The GiD Report — XRP isn’t a security, a new SEC chief, and everyone’s going after Big Tech

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GlobaliD

11 min readJun 23, 2020

Welcome to The GiD Report, a weekly newsletter that covers GlobaliD team and partner news, market perspectives, and industry analysis. You can check out last week’s report here.

Some ecosystem updates:

Greg’s followup investment in latest TransforGo round (via Greg)

The startup is also announcing it has launched in 11 new markets, including Japan, New Zealand, Saudi Arabia, Singapore and Ghana. That’s a doubling down on South East Asia and African market expansion, beyond its original focus on Europe.

Greg’s seed investment in UnumID (via Jun)
4 HY companies were named in CNBC’s Disruptor 50 companies (via Jeff)—Kabbage (24), Ripple (28), Marqeta (33), Robinhood (46)
GlobaliD was a launch member of the PayID Open Payments Coalition:

Whereas GlobaliD can privately and securely connect any two identities, PayID can connect any two accounts — be they traditional bank accounts or new digital wallets — across any payment network and in any currency.
…
While GlobaliD sees value in what might be a universal namespace, the PayID solution looks and feels like a step in the right direction of getting to a MECE solution (mutually exclusive, collectively exhaustive) that gets everyone thinking about how to make the Internet of Value a truly interoperable reality.

On the cards this week:

Former CFTC chairman: XRP isn’t a security
A new SEC chairman incoming?
Antitrust momentum continues to build
a16z on the partner bank boom
Stuff happens

1. As we like to say, fintech is as much a regulatory game as it is a technological one — perhaps even moreso.

We see it everywhere — whether it’s potential antitrust action, litigation against dominant platforms (such as the case of a Hard Yaka portfolio company), or in today’s case, regulatory uncertainty around innovation.

Last week, former CFTC chairman Chris Giancarlo (AKA “Crypto Dad”) and Conrad Bahlke of Willkie Farr & Gallagher published a piece at the International Finance Law Review on the topic of Ripple and whether XRP should be considered a security.

Their conclusion? XRP is not a security because it doesn’t satisfy the 4 prongs of the Howey test.

Prong 1: “No investment of money”:

While one could argue that many outlays of money constitute an ‘investment’, the common understanding of the term ‘investment’ is the transfer of something of value in exchange for a future return rather than a present one. Yet, XRP cannot be an investment contract as there is no contract or arrangement to speak of between Ripple and the overwhelming majority of XRP holders. To the contrary, the contracts that Ripple has entered into explicitly exclude general XRP holders as third-party beneficiaries.

Prong 2: “No common enterprise”:

Further, as discussed above, ownership of XRP does not, and does not purport to, give the holder any rights with respect to Ripple and a holder of XRP is not entitled to share in the profits and losses of Ripple. The same is true as to individual XRP holders, none of whom are in privity by mere ownership of XRP any more than two people who hold bitcoin or ether can be said to have “tied their fortunes” to one another. To the contrary, given the juxtaposition between XRP’s intended use as a liquidity tool, its more general use to transfer value and its potential as a speculative asset, XRP holders who utilise the coins for different purposes have divergent interests with respect to XRP.

Prong 3–4: “No reasonable expectation of profits derived from the efforts of Ripple”

The third and fourth prongs of the Howey test (a reasonable expectation of profits derived from the efforts of others) are also absent given Ripple’s marketing forbearance and the autonomy of the XRP architecture. The expectation of profits derived from the efforts of others must be reasonable. Ripple has not marketed XRP as an investment product, nor has it promised XRP holders any sort of profit or return on investment. To the contrary, Ripple has repeatedly emphasised the functionality of XRP as a liquidity tool and a settlement mechanism. The fact that certain parties may acquire XRP with the hope that it may appreciate in value cannot be dispositive as the same is equally true of the large number of bitcoin and ether speculators.

Farr and Ghallager further argue that XRP is sufficiently decentralized and that the token serves a purpose as a utility (providing liquidity for payments).

The above is a quick skim of their arguments. You should check out the entire piece for a more comprehensive take.

Ripple has benefited from a couple of factors. First, they’ve taken a cautious approach from day one, taking into consideration that this sort of scrutiny over the question of security status would one day arrive, and structured their offering as such. XRP was created by its founders and then gifted to Ripple, the company. They’ve also been extremely careful about their marketing and messaging around XRP. (Greg was the Chief Risk Officer at Ripple.)

Compare that to the height of the ICO craze where companies were creating crypto and selling them directly to non-accredited investors. Even the name ICO is purposefully coined to sound like IPO — which are initial public offerings for… securities. It’s one reason why Telegram was a much easier target for the SEC. Outside of direct OTC sales, Ripple, through a separate regulated entity (with New York’s BitLicense), only sells XRP programmatically on the open market.

Which leads us to benefit number 2 (re: open markets) — the genie is pretty much already out of the bottle with XRP. Ripple has benefited from being a first mover in the space long before anyone started paying attention. And when they did, they quickly made up with FinCEN. Today, billions of dollars worth of XRP is traded on exchanges around the world. XRP is also actively used for cross border payments — Ripple’s primary use case — around numerous high volume corridors such as U.S.-Mexico. So it’s hard to see how regulators can put all that back in the bottle.

Of course, Ripple also faces challenges as one of the oldest and biggest names in the space. And having a company that holds a significant portion of XRP (about half) — albeit in escrow — continues to serve as a lightning rod for the other side of the argument. But as Giancarlo and Farr argue in their paper, the rule of law may very well be on their side.

Crypto is pretty mainstream now and so these open questions need to be addressed. This latest piece from a prominent former regulator is a strong step — but an SEC decree it is not. And so the uncertainty continues.

Which brings us to our next newsy thing.

SEC chair Jay Clayton, Photo: Brookings Institute

2. Much of this hinges on the SEC, and as we’ve seen since the ICO bubble, they’ve taken a relatively aggressive approach — which many experts at the time expected that they would (including GlobaliD).

The big surprise news over the weekend was that President Trump was picking SEC chief Jay Clayton to be the next NY AG. Political ramifications and intentions aside, the move could have a major impact on fintech:

Crypto industry thought leaders immediately noted this announcement and described what is at stake for crypto regulations.. Jake Chervinsky, who serves as general counsel at Compound and an adjunct professor at Georgetown University Law Center, posted on Twitter regarding the announcement. Chervinsky states, ‘The SEC chair is one of the most important U.S. officials for crypto regulation. Chairman Clayton’s replacement will have a massive impact on the industry…clarity on a wide range of issues for years to come hangs in the balance.”
Michael Arrington, the Founder of TechCrunch, CrunchBase and Arrington XRP Capital, noted his thoughts of Chairman Clayton’s departure from the SEC. Arrington stated, “Whatever else, Jay Clayton leaving the SEC is a win for crypto and sound money fans across the world. Hopefully he does less damage as a US atty.”

Preston Byrnes provided a necessary counterpoint:

Meanwhile, Preston Byrne, Attorney at Anderson Kill, responded to Arrington’s opinion of Clayton and defended the SEC Chair for his time in the oversight of the crypto industry. Byrne stated, “I think he did a good job at the SEC and read the tech more or less correctly. He determined Bitcoin wasn’t a security, after all.”

But as Andrew Ross Sorkin suggested in his Dealbook newsletter, Clayton’s generally considered to have a tough stance on crypto:

A big item on the S.E.C.’s agenda is how to regulate cryptocurrencies. Mr. Clayton is seen as a critic of crypto (though not all of his S.E.C. colleagues share that view), with several attempts to launch bitcoin E.T.F.s blocked on his watch. If he goes, will the commission become more amenable to new crypto offerings?

All that being said, the move only presents more uncertainty into the equation. A Senate confirmation is by no means guaranteed:

Mr. Clayton isn’t going anywhere, for now. He told staff members yesterday, “We will be together for at least some meaningful period of time.” He may not have much choice in the matter. Democrats and Republicans were outraged by Mr. Berman’s ouster, making it challenging for Mr. Clayton to win Senate confirmation.

Moreover, it’s unclear who his successor might be. But some might take solace in the appointment of Brian Brooks as the country’s chief bank regulator, as we discussed last week — a potential sign that the current administration is taking a more bullish stance on crypto innovation. (Given China’s aggressive ambitions in the space, it would only make sense from a geopolitical perspective)

Currently, Bitso is managing 5% to 10% of all US remittances sent weekly to Mexico this year and is expected to keep growing. By the end of 2020, Bitso has set the ambitious objective of sending and receiving 20% of weekly remittances via cryptocurrencies.

3. This week in antitrust. Uproar over Apple’s app store while Amazon and the rest of Big Tech continue to feel the heat.

But first, a reminder of how Facebook came to be — The Reckoning Is Coming: Regulating Big Tech:

The irony is that Facebook was sold to its early users as a privacy-forward service. You might remember how MySpace faded into oblivion after Facebook arrived. That wasn’t an accident; Facebook intentionally painted itself as an alternative to the wide-open world of MySpace.
At this time, “privacy was … a crucial form of competition,” researcher Dina Srinivasan, a Fellow at the Thurman Arnold Project at Yale University, wrote in her Berkeley Business Law Journal paper, ” The Antitrust Case Against Facebook.” Since social media was free, and no company had a stranglehold on the market, the promise of privacy was an important differentiation. You needed a .edu email address to sign up for Facebook, and only your friends could see what you were saying. Facebook made this promise initially: “We do not and will not use cookies to collect private information from any user.” In contrast, MySpace had a policy in which anyone could see anyone else’s profile. Users, deciding they favored privacy, decamped en masse.

Axios:

A new Justice Department proposal released Wednesday accelerates a headlong charge in Washington to rewrite a law that protects online services from being sued over user-created content, Axios’ Scott Rosenberg and Margaret Harding McGill report.
Why it matters: If Congress approves any of the bills in play, every dispute over content moderation on platforms like Facebook, Google and Twitter could turn into a court case — while the government could find itself with a big new job deciding whether companies like Facebook and Twitter are acting neutrally and “in good faith.”

4. Finally, the fintech space continues to heat up.

Here’s a16z on the partner bank boom:

Partner banks, chartered institutions that provide fintech companies access to banking products, have exploded in recent years — by our count, their ranks have grown more than five times over the past decade. Today, there are more than 30 partner banks representing hundreds of fintech relationships and financial services. These partnerships come in all shapes in sizes, from mega-banks like Goldman Sachs, which powers the Apple credit card, to Hatch Bank, which has $68 million in assets and started with a single fintech partner, HM Bradley.
The rapid rise of this trend begs the question: Why has the number of partner banks increased so suddenly over the past decade? For one, the relationship is mutually beneficial. Fintech companies are able to offer banking products without the regulatory overhead of becoming a bank, while banks harness these partnerships to improve their returns by gathering low-cost deposits or growing asset-light fee streams. In addition, it has become increasingly easier to form these partnerships. Eliciting a partner bank used to require a herculean effort, due to both compliance concerns and technical hurdles. Now, thanks to the rise of companies that provide banking infrastructure as a service, fintech companies can launch products in a matter of months, not years.

Ayo!

T-Mobile is in on the party — via Paul:

Plus WhatsApp payments stuff:

5. Stuff happens:

Civic also announced proof-of-health verification for companies with more than 500 employees, called Health Key by Civic. Proof-of-health information will be accessible through Civic Wallet. Civic’s partner, Circle Medical, will supply testing for interested San Francisco Bay Area companies and additional regional testing partners will be coming online to support customers in other locales.