I recently sat down with Harris Bricken Attorney and web3 legal expert, Jonathan Bench, for a discussion about the controversial SEC V Ripple case. (This interview has been abridged for the ease of the readers) .Read on!
It's good to once again sit down with you for a discussion about cryptocurrency and other related matters affecting the industry. I would like you to tell us about the background story of the SEC V Ripple case.
I have been in the crypto space for a couple of years now. I came as an international transactions lawyer kind of understanding where things are coming from. So my my perspective is pretty broad. This decision on Ripple is what everyone had been waiting for a long time. Ever since I have been paying attention to the industry very closely, I've been waiting to see, you know, how the kind of attack the SEC would take against Ripple and what the court would agree to. And you got to keep in mind that this is a low-level court decision.
There's still a Court of Appeals, Second Circuit, and this covers all of the financial headquarters, but what we think in the US so very significant in terms of the geography of the decision. And there's also a lot a long way to go from here.
So the background is simple. For those of you that don't know a lot about it or at least have been following it kind of tangentially like I was from the early days, it's a pretty typical scenario where we have founders who took the Bitcoin code, wanted to improve it and kind of replace Bitcoin and make it more functional.
So they developed, they developed the token, they have a smart contract Ledger and they kept about 20% of the minted tokens for themselves and then contributed that 80% of the remaining tokens to Ripple Labs entity to develop software to help manage the international payment transactions. It's pretty typical from what I'm seeing in the crypto space.
A lot of companies have been issuing tokens that compete with Bitcoin in some way and there's really not a lot of functionality.
You know that's kind of where we're sitting in terms of understanding where this case sits in the precedent and this is a very early project, right? They started doing this around 2012. So in terms of the US legal system, ten years is a long time for a project to be out running before getting any kind of legal action against, and of course it's taking a couple of years for the court to really come down with this decision.
We have a free-floating token competing with Bitcoin and a lot of adoption. The market cap for XRP's is fairly insane in terms of overall value. So that's kind of where I'm seeing this in terms of where it fits in the industry.
https://youtu.be/Q-nNSG8zNT8?embedable=true
Do you consider the SEC’s action to be grandstanding or scapegoating?
I have a little bit of background on this. I have worked for a summer during law school for FINRA and FINRA is kind of the principal's office for the securities industry. So anybody with a trading license, all the firms you'll get regulated by FINRA, and FINRA has the same kind of mandate to you know their mandate is investor protection, market integrity.
And so I feel like that's the mantra that we're talking about here is how close, how close to these cases hue to that ethos of making sure the market is as clear and open as possible, that investors are protected, know what they're getting into.
And I feel like there is some overreaching by the SEC in terms of not being willing to engage very deeply and looking at tokens beyond those tokens that are trying to act as pure currencies. So like I said here with XRP, it seems to be very much focused on cryptocurrency. So from my perspective, the way that the SEC came down, the way the court decided this, I felt like it was fairly consistent with my understanding of how I thought it would come down where we are just dealing with something that looks like a traditional currency.
You know, a lot of projects between then and now have tried to add a lot more functionality. We have a lot more utility tokens. We have things that could be classified as security tokens, but there are a lot more complicated than traditional security tokens we have. We have this 4th prong of the Howie test where it's really interesting.
You know this case is fairly consistent with the way I've been advising my clients and others who I have been talking to along the way. This looks and feels like security to a large degree to me. And of course, the court didn't get to all of the nuances that we want. The court’s holding is limited to the actual facts of the case and so if you read the footnotes you'll see kind of read them as I did and feel a little unsatisfied because we want the court to give us opinions on them.
How Has XRP as a cryptocurrency failed the Howey Test?
The Howie test is an old Supreme Court case that looks at what an investment contract is.
That's kind of standard in the US parlance when we're talking about securities. When we're talking about investment contracts traditionally, they kind of get pushed together. And so we have 4 prongs.
It has to be an investment of money or other consideration in a common enterprise with the expectation of profits derived solely from the efforts of others.
So typically I look at the fourth prong. What is being done in terms of the effort?
If I give you a pile of money or crypto and you have a project that seems pretty clear I'm relying on you to do all of the work. The difference in the decentralized world is we have protocols that allow input in all kinds of different ways and so we don't have that guidance yet in terms of where the lines were and how much effort. You know is it a 50-50 effort.
If I'm doing less than 5% of the overall effort for the organization or the project, does that mean that I'm primarily relying on someone else's efforts or how much do I have to contribute?
So I think about this in the context of DAO, especially because DAOs have 1000 members but everyone votes on every decision through the smart contract protocol. To me, that looks like everyone's participating. You know there are a lot of traditional companies where people will just have passive investor seed or a board observer seat, maybe they won't even vote or they will have a voting interest on the board and it's a shareholder going to have a vote anyway.
So there are a lot of different nuances for this and so I think. Is it a great illustration for when this digital world that we're in and we're building an intersection of in a very bad way, very unsatisfying way with legal precedent that's been around for decades.
Utah has done a great job and Rob Lam is a close friend of mine and mentor in this space.
Yeah, and he was instrumental. I could see his hands in in the Utah DAO legislation that was passed earlier this year and will go into effect on January 1, 2024. So I see that as some of the most forward-looking legislation that I've read across the world.
A lot of the current virtual asset service provider regimes for instance in the Caymans. They provide the framework and kind of general guidance. But I see the Utah DAO Act is really diving deep into the issues that matter. You can tell that the group that was put together by the Utah Blockchain Coalition helped advise the legislators on this Utah DAO Act. You can tell that they put a lot of thought into not just what the lawyers thought was important, but what the industry thinks is important.
And practitioners of DAOs who have these issues are addressing a lot of issues wrapped around a DAO manager.
And I feel like if the SEC and courts are looking for a model to address this new 4th prom, how does this new technology enable interaction with the 4th prong of the Howie test?
Absolutely,it's a great model. I don't think it's going to be a cure-all because I'm sure there are things that were missed in Utah DAO Act but I think it's much more forward-looking than any of the other legislation that I've seen in terms of addressing how much do the efforts of others matter and how big is the group of people that can be involved from a foundational stage of an enterprise. Because typically that's where the line is.
You have a big difference between a founding team and then those who are added later as investors. So if you have a situation in doubt where you can marry those and have the founding team expanded to include 1000 to 2000 or 5000 people, what does that mean in terms of the capital they're putting at risk in the venture and putting it to the war chest of the DAO or whatever the project is going to be. So it may have to do with the timing.
You know how early people get involved and maybe does will have to cut off after a certain period of time and say this DAO is now closed because everyone who is in at the early stage is considered a founder and everyone who comes in later is not. They're going to be considered investors and they're going to blow the project apart in terms of what a security is.
So it doesn't mean the secondary trading could be limited significantly in those kinds of projects, but those that are planned from the beginning. I think could really have some legs to stand on. We're projecting out years now in terms of where the SEC and how the SEC would look at this and whether the courts would agree. But I think that it's more the creative way of looking at this and trying to decide how much capital can people put at risk safely.
What, in your view, do you think is the right approach when it comes to in terms of regulating the crypto industry in the United States? Do you think that revelation by enforcement action is the way to go?
It has done a lot of harm to the US industry. I don't think the SEC cares at this point about the crypto industry. You know it does not see it as a viable industry. I don't think that they've shown that it is a priority. I think they see it as a kind of stepchild of the greater securities industry.
I have been in the industry for a couple of years now focused very heavily on the blockchain space and I've seen a lot of inquiries move from well maybe Wyoming DAO or a Delaware DAO using Delaware LLC code. We really need to look more seriously at offshore projects. And I say that it's accelerated over the last 12-18 months.
Initially, you know a couple of years ago, everyone wanted to be in the US: they were looking at perhaps Colorado,UH Collective or Wyoming DAO and I'm getting those increased less frequently where even US-based projects are looking at saying we know that we will be subject to US jurisdiction in some degree want as much as possible to be outside of the US.
That's been challenging for me in a good way I think because I've had to digest Singapore, Switzerland came in BI you know offshore jurisdictions that are that and I like to look at jurisdictions that are very forward thinking; those that are very technology-friendly and not those that are just kind of agnostic.
Take Panama, for instance, where they don't apparently care about what's going on in the space and there are projects that flock to those kinds of jurisdictions. But I'm of the mind that projects that set up in jurisdictions that have a clear vast regime where they can point to and say we've we followed the regulations as far as we can and a lot of those vast regulatory guide, you know those guidelines are very clear or, at least, very well thought out
And so I think the projects that are based in those jurisdictions will have a much better time interacting with the SEC than those that tried to go to jurisdictions where there is literally no governance at all. And they're just probably projecting up based on what they think will fly under the radar in those areas.