applying the securities laws by pretending that tokens are being sold for a consumptive purpose when the real hope is that they will be bought by speculators, pushing the price up.

Each of these are reasons that using a straight-forward utility test as the Ripple test might be problematic.

Alternatively, if FinCEN has the ability to determine that a crypto asset is a digital currency even after the SEC has acted first, this could lead to the very kinds of uncertainty and inconsistency that crypto entrepreneurs protest against under the current system.

It may have taken the SEC a considerable time to figure out exactly what was going on with XRP tokens precisely because they do have some utility and they work in an extremely complicated space.

First, because it is absolutely clear that there are bad actors in the crypto space, it is important to have an active federal regulator that can intervene when members of the public are defrauded.

It also makes sense to require that the crypto assets be designed with a consumptive purpose and that the tokens should be functional at the time of the sale.

These suggestions may be just another version of a Ripple test, they may be seen as a modified utility token test, or they may be regarded as something else.

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