Is Ripple’s XRP token a security and what happens if the SEC regulates it as one?

Anthony Balladon
Apr 29, 2019 · 8 min read

It is a question that concerns all cryptocurrencies and crypto investors, not just Ripple enthusiasts. Over the last year, the SEC has announced that, for the moment, they will not classify Bitcoin and Ethereum (the two largest cryptocurrencies by market cap) as securities, but will this decision last and how does it impact other cryptocurrencies?

What is XRP?

XRP is the 3rth largest cryptocurrency by market cap, $12.9bn, and sits behind only Bitcoin and Ethereum. It was created in 2013 by Jeb McCaleb as a way to exchange real currency and perform international transactions much faster and at a much lower cost than the current SWIFT system.

XRP is the digital token issued by Ripple which is used for the transfer of value across the Ripple Network, making Ripple both a platform and a currency. Its intended use is a platform to allow cheap and fast international transfers and not as a payment machine (Cointelegraph, n.d.).Ripple says that “XRP is a digital asset that trades on digital asset exchanges around the world, which RippleNet customers can use to source on-demand liquidity for cross-border payments.”

Currently to transfer money internationally a business or individual must use the Society for Worldwide Interbank Financial Telecommunication (SWIFT) payment system. Swift is essentially an interbank messaging system using a standardized language which financial institutions use to communicate payment instructions and details amongst each other. SWIFT itself does not move money and as such banks need to have their own SWIFT interface to process and send the unique alphanumeric code which identifies where a transaction originates, where its destination is and the value of the transaction. International transfers are often complicated, especially when the transfer of funds is between different banks in different countries, sometimes an intermediary bank (where each of the two other banks holds accounts) will be used if there is no direct link. This all adds up to the fees associated with a SWIFT transfer which takes a cut every time. This is why there are international transfer fees on top of the currency exchange fees when conducting international transfers with the process often taking over 24hrs.

XRP allows international money transfers to be conducted at a fraction of the cost and in real-time through its xCurrent and xRapid products. Both products primarily use XRP as a cryptocurrency intermediary between two fiat currency exchanges. For example, say I want to send a friend £100 in London from New York using $110 (assuming the USD/GBP exchange rate is 1.1), I would buy $110 worth of XRP, transfer the XRP to the friend who would then sell it for £100. This transfer would happen I real time since there is a market for the exchange and the fee paid would be a fraction of that had it been conducted using SWIFT. Another added feature is that you can decide the fee that you pay by determining how fast you want the transfer to happen and therefore how high the transfer is prioritized. The more you pay, the faster the transaction (the minimum fee is 0.00001 XRP).

What is a Security?

In 1933 the Securities Act was written into law with the dual purpose of protecting investors by requiring they that they receive “financial and other significant information” about a security before it is sold, and to “prohibit deceit, misrepresentation, and other fraud in the sale of securities.” This required all companies issuing stocks, bonds or other securities to provide investors with information such as:

· Overview of the company’s holdings (properties and businesses)

· Information about the security being sold

· Information about the company’s management

· Audited financial statements

This act along with the Securities Exchange Act of 1934 created the Securities and Exchange Commission which has the authority to decide on what securities and the regulation surrounding them.


To decide what is a security and what is not, the SEC devised the Howey Test which is a set of questions which if all true then the asset in question is regarded to be a security.

The Howey Test:

1. It is an investment of money

2. There is an expectation of profits from the investment

3. The investment of money is in a common enterprise

4. Any profit comes from the efforts of a promoter or third party

If an asset ticks all of the above boxes it is then classified as a security and is regulated as such in the United States which can have significant impacts on the asset, especially in the case of cryptocurrencies or digital assets.

Is XRP a security?

To determine whether XRP is a security or not, we will apply the Howey Test.

1. It is an investment of money

Ripple explicitly states that XRP is not an investment vehicle. That it is a digital asset which institutions can purchase to complete international money transfers. When you buy XRP you are investing in the XRP ecosystem. While you are not necessarily investing in the traditional sense, such as buying a bond, but you are investing the idea and hoping to increase the network effect implications on the XRP ecosystem. This is not considered an investment in the eyes of both Ripple and the SEC at this present moment.

2. There is an expectation of profits from the investment

The company has never made any comments or promises about the currency going up in value while they hold it. If we take XRP as it was designed to be one would benefit from the cost savings involved with using XRP tokens to conduct international transfers instead of using SWIFT. This would decrease costs from both companies and individuals, therefore, increasing profits.

Looking at XRP as a vehicle for speculation, as some cryptocurrencies have become, there is an expectation of buying XRP, seeing a rise in the price and then selling for profit. This sounds a lot like buying a share of a company’s stock. One big difference is that buying XRP does not give you any ownership rights over Ripple or rights to a share of any profits. The original intention of XRP, if used in cross-border transactions, is to hold the coin for as short a time as possible therefore minimizing the expectation of profits from a change in the value of the coins.

3. The investment of money is in a common enterprise

Ripple’s founders claim that buying XRP is not related to Ripple, saying that XRP is an opensource decentralized ledger of which Ripple is an early adopter and most significant player. They say that XRP was designed outside of Ripple and then donate to them to keep the social integrity of the application. The grey area comes in when one of the creators of XRP is a founder of Ripple, so it was essentially a gift to themselves.

It is reasonable to think that investing in XRP is investing in the technology itself and by using it as a means of international transfer will increase its network effect and therefore its value. However, since there is no ownership stake in the company, there is no “investment” if it used for its intended purpose since the price of XRP is irrelevant if I want to transfer USD to GBP. This looks a lot more like the Forex market than the securities market. This exactly how the SEC currently sees it with SEC chairman, Jay Clayton, saying “these are replacements for sovereign currencies [like] the dollar, yen, euro, etc. [This] type of cryptocurrency is not a security”.

The complication comes when you consider how cryptocurrencies have been viewed over the last few years with many investors seeing them has high yield investments with many losing big due to misunderstandings about the underlying asset. This puts the SEC in an interesting position when you consider that its original intention was to protect investors. A question some are asking is whether investing in crypto assets should be seen as a form of venture capital and therefore limited to sophisticated investors.

4. Any profits come from the efforts of a third party

Profit is made when the XRP ecosystem grows causing the price to rise; it is not influenced by the efforts of Ripple but by all of the participants in the XRP ledger. In some sense, the investor is playing a part in creating profits from the XRP ecosystem by increasing demand and therefore the price.

Therefore, based on the traditional application of the Howey Test we must conclude that XRP is not a security since it does not fulfill all the aspects of the test. However, there are some schools of thought who think that the Howey Test is too outdated to be applied to cryptocurrencies since they are far removed from its original intention. Perhaps and new test or an adaptation of the Howey Test will surface in the coming months or years.

What happens if the SEC were to classify XRP as a security?

In June 2018 the SEC chairman said that they would not change the definition of a security on the back of the rise in cryptocurrencies. It is therefore unlikely that XRP will be classified as a security in the near future but what would happen if it did?

If XRP was classified as a security than Ripple would be beholden to its “shareholders,” anyone that owned XRP would own a share of Ripple, the company. In this case, purchasing XRP, the digital asset, would be the same as buying a share in Ripple like you would on the NYSE or any other global exchange.

Most analysts expect that were XRP to be classified as a security there would be a massive sell-off of the cryptocurrency, causing the price to plummet. Those who do not sell their coins would be, as mentioned before, shareholders of Ripple which would be free to list on traditional stock exchanges such as NYSE, Hong Kong and London which would potentially open it up to more investors who were either skeptical about the coins legitimacy or were institutional investors prohibited from any type of speculation.

On the downside, it would make ripples intended use as a cross border money transfer much more difficult due to liquidity restrictions which arise from its security classification and SEC regulation which has an entirely different legal framework.

For the moment it is unlikely that XRP will be classified as a security since it doesn’t comply with the Howey Test and the SEC would need to write the classification process for digital assets and cryptocurrencies. This may happen but would likely have strong resistance from crypto-based firms. That means that XRP is free to be used for its intended purpose of cheap and fast international money transfers.

Anthony Balladon

Written by

Finance | Business Strategy | Clean Tech | Venture Capital | Sustainability | South African living in Boston

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