A primary attraction of decentralized cryptocurrencies is that they’re censorship-resistant. The more centralized a coin is, the easier it is for its supply to be controlled. But there’s another problem with overly-centralized cryptocurrencies such as ripple: they risk being classified as a security, which brings all kinds of problems.
How Centralized Must a Cryptocurrency Be Before It Becomes a Security?
Ripple has long been criticized for its centralization. These concerns have revolved around the degree to which Ripple, or its partner exchanges – aka Ripple Gateways – have the power to freeze and reverse transactions. Ripple’s greatest centralization problem may owe less to the way its nodes operate, however, and more to the amount of coins held by the company. Given that Ripple owns the majority of all XRP, the argument goes, anyone buying the coin is essentially buying shares in the company.
Many cryptocurrencies are the product of an incorporated company, but these companies don’t generally hold the bulk of the supply. For months, Ripple was regarded as a stick-on to become the next coin listed by Coinbase. But as news.Bitcoin.com recently reported, “Ripple may not qualify because Coinbase decrees it essential that “the ownership stake retained by the team is a minority stake””. This week, it emerged that Ripple had tried to buy its way onto Coinbase and GDAX, only for its $1 million sweetener to be rebuffed by the U.S. exchanges. There’s a certain irony in a centralized exchange not wanting to accept a coin because it’s too centralized.
Exchanges Don’t Want Securities
On Thursday, Binance moved fast to delist centra after the coin’s founders were arrested and the SEC’s investigation into possible security fraud cranked up. Cryptocurrency exchanges don’t want security tokens: they’re a regulatory headache, and exchanges such as Bittrex have already delisted tokens that could be deemed securities. Following its acquisition by Circle, Poloniex is believed to be following suit. If ripple was to be classified as a security, its sale would be subject to much more stringent regulations in the U.S., making it more akin to a stock than a cryptocurrency.
2018 has been billed by some in the crypto space as the year of the security token, but these tokens will be traded on specialist exchanges that are licensed to sell them, and to accredited investors. Cryptocurrency exchanges have enough regulatory issues to deal with as it is, what with the threat of banking facilities being withdrawn at short notice, without having to worry about the SEC breathing down their necks.
Ripple Has Its Feathers Ruffled
Over the last couple of days, several commenters have crafted scathing critiques of ripple, averring that the cryptocurrency is swimming in security seas. “XRP is a security. Ripple Co is the issuer. Brad Garlinghouse, Chris Larsen, and other Ripple Co executives are subject to the anti-fraud laws under SEC jurisdiction,” opinedLawson Baker, adding “A supposed decentralized cryptocurrency can be a security with enough centralization.” Baker also claims to have assessed ripple using Coinbase’s own listing criteria, and found that there’s a 50% chance of the token being categorized as a security.
Lawson Baker continues: “XRP is definitely not decentralized. Ripple Co creates the common enterprise. Ripple Co initially distributed all of XRP for money. This is the “investment of money” element of Howey Test. Ripple Co and founders control more than ~60% of the XRP in existence. Control is general 10% of voting power in traditional finance. Ripple Co even controls the inflation / dilution rate of XRP”. He finishes: “Security analysis is a spectrum. XRP is the blinding security white light.’”
Ripple Critics Pile In
In a blogpost on April 5, Messari founder and prominent crypto voice “Twobitidiot” joined in, writing: “crypto companies tend to want things both ways. Act like a securities offerer when it’s convenient from a capital formation perspective or when you’re doling out “founders’ rewards”. Pretend you’re actually selling a currency or commodity when it becomes markedly less convenient from an investor disclosures standpoint.” He then went on to ask a series of questions such as “Why does the company write about XRP price appreciation as if it’s a milestone? Why do they do little to tamp down speculation around XRP enterprise adoption?” No, why do they actively insinuate big news is coming by writing things like “XRP markets began to connect the dots once again?”
XRP is by no means the only cryptocurrency that could be construed as a security, but it’s the most high profile, and its knockback by Coinbase has shed new light on Ripple’s business practises. If other crypto projects could spare $1 million cash and $100 million in tokens for a Coinbase listing, many would behave in exactly the same manner. As it is, only a handful of players including Ripple, with the billions of tokens at its disposal, is in a position to make such an offer. Centralized cryptocurrencies aren’t crypto and they aren’t currency either – they’re company stock.