Last month I noted that I was glad – if not downright excited – that Coinbase was getting sued by the SEC. Now, I can say I’m absolutely elated. Markets are shifting, Spring sure appears in bloom and moving into Summer, and the regulatory clarity that we are all craving is starting to take shape, though perhaps not in the way the SEC would prefer.
Before I dive into the SEC v. Ripple case, I need to highlight the huge about-face that occurred by BlackRock CEO Larry Fink. Fink, who just a few years ago called Bitcoin a Ponzi scheme now states that crypto is going to “revolutionize finance.” Wow. This is from the head of the largest asset manager in the world, is a 100% shift in position and is a full embrace of the world of blockchain and crypto. Now, we’ve known that BlackRock has been partnering with Coinbase to build out the ability for their institutional clients to transact, but a statement this bold changes everything.
Accordingly, BlackRock has filed for Bitcoin ETF (as have Fidelity, Invesco and WisdomTree) demonstrating their bullish stance on this asset class. From our view it could not happen at a better time and, with adoption happening, a friendlier macro climate on the horizon, and the Bitcoin Halving event happening next year, we expect it’s not long before the bulls are not just running but stampeding. As if we needed more good news, this is also bolstered by the SEC v. Ripple judgment which I’ll now dive into.
The big news this month, at least from a crypto standpoint, is the ruling in the SEC v. Ripple case. As a refresher, Ripple is a private, centralized company that offers a blockchain based digital payment network that uses its own token, XRP. Launched in 2012, this network has been focused on being an asset that serves the traditional financial systems by facilitating fast and inexpensive cross-border transactions. More simply, Ripple wants to be the payment network of choice for banks and financial institutions, and XRP is the token that facilitates the use of that network.
Ripple Labs (now Ripple) initiated the creation of XRP cryptocurrency with a total supply of 100 billion coins, roughly half of which was sold primarily to institutional investors. In 2020, the SEC sued Ripple stating that XRP was offered as a security and is, in itself, a security. The entire crypto world has been watching this one.
Which brings us to the landmark ruling by U.S. District Judge Analisa Torres of the Southern District of New York on July 13, 2023. This ruling states that selling XRP, the token of Ripple, when bought and sold on a secondary exchange, did not constitute selling a security and that XRP is not, by definition, an investment contract.
Now, it wasn’t a complete win for Ripple as the courts also found that the original offering, the institutional sales of Ripple’s XRP token,- was an unregistered offer and by a private company to sophisticated investors who could reasonably expect profit. (Note that, at Tradecraft Capital, we have been wary of this since the beginning.) We’ve seen this a lot in the world of early crypto projects and, for those that have been here a while I’m referring to the ICO craze. This should not be conflated, however, with the token itself being a security if it’s being listed on an exchange such as Coinbase.
At the heart of the SEC’s legal action is the Howey Test, a somewhat antiquated legal framework conceived in 1946. This test, named after the landmark court case SEC vs. W.J. Howey Co., determines whether an investment qualifies as a “security.” It comprises four key criteria: an investment of money, in a common enterprise, with an expectation of profit derived predominantly from the efforts of others. In the case of the initial offering, it clearly met these measures, however, in the case of a secondary offering on an exchange, XRP purchases and sales were basically deemed to be “blind” retail transactions between two parties that did not necessarily benefit the company, Ripple. In addition, the value of XRP is also not tied to Ripple in the same way that the value of a stock is directly tied to the performance of a company, so it failed the Howey test.
This is a huge step for regulatory clarity in the US. It also bodes well for Coinbase in its own battles with the SEC, which I discussed in my previous blog Thank God Coinbase is Getting Sued, as it creates precedent and quite likely makes the SEC’s case much more difficult, if not impossible.
The SEC’s entire premise for attacking Coinbase is that it is an unlicensed securities exchange. Well, if the assets that are being offered do not fit the definition of securities,then, by definition, Coinbase is not such an animal. The SEC listed 13 assets which included Solana (SOL), Polygon (MATIC) and Cardano (ADA) among others, and stated they are securities.
In the case of XRP, the ruling stated that because there was not clarity that any transaction done on a secondary exchange resulted in any benefit going to a primary company that it was a blind transaction between two buyers. This ruling comes into view even in consideration that there is a private, for-profit company, Ripple, behind XRP. This is markedly different than most other blockchain offerings such as Solana, which is not designed to be a payment platform and also not backed by a centralized private company. So if XRP is in the clear, it seems a slam dunk for these others.
We believe this clarity is one of the final steps before we see significant institutional capital enter the markets.
Now, before we get too far ahead of ourselves, this is one ruling by a district judge. It’s also possible there is an appeal, though none is in the works at the time of this writing. Even so, it sets the stage and points to what we have been driving at since the beginning, that crypto is an entirely new asset class. Yes, we need to follow laws on offerings (and XRP still has some sorting to do on that front.) Outside of an offering, however, what we really need to do in my opinion is get away from the Howey test when evaluating these assets. It is illogical to use an antiquated ruler for a new asset class. Think of it like this – it’s kind of like trying to measure how fast a rocket is going with a measuring cup. It makes no sense. So, we’re glad that XRP as a token got a pass, but argue that the Howey Test, in the world of crypto, is attempting to jam a square peg into a round hole.
Crypto assets are an entirely new construct in the world so it’s no wonder that regulation has been difficult. One of the most misunderstood things about them is that, largely, crypto assets are not financial capital. Consider that what they are instead is actually production capital.
Production v. Financial Capital
Production capital, by definition, are assets that do things. Think of a traditional manufacturing assembly line, for example. That was production capital and the genesis of such, in the industrial age, is what changed everything.
Many coins and tokens – and this is something the SEC simply does not seem to want to understand – serve as production capital because they also do things. They are real software. They have associated smart contracts. They perform work. They are not just characters on a screen.
Frequently they act as protocols, creating two-sided marketplaces where supply and demand meet, forming a market and identifying a price concurrently. Think about it like this: it’s like Uber, but without the company Uber. We could have drivers on one side of the equation and passengers on the other, matched up by software without the need for a corporate middleman. It’s really exciting! It’s also honestly a little hard for us humans to grasp, we’re so used to companies controlling any type of transaction. That’s now changing.
I could – and will – elaborate on this further but, for now, I just want to leave this as a teaser. Part of why this is also so hard is that we’re not used to having liquid, exchangeable, easily accessible production capital. It’s a new paradigm. Ok, ok, I’m really going to pause for now before I fall down this rabbit hole too far. Rest assured, I will pick it up in a future missive!
The point of this is that, from our view, we’re in the final innings before a proper breakout. Crypto has already had a strong year but is nothing compared to what we are expecting.
The macro climate is warming up at the exact right time, we’re getting regulatory clarity and, importantly, we’re coming up on the next halving event for Bitcoin, which happens every four years, in 2024. While past performance is never a guarantee of future performance, history does seem to have a way of repeating itself and, if the last bull run was any indication, this next one is going to be a doozy as we have more clarity, more interest, more use, more endorsements, and more adoption of blockchain and crypto across the board.
If you’re not an investor you’re still going to be surrounded by this world, because it’s happening. If you are an investor, consider this may well be the last, best time to get in at these prices.
That’s it for now! Until next time be well, stay safe, and I’ll keep Decrypting Crypto for you!
Disclaimer: Not investment advice. This information should not be construed as a recommendation, investment or tax advice, or an offer or solicitation to buy or sell any security.