Over the past month, Ripple Labs Inc. has been beset by legal difficulties stemming from its sale of XRP—a digital asset or crypto token. In late December, the Securities and Exchange Commission filed an enforcement action alleging that XRP is a security and that Ripple and its principals had sold nearly $1.4 billion worth of XRP in unregistered securities sales since 2013.
Based on the SEC’s finding, one of Ripple’s investors—Tetragon Financial Group Ltd.—filed a suit in Delaware Chancery Court seeking to compel Ripple to redeem $175 million of Ripple stock that Tetragon purchased last year. Over Ripple’s objection, the Delaware Court issued a preliminary injunction requiring Ripple to maintain its current holdings of XRP and prohibiting Ripple from redeeming any other stock before Tetragon’s.
In the meantime, cryptocurrency exchanges have suspended trading of XRP, and class actions against Ripple and those exchanges have been filed in California and Florida. Though still in their infancy, these cases illustrate the challenges facing blockchain companies that sell digital tokens.
Blockchain companies wishing to sell tokens without registering them as securities and making the required disclosures need to candidly evaluate whether they can successfully sell their tokens without engaging in promotional conduct akin to Ripple’s, and must be aware of the challenges of creating so-called “utility tokens.”
The SEC’s allegations illustrate the factors likely to render a digital token a security.
SEC Says XRP Is a Security Under Howey
The primary dispute between the SEC and Ripple is whether the XRP token is a