The blockchain industry and various crypto-communities, especially those related to crypto-assets that had come under scrutiny by the U.S. Securities and Exchange Commission (SEC) as deemed irregular #securities, enthusiastically welcomed the order of July 13, 2023, from the U.S. District Court for the Southern District of New York in the case SEC vs. Ripple Labs et al. In reality, the effects of this order for investors, exchanges, and the market, in general, differ from those it may have for token issuers, as will be discussed shortly. The decision is relevant in Europe as well since the #SEC considers its jurisdiction based on the fact that validation nodes, for example, of #Ethereum (the main blockchain on which tokens are usually issued), are primarily located in the United States. Thus, it deems that transactions between parties unrelated to the United States actually occur in the U.S. (complaint at 69, SEC vs. Balina). Moreover, the qualification as a security under the U.S. federal law may also have implications in European legal systems due to the typical mechanisms of private international law, even before the entry into application of the #MiCA regulation (just these days the public consultation for the issuance of the first implementation package is underway). The Court ruled on three different types of #XRP distribution by #Ripple: The SEC's contention was that all three of these distributions constituted an investment contract, which is a type of #security. The Court sided with the SEC only concerning the first type of sale. The Court's primary assertion is that a digital token itself is not an investment contract, but it can be the subject of an investment contract, like any other asset. According to well-established legal precedents, the configuration of an investment contract is based on three criteria (known as the #Howey test, partially modified by subsequent judgments): a person (1) invests money (2) in a common enterprise, and (3) expects profits primarily from the efforts of others. The Court found that Ripple's direct sale of XRP constituted an investment contract and thus a security, meeting all three of the aforementioned criteria. The common enterprise exists because the funds flowed together into Ripple's coffers to promote and increase the value of XRP for the benefit of all buyers, who received the same fungible crypto-asset. The requirement of efforts of others is also met, as Ripple conducted a marketing campaign linking the value growth of XRP to its development efforts. Moreover, the restrictions imposed on buyers are incompatible with a direct usage purpose. On the contrary, the Court ruled that the sale of crypto-assets by Ripple on exchanges, where buyers do not know the seller, does not constitute an investment contract. In such cases, at least the third requirement of the Howey test, i.e., the expectation of profits derived from the efforts of others, is lacking. This determination should be based not on the motivations of each individual buyer but on the promises and offerings made to investors, which are absent in exchange sales as the buyer is not acquainted with the seller's identity. The distribution of XRP as payment for rendered services is not an investment contract because it lacks the first requirement of investing money. By distinguishing between direct sales and sales through exchanges, the order refutes the SEC's position, expressed recently in the action taken against #Coinbase, and potentially has a broader scope than the Ripple case. The Court's reasoning regarding the absence of the third Howey test requirement is likely extendable to any crypto-asset because it is based on the lack of knowledge of sellers by buyers on exchanges. Probably, in this type of exchange, where, as in the vast majority of cases, exchange sellers are different from the issuer, the second requirement is also missing because there is no pooling of buyers' funds, which are instead distributed in a fragmented manner to each individual seller. This is excellent news for the free market of crypto-assets, but it leaves token issuers in a nuanced position. Private sales of tokens have long been one of the preferred financing tools for blockchain start-ups, which believed that restricting sales to institutional entities would shield them from SEC disputes. Based on this decision, it is almost the opposite. All token sales in which buyers are reasonably aware that their money will flow into the issuer's coffers, which will use it for a series of actions aimed at increasing the token's value, could be subject to regulation as securities. However, there should be no generalized exemption for all sales passing through an exchange: the reason for exemption, in the commented decision, is still the lack of knowledge of the sellers' identity by buyers. For example, so-called Initial Exchange Offers (#IEO), if advertised as such, could fall under the notion of an investment contract and thus security. If, on the other hand, they occur as if they were sales on the secondary market, without mention of the seller, they might fall under the same category as the second type of Ripple case sales and thus be exempt. The boundary might be thin, but the decisive factor should remain, according to the commented decision, the presence or absence of “promises and offers”. The situation might be different when it comes to non-fungible token (#NFT) placements: the fact that each buyer receives a token with distinct characteristics could determine a weaker link between buyers' fortunes and thus less horizontal commonality (the Court did not intend to resolve the issue of whether vertical commonality is relevant to the Howey test). Also, in certain types of NFTs (e.g., virtual land for professional use), the purpose of use might prevail over the investment purpose, and therefore the third Howey test requirement of expecting profits primarily from the efforts of others might be lacking. In conclusion, the commented decision, while certainly positive for communities and exchanges, does not at all provide a generalized "green light" for everything passing through these latter, especially if it comes directly from the token issuer. Furthermore, it is essential to remember that the decision under review could be overturned in a potential appeal judgment. The Order can be downloaded
here