How Ripple Could Spell the End for Utility Token ICOs

Ripple is probably one of the most successful utility token stories that has not yet been told. The Ripple coin (XRP) currently trades at 78 cents per token and has the third largest market cap in cryptocurrencies (following Bitcoin and Ether). Ripple is a big deal, but at one point it was even bigger.

During a brief period in January 2018, Ripple’s co-founder and executive chairman, Chris Larsen, had $59.9B in Ripple tokens, more money on the blockchain than Mark Zuckerberg had in Facebook shares. His Ripple holdings also briefly made Larsen the 5th richest man in the world as Ripple prices surged more than 30,000% in a year.

Larsen was richer than the founders of Google.

How Ripple Became a Sensation

Ripple was actually created in 2004 by Ryan Fugger (then called Ripplepay) to be a peer-to-peer payment network that centered around debt and was in essence a network of imaginary credit lines. Ripple’s founding in 2004 makes it older than Bitcoin, which Satoshi Nakamoto first dreamed up in 2009.

While Ripple showed some adoption in its early years, it was inherently limited in scale by its centralized network (in which you had to be invited in by someone already in the network) and so Ripple never entered mainstream conversations until 2012 when Ripple decided to revamp its business. Enter the A-list management:

Jed McCaleb — a programmer responsible for the creation of the first Bitcoin exchange, Mt. Gox, one bound to infamy with a hack of 850k stolen Bitcoin before Mt. Gox’s dissolution forever marring its name

Chris Larsen — a serial entrepreneur, the co-founder of E-Loan, an online mortgage lender, and Prosper, a peer-to-peer lender.

Together, Larsen and McCaleb envisioned Ripple tokens to be a replacement to Bitcoin, a replacement that was faster and more efficient with its transactions as all of the Ripple tokens are pre-mined. According to the Ripple website, Ripple can settle payments in 4 seconds, compared to 2 minutes for Ethereum, over an hour for Bitcoin, and 3–5 days for traditional systems.

In total 100 billion Ripple coins were created when the Ripple network we know today launched in 2012, but the powers that be at Ripple decided not to release all of the tokens to the public at once, but instead to release fractions of the hoard over time. Larsen and McCaleb kept 20 billion coins for themselves, and the rest went to the company. To date, Ripple still holds nearly 50 billion Ripple in escrow.

However, the XRP token is only a fraction of Ripple’s business. The buzziest element of Ripple, and its true appeal, is not its token, but its business. RippleNet is an open-source software that enables money transfers between wallets globally. The Ripple token is just one of many currencies that can be transferred through RippleNet.

Revolutionary? Not quite. But it is efficient across international borders, which is what caught the eye of the banks, including Santander and American Express, among a hundred or so others. However, it’s worth noting that banks can use RippleNet without actually using XRP tokens, which is a fact that is lost on many investors. Speaking of investors…

The lawsuit that could unravel Ripple

On May 3rd 2018, Ryan Coffey filed a class action suit against Ripple. Ryan is an investor who purchased Ripple at $2.60 as an investment when the token was exploding in value in January 2018. Coffey lost $585 when he sold his Ripple tokens at $1.30.

You could argue so what? Who cares that an investor lost $500. This is a small amount, and investors lose money all the time. What’s the fuss? Usually, you’d be right that the story ends here because the old adage “investor beware” holds true to this day. Losing money on an investment is par for the course in the speculation of early-stage companies. If every investment was guaranteed to not lose money or investors would get their money back, then there would be no sellers; there would only be buyers.

What is unusual about this situation and this particular class action suit is Coffey’s claim that Ripple sold unregistered securities to investors. That is fraud, if true. With this kind of claim, an ordinary investor can easily go to court and be made whole with their losses. Because this is a class action suit, it in theory represents all of the U.S. based investors who purchased Ripple.

This can amount to billions of dollars in claims that investors can ask the company to repay. This would demolish Ripple and its founders, including CEO Brad Garlinghouse (McCaleb left Ripple and started Stellar, and Larsen is now the executive chairman after stepping down as CEO last year). This lawsuit names others with the ambition to sue every single person in the Ripple food chain, including those who marketed it to investors.

According to the lawsuit, the suit “arises out of a scheme by Defendants to raise hundreds of millions of dollars through the unregistered sale of XRP to retail investors in violation of the registration provisions of state and federal securities laws.”

The lawsuit further alleges that the “Defendants have since earned massive profits by quietly selling off this XRP to the general public, in what is essentially a never-ending initial coin offering.” The lawsuit goes on to use Ripple’s attempts to bribe exchanges to list XRP as well as their conflation of XRP with RippleNet as further evidence of misleading investors and attempts to inflate the price of XRP, which is directly tied to the amount of money Ripple Labs brings in.

Since Coffey (and likely the majority of XRP investors) purchased the tokens with reasonable expectations of profit, and Ripple Labs itself marketed XRP as a promising investment, then XRP is indeed a security to the eyes of the SEC.

If Coffey’s lawsuit succeeds, this is a serious blow to the crypto industry. Not only does it beg the question of how many cryptocurrencies are actually securities, but it also means that every exchange that listed XRP is in trouble unless they are an exchange registered with the SEC or a broker dealer using an ATS. Hint: that is zero of the exchanges that list XRP.

As the clamor for regulation grows, this lawsuit could very well be the tipping point that changes the name of the game for crypto and cleans the house of unregistered exchanges. If the third largest coin isn’t safe, then no one down the list is.